Roger J Kerr says the US bond market does not buy into Fed policy U-turn; he doesn't buy the RBNZ inflation forecast either

 By Roger J Kerr

Any expectations of a major pull-back downwards in term swap rates from the Ben Bernanke non-tapering decision last week have been effectively dashed as buying of local bonds or receiving interest in the swap market just failed to materialise.

New Zealand long-term interest rates only decreased by five basis points on the US 10-year bond yields reducing from 2.85% to below 2.70% last Thursday.

If term interest rates cannot move downwards on a major market surprise like that experienced last week, then there is not much hope of other economic or market events forcing rates lower.

The far greater risks remains to further increases, however it will need super-strong US economic numbers (jobs, retail and real estate) over coming months to convince the US Federal Reserve that tapering should commence this year.

Lead economic indicators in the US certainly point to more momentum in the economic recovery and there is no evidence that increased mortgage lending rates has dented the US economic expansion.

It was very instructive that the US bond market did not react as violently as the FX markets to Ben’s little surprise last week.

The bond market takes a much longer and considered view and seems to be telling us that this is merely a delay and not too much should be read into short-term Fed flip-flopping between market guidance/conditioning delivered in May and the opposite signalled in September.

As always, monetary policy guidance and settings will be dependent on the future data.

Anecdotal evidence suggests that the supply overhang in the US residential property markets post the GFC has all but gone now. My Kiwi architect mate in Miami who laid-off 40 of his 42 staff in 2009 is back to flat out again this year with his property developer clients back to building whole new suburbs again in the Florida swamps!

The timing and extent of OCR increases next year seem all the more dependent on the NZ dollar exchange rate level.

A higher NZD/USD rate to 0.8400 and a TWI almost 78.0 automatically lowers 2014 inflation forecasts as imported product is cheaper, not more expensive as most were expecting.

It will require the NZD/USD rate to return to below 0.8000 again rather rapidly for current RBNZ 2014 inflation forecast to be accurate.

Not too much should be read into the current steep upwardly sloping NZ interest rate yield curve from 90 days to 10 years as an accurate precursor of things to come with short-term interest rates. We continue to have two independent and separate interest rate markets driving each end of the yield curve, NZ economic/monetary outlook determining 90-day to two year swap interest rates and the US economy/bond market determining two year to 10 year swap interest rates.

The local economic doom merchants and perma-bears will be disappointed that the seemingly Fed monetary policy U-turn has not produced lower market interest rates here.

Increasing mortgage rate fixing continues to cause one-way traffic (fixed rate paying demand) in our wholesale swaps market. 

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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