By Roger J Kerr
A comment from a Board director of a new client this week about NZ interest rates always following Australian interest rate movements and therefore there was no hurry to fix as Australian interest rates were going down, reminded me of the dangers of relying on market correlations always holding and therefore a “no worries” risk management approach.
The professional director in question use to head one of New Zealand’s major companies so his view needed to be taken into seriously.
However, right now the NZ and Australian economies are heading in different tangents and the divergence in direction of our two-year swap interest rates and thus rising NZD/AUD exchange rate proves the point.
The integration of the two economies and closeness of our banking and financial markets does mean there is a natural linkage between the interest rate markets.
Any correlation that may have existed has broken down over recent months as the NZ economy steams ahead on high milk and house prices, while the Aussie economy wallows in doubt and uncertainty (some of which is self-inflicted by political changes and risks).
Over recent months NZ two-year swap rates have increased from 2.60% to 3.35%, whereas Aussie two-year rates have reduced from 3.25% to 2.55%.
Concluding not to hedge NZ interest rate risk because the view is that Australian interest rates are going lower seems a dangerous strategy currently.
Normally correlated financial market variables de-linking is just the type of financial risk that needs to be proactively hedged, otherwise the diverging price action can bite you in the backside.
The first issue to recognise is that the Australian and New Zealand economies are out of synch with each other and thus the risk of divergence is high.
The RBA will cut their OCR by 0.25% tomorrow, Tuesday 6 August, however the market is already pricing in reductions of 0.70% over the next 12 months.
Once the 6 September election is out of the way, I would expect Australian economic data to start to improve as they receive the benefit of lower interest rates and the lower AUD exchange rate over recent weeks.
The prudent interest rate hedger will not only be fixing higher levels of NZD debt right now, but also starting to lift AUD interest rate hedging as well as it is always easier to hedge on the way down than to attempt hedging decisions when the market direction in interest rates is up.
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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
5 Comments
I dont understand how rates are suddenly going to rocket upwards
I do understand all the issues around the yield curve and potential inflationary pressures from loose monetary policy , but the QE policies , interest rate cuts everywhere from Australia to Brazil , South Africa and Zambia , and huge excess capacity in factories , foundries and farms , means we still have some way to go before we see and increase in aggregate demand , expansion of industrial capacity and solid GDP growth .
Until then ,why should interest rates do anything but remain pretty benign ?
Well, I suppose it could go something like this. NZD continues down against USD as USD strengthens and US interest rates firm; NZ house prices keep roaring away in parts of Auckland and Chch (as people with jobs can borrow more). The lower NZD takes away the restraint on the RBNZ from normalising interest rates.
I dont understand how rates are suddenly going to rocket upwards
I do understand all the issues around the yield curve and potential inflationary pressures from loose monetary policy , but the QE policies , interest rate cuts everywhere from Australia to Brazil , South Africa and Zambia , and huge excess capacity in factories , foundries and farms , means we still have some way to go before we see and increase in aggregate demand , expansion of industrial capacity and solid GDP growth .
Until then ,why should interest rates do anything but remain pretty benign ?
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