By Roger J Kerr
The international events of the last two weeks with the US Government debt palaver, S&P downgrade, wild equity market movements, global growth forecasts slashed and the US Federal Reserve pledge to keep their interest rates super low until 2013 - have all combined to make the local interest rate outlook cloudier than ever.
In fact, we appear to be looking straight into a rather bleak winter snowstorm.
Long-term, five to 10 year wholesale market swap rates have reduced sharply, however not as far as the US 10-year Treasury Bond yields which have plunged from 3.00% to 2.25% as global investors still see this biggest market in the world as the safest place to be with their money in times of market turmoil.
Our 10-year swap rates have moved down from 5.25% to 4.90%, a 0.35% reduction compared to a 0.75% drop in the US Treasury Bonds. New Zealand 10-year Government bond yields have decreased over the same time period from above 5.00% to 4.50%.
The net, net result of these movements is that our 10-year swap spreads (swaps against 10-year NZ Govt Bonds yields) have moved out from 20 basis points to 40 basis points (4.50% compared with 4.90%).
The change in the swap spread demonstrates investor preference for sovereign credit risk over bank risk.
If global financial and investment markets are still volatile in a month’s time when the RBNZ release their 15 September Monetary Policy Statement, Alan Bollard will be 'on hold' with any changes to OCR monetary policy settings - not even taking back the March earthquake 0.50% OCR reduction.
The RBNZ are concerned about the global GDP growth outlook in terms of its impact on the NZ economy. As this has deteriorated since the upbeat June RBNZ MPS economic prognosis, you have to expect the September statement to be dovish and downbeat.
Such a statement will be negative for the NZ dollar at that time; however the moneymarkets have already priced-out the interest rates increases that were priced into the forward market previously.
In particular, if the NZD/USD exchange rate remains above 0.8000 over the next month or two, you have to anticipate that the RBNZ will be lowering their 2012 GDP growth and inflation forecasts. Interest rates lower for much longer is the outcome under that exchange rate scenario.
If the NZ dollar depreciates further to the mid-0.7000’s over coming weeks the RBNZ might not be so drastic with cutting their GDP growth forecast. One reason why the NZD would be in the mid-0.7000’s is further falls in our export commodity prices, which does pull economic growth down from +4.5% projections. If however, the NZD depreciates to the mid-0.7000’s entirely due to EUR/USD reductions (not commodity prices falling), the growth outlook is improved and interest rates will then be heading upwards earlier.
Never underestimate the dominant impact of the NZ dollar exchange rate on our GDP growth performance. A NZ dollar remaining in the 0.8000’s suggests GDP growth dropping away as the big export industries dominate our economy and economic fortunes. If the exporters are not expanding and investing due to a high exchange rate, economic growth goes downhill rather quickly here.
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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. This column was written before the Monday quake. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
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2 Comments
Thanks for an interesting and informative article.
It is interesting to note what appears to be a creeping distrust of the longer term future for banks. The increase in the swap spread is another indicator, it would seem.
Are we over-rating the influence of the NZD/USD rate? If we look at Aussie, Renminbi and euro, the Kiwi is not much higher than it was in md 2010. Or is that combination of history and reserve currency just too hard to break?
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