sign up log in
Want to go ad-free? Find out how, here.

Roger J Kerr does not see the current fall in benchmark bond yields and the rush to safety resulting in lower New Zealand interest rates nor a slowing local economy

Bonds
Roger J Kerr does not see the current fall in benchmark bond yields and the rush to safety resulting in lower New Zealand interest rates nor a slowing local economy

By Roger J Kerr

Over recent months geo-political developments, the Ebola virus threat, incredibly low inflation outcomes and other financial market events have driven a considerable number of global investors to the security and safety of US Government Treasury Bonds.

As a consequence, the weight of investor money has driven US long-term (10-year) interest rates down from 2.80% to 1.80%.

These bond investors do not seem perturbed that the US Federal Reserve are on track to increase short-term interest rates from mid-year as US economic growth, employment growth and thus (in theory) inflation increase.

The recent dramatic and unforeseen collapse in oil prices has changed the inflation outlook for the meantime and therefore has perhaps provided a sense of security for those buying and holding US Treasury bonds at 1.80%.

However as we have seen with the Swiss currency risk event last week, the direction of prices can change abruptly when you least expect it.

A rebound in oil prices may already be underway with West Texas crude now back at US$48.50/barrel after lows of US$44.50/barrel.

The rush into the safe-haven of US dollar denominated Treasury bonds over recent weeks is also explained by the carnage experienced by many investors in the Euro currency, the plunges in the Aussie dollar and Russian Rouble, the collapse of oil and commodity prices (copper) and general uncertainty as to the sustainability of global sharemarket gains/values. Add in the extreme pressure many emerging market economies are now under with the fall in oil and commodity prices and it is no wonder investors are running scared of any risk assets.

The next market fallout could well come from the US high yield bond arena where investors in the search for a yield return have lost sight of credit risk and driven these bond values to unsustainable levels.

It is reported that many of the shale oil and gas extracting companies in the US have been debt financed by high-yield hybrid and subordinated instruments, so potential for more carnage as new extraction activity comes to a shuddering halt with the oil price collapse. Shocks are also still possible from political change in Greece and Russian economic, corporate borrower and bank problems.

In the absence of any new and major risk events around the world, one would have to expect an unwinding of the “long bond” positions well before the Federal Reserve start to lift US short-term interest rates around mid-year.

The decline in US Treasury bond yields has pulled NZ 10-year bond and swap interest rates back to their record low levels of 2012 and early 2013 (3.70% for 10-year swaps).

The difference today is that the 90-day floating rates are 1% higher than they were in 2012.

Therefore, through the combination of OCR increases in NZ last year (fully justified) and much lower US long-term interest rates today the yield curve has totally flat-lined from 90-days to 10 years.

Such a yield curve shape would normally depict an economy slowing up, heading for recession and the central bank more likely to cut official interest rates than increase them.

Such a scenario is a long way from the relatively buoyant economic conditions in NZ right now.

While several interest rate market analyst and commentators are now forecasting the RBNZ to cut the OCR over the next 12 months, it is almost impossible to see this occurring for the following reasons:

• The NZ economy will not import deflation from Japan and Europe.

• Oil prices can reverse and the RBNZ “looks through” such first round inflation impacts anyway.

• The housing market has strengthened further since the general election last year and is buoyed along with even lower fixed rate mortgage interest rates and still strong migration inflows. The RBNZ is hardly likely to fuel the property market further with interest rate cuts when they are attempting to control it with macro-prudential measures through the banks on the other side!

• The current low annual inflation rate will not stay this low for too long this year (refer to last week’s comments). Ask anyone trying to secure a rental property in Auckland whether we are experiencing deflation in the economy!

 

Daily swap rates

Select chart tabs

Opening daily rate
Source: NZFMA
Opening daily rate
Source: NZFMA
Opening daily rate
Source: NZFMA
Opening daily rate
Source: NZFMA
Opening daily rate
Source: NZFMA
Opening daily rate
Source: NZFMA
Opening daily rate
Source: NZFMA

 

-----------------------------------------------------------

Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

1 Comments

As a consequence, the weight of investor money has driven US long-term (10-year) interest rates down from 2.80% to 1.80%.

These bond investors do not seem perturbed that the US Federal Reserve are on track to increase short-term interest rates from mid-year as US economic growth, employment growth and thus (in theory) inflation increase.

 

These bond investors know the shorts have to cover - which, I suggest, is part of the reason why the unexpected upward and onward price trend is unfolding. Read more

Up
0