Opinion: Investor demand driving interest rates lower

The rapid fall in three to ten year wholesale swap interest rates to 7.00% is telling you where 90-day rates are headed. Another fairly reliable lead-indicator for 90-day interest rates is the spread (or margin) between 10-year NZ Government Bonds and 10-year swap interest rates. They also point to sub-7.00% 90-day interest rates within a few months. What happens in the wholesale swap interest rate markets when the sentiment turns to a very high conviction of a change away from tight monetary policy to more neutral settings, is that offshore investment banks, local bank traders and hedge funds enter “spread trades” between Government risk and bank risk (swaps). This one-way and strong investor demand drives the 10-year swap spread sharply down with no borrowers (yet!) “paying the fixed rate” on the other side of the swaps market to counter the investor buying. Joining in on the action are the local wholesale fund managers (institutional investors) who are seeking additional added-value, “alpha” returns over their fixed interest portfolio benchmarks for their pension fund clients. There has been a dramatic reduction in the 10-year swap spread from 1.50% in March to just 0.75% today. This swap spread decrease has occurred at a time when the layman would have expected bank credit risk to increase vis-à-vis Government risk as the Australasian banks come under share-price, credit rating and profitability pressures. Individual banks may have their own funding issues and are paying up large in terms of credit spreads for term borrowings, but the weight of money being attracted to the NZ swaps market in expectation to lower rates yet is outweighing those specific credit concerns. *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.