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Moneymarkets look ahead and see worries

Moneymarkets look ahead and see worries

By Roger J Kerr

Local borrowers and investors alike are well advised to keep their eye firmly on market movements in the one to three year wholesale swap interest rates as lead-indicators of what kind of increases they can expect in 90-day rates over coming years.

The pricing of the one to three year swap rates are very much a reflection on future expectations for GDP growth and inflation and the likely RBNZ monetary policy response.

Over the last two weeks as global investment and commodity markets have taken the opportunity of lower prices caused by the Japanese earthquake, the local moneymarkets have pushed the three year swap interest rates back up to early March levels, that is, before the OCR cut (see chart below).

The trend back up suggests that the moneymarkets over-reacted to the 'special' OCR cut on 10 March and have taken on board some of the positive economic news since.

January and February export figures were very positive in terms of agriculture production after disappointing numbers in the September and December 2010 quarters.

Bank economists have suddenly woken up to the inflation threats around the place with price increases occurring across the board, as we alluded to two weeks ago in this commentary.

The second half of 2011 is going to be a very challenging time for the RBNZ as they debate the timing of interest rate increases and the impact on the economy. It is an academic exercise; however had the Christchurch earthquake not happened, I would suggest that the bank economists would have been by now bringing forward the timing of the first OCR increase in 2011 to the June date we were originally sticking with.

The whole timing is now all pushed back six months due to the earthquake, but the extent and speed of the upward movement in short-term interest rates later this year and early next will still surprise many.

Three year swap rates may be 3.85% today; my view is that they will be above 4.85% in nine months time.

Interestingly, there was no reaction by the short-term interest rate markets to the massive fall in business confidence last week. It was expected and of course no surprise. The NZIER Quarterly Survey of Business Opinion (“QSBO”) will also record a humongous decline in business confidence.

However, I would not read too much into the negativity as NZIER (inexplicably!) exclude the dominant and booming agriculture sector from their survey.

Expect business confidence to bounce back up over coming months.

Government fiscal deficit figures out today will also reinforce the upward trend in our long-term bond yields. Finance Minister Bill English has a major task to keep Standard & Poor’s happy come the budget announcement in a month’s time.

Long-term interest rates are only going one way from here (up), particularly if the NZ sovereign credit rating is downgraded.

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 * 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

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