Roger J Kerr doesn't see the 'geo-political risk' inspired reversal of interest rates continuing for long, but says the recent drop has provided an opportunity

By Roger J Kerr

The “global geo-political risk” inspired reversal of US Treasury Bond yields from above 2.50% to the current 2.25% provides a short-term golden opportunity for borrowers and investors alike to re-position themselves for the future.

If you believe that the Syrian and North Korean tensions will escalate further from here into more severe outright conflict involving the US, China and Russian you will not follow the recommended strategy for borrowers to lengthen their portfolio duration and investors to shorten theirs from the current market window of opportunity.

If you, however, believe that no-one has ever solved the conflict and tension inherent in Middle East and the Korean peninsula, thus the current geo-political risks in the markets will reduce in intensity, then the current “safe-haven” investors flows will not continue and soon reverse.

Currently it is a standoff between geo-political worries sending long term interest rates lower and economic conditions and trends in the US that fully justify higher short-term and long-term interest rates.

Pretty soon the financial and investment markets will realise that the underlying economics will win out, as everyone has far too much to lose if the current geo-political tensions escalate.

The US economy continues to truck on, producing the inevitable inflation increases as resources tighten up.

Energy prices are no longer falling and wages rates are increasing.

The Chinese Government and their sovereign wealth funds who have their funds invested in US Treasury Bonds will be eyeing the opportunity of this safe haven induced rally down in yields to offload bonds at a better price (lower yields) than they would have expected a few months back.

One interesting aspect on the outlook for US interest rates is the massive kick up US inflation would experience if “the Donald” gets his way with his promised policies on import tariffs and a weaker US dollar exchange rate.

He wants to reduce the US’s external trade deficit by making imports more expensive and locally manufactured goods more competitive.

However, a double whammy of a weaker US dollar exchange rate and border taxes would send inflation sharply higher.

The end result is the Fed pushing up interest rates faster than what the economy can handle and GDP growth stalling.

Stagflation and job losses is not what Trump voters signed up for. However, that is precisely what would happen if Trump implements the weaker dollar and import tariffs together. The reality is that it is more likely he will be forced to back-track on both policy pledges.

The global forex markets are now almost completely ignoring (as they should!) the Trump tweets on the dollar’s value.

Market pricing of the timing of when short-term interest rates increase in New Zealand next year may well receive an early indicator this Thursday with the release of the CPI inflation rate for the March quarter.

A quarterly increase well above the +0.7% consensus forecasts would have annual inflation above 2.00% much earlier than the RBNZ anticipated.

Much depends on whether food and fuel prices will reverse back down over the remaining quarters of 2017.

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Roger J Kerr contracts to PwC in the treasury advisory area. 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

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1 Comments

The US economy continues to truck on, producing the inevitable inflation increases as resources tighten up.

Energy prices are no longer falling and wages rates are increasing.

Hmmmmm...

The euphoria peaked with February inflation statistics, the month of comparison to the absolute trough in oil prices. The CPI registered 2.74% while the PCE Deflator finally for the first time in almost five years reached the Fed’s inflation target. But these are only to be very short stays, for this burst of inflation is the only thing that will prove to be “transitory” and therefore another embarrassment for the $4.5 trillion Federal Reserve. It is oil prices not LSAP’s that gave the media this island of reprieve and it is oil prices that are already taking it away.

The CPI for March dropped back to 2.38% as the base effect from WTI scaled back. The average gain last month for the benchmark oil price was 33% compared with 77% in February. The energy component of the CPI rose 10.9% last month but 15.6% the month before.

Stripping out food and energy, the so-called core index rose just 2% in March year-over-year, the smallest increase since November 2015. That indicates, like everything from GDP to retail sales, very little momentum in money and therefore economy in the US (or anywhere else) aside from the oil comparison (meaning that even oil prices exhibit no more momentum).

The only part of the CPI report where prices have increased at a robust rate is the very place where price inflation is the most economically damaging. The rental component of the index rose by more than 4% for the eleventh straight month, making seventeen out of the last nineteen (with the other two just barely less than 4%). With wages nominally rising by about 2% on average, this disparity continues to press consumers with conditions that feel very much like unending recession. Read more