Opinion: Down-rally ahead of reality?

By Roger J Kerr Short-term and long-term interest rates continue to tumble in New Zealand to (and past) record low levels. The momentum of the downward push has not abated for weeks as the global economic situation continues to deteriorate. At some point soon, maybe not that far away, the interest rate market will have overshot on the downside. Has the local market become too far ahead of itself by just marking rates substantially lower because of what is happening internationally and forgetting about whether the NZ economy might by out of synch on timing of economic/inflation/interest rate cycles? We went into recession well ahead of other economies, therefore an export-led recovery may bring us out earlier than others. I continue to see our export commodity prices as they ke determinant of where our economy and interest rates bottom. If our food export commodity prices stabilise at current levels, I can see a very good chance of the NZ economy growing positively again in the second half of 2009. Under this scenario our interest rates are today not far from the bottom and we will be back to positive GDP growth well ahead of other countries. Should the food export commodity prices continue to fall, our recession will be longer and interest rates will be lower, for longer.  Much depends on how food commodity prices behave vis-à-vis other commodities and global consumer demand. They all have to eat, but can go without the new car and plasma TV! With 10-year swaps rates dropping to 6.09% today and now within 25 basis points of 10-year NZ Government Bonds, there is a clear sign that the swaps market is ignoring a few fundamental issues. The 10-year Government Bonds are not stuck at 5.85% just because there are no price-makers in the interbank market. The additional supply coming on to the market (from larger fiscal deficits) over the next few year does limit yield reductions and buying demand. You do wonder just who the buyers of the additional NZ Government bonds will be as foreign investors reduce their holdings and local fixed interest fund managers get instructions from their pension fund clients that their bond mandates will be 100% offshore bonds in the future. It is instructive to the argument that the US 10-year Treasury Bond yields have not reduced in recent weeks. They look very stable at 3.70%. If the world was headed to a deflationary phase, these Treasury Bond yields would be pushing below 3.00%. That is not happening, so the risk of our markets overshooting on the downside continues to increase in my view.     --------------- *Roger J Kerr runs Asia Pacific Risk Management. 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