By Roger J Kerr
The term “bouncing along the bottom” used to describe local interest rate direction since mid-2009 is in danger of being revised as a combination of forces are acting to drive term interest rates higher.
The five-year wholesale swap rate has lifted from 3.00% in December to 3.45% in the market today.
Not surprisingly, it is the one-side demand often seen in the swaps market that has caused the sudden change in direction.
Investors receiving fixed rate swaps have disappeared and borrowers paying the fixed rate are finally recognising the sentiment change and for the first time in three years are prepared to see value in fixing against rising interest rates.
The likelihood of any cut to the OCR by the RBNZ has been eliminated from market pricing as Governor Wheeler states the reality that the NZ economy is growing, house prices are increasing and capacity utilisation is also increasing.
It would only take a fall in the NZ dollar currency value to complete the full suite of risks that send inflation higher.
However, it is clear from the inferences from last week’s OCR review statement that the RBNZ will be closely examining the implementation of the macro-prudential measures on the bank lenders before raising official interest rates.
Nevertheless, the mood and sentiment in the interest rate market has changed to growing expectations of higher rates in 2013 and 2014.
The only factor possibly holding our rates down lower than where they would otherwise be is the monetary easing bias being adopted by the Reserve Bank of Australia as they recognise the damage the high AUD exchange rate is having on their economy.
Our interest rate market is influenced by changes in Australian interest rates; however it would be dangerous to assume that our interest rates cannot increase when Australia’s are declining.
It would also be dangerous to read too much into the contraction in the US economy in the December quarter causing lower Treasury bond yields. Behind the headlines it was massive reduction in defence spending and lower inventory build that caused the negative growth number.
Consumer spending, business investment and construction activity were all up strongly, as has been confirmed in the more recent US non-farm payrolls (jobs) data for the November, December and January period.
US 10-year bond yields have already increased from 1.6% to above 2.0% over the last six weeks, further increases are likely as US fund managers, pension funds and insurance companies off-load bonds, thus reducing portfolio durations and risk of marked-to-market revaluation performance losses.
During the emergency monetary stimulus period after 2009 the inverse correlation between US equities and bonds broke down. As the economy and markets normalise, the inverse correlation movement linkage should re-establish, thus bond yields higher (bond prices lower) as the Dow Jones Index increases.
We have seen periods when local NZ Government Bond yields do not follow the US 10-year Treasury bond yields, however they are few and far between. The correlation between the two markets is close and relentless.
Rising US yields is another reason why our swap interest rates can and will move higher.
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Roger J Kerr is a partner at PwC. 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