By Roger J Kerr
It is a big week for the long-end of the interest rate curve with the US Federal Reserve confirming the quantum and timing of the tapering of monetary stimulus.
US and NZ long term bond yield have already increased substantially since May when Ben Bernanke first signalled the Fed’s intentions to progressively unwind their monetary stimulus.
Having raced up to 3.0% from 1.5% over the last four months, it is significant that US 10-year Treasury Bond yields have not really pulled back too much from 3.0% over recent weeks.
Generally, US economic data has been mixed with employment and retail sales increases disappointing some market pundits.
If there was a real risk of the Fed totally delaying the tapering commencement then the 10-year bond yields would have rallied lower than the current 2.9%.
My hunch is that the Fed will start the tapering at US$10 billion to US$12 billion reduction per month from the current US$85 billion level.
I would see such a decision come Thursday morning as positive for the USD, negative for bonds and thus higher NZ swap rates.
It appears some in the market are anticipating a delay in the commencement of tapering altogether, I think they will be disappointed on that score.
Who will be right and who will be wrong on the tapering will only be resolved by time.
The same could be argued for Westpac’s NZ$100m to NZ$500m domestic bond issue last week. The offer of a fixed interest return of 5.55% (103 basis points over 5-year swap rates) was too much for retail and wholesale investors and they rushed the highest yield they have seen for a while.
So, Westpac is very happy to have raised NZ$800 million, however investors may be kicking themselves in six to 1 2 months time when they realise that they could be investing for five years by anything up to 1.00% above the 5.55% they have just locked into.
In other words, the increase in long-term interest rates is far from over.
Perhaps you cannot blame the investors for swamping the Westpac offer after barely living off 3.0% to 4.0% bank deposit rates over the last four years.
Future interest rate market rise with bond yields moving even higher from here has obviously not come into their reckoning too much.
Borrowers who have not taken advantage of the opportunities of the super low market interest rates over the four year period to May 2013 to fix their interest rates long term cannot expect any respite or pull-back in rates from here.
The horse has well and truly bolted !
Those borrowers who have maintained a heavy reliance on the very low floating interest rates over recent years have experienced a very sharp lesson in interest rate risk management.
The lesson is that the US bond market drives our wholesale swap rates from three years on, thus the risk is not about when and how fast the New Zealand OCR will increase, it is all about future movements in term interest rates.
-----------------------------------------------------------
To subscribe to our daily Currency Rate Sheet email, enter your email address here.
No chart with that title exists.
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
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.