By Roger J Kerr
Wholesale term swap rates have decreased another 10 basis points over the last two weeks in something of a delayed, second-phase response to the 30 point pull-back we have witnessed in US 10-year Treasury Bond yields from 2.95% to 2.65% over the last month.
My view is that the US yields are going no lower and will drift back up again once in anticipating that the US fiscal shutdown and debt ceiling issues will be resolved.
The US jobs number for September has not yet been released yet due to the US Government shutdown.
When the figures are released, the September employment increase is expected to be above the 180,000 increase of consensus forecasts.
The focus should then quickly return to the strength of the US economic recovery and the majority of the lead-indicators still have this on a solid upward trajectory.
There does not appear to be any sustained buying interest for NZ bonds currently (note LGFA credit spreads shifting out a little) and the “receiving-fixed” interest in the swaps market is also muted.
On the other side, I observe plenty of pent-up demand brewing from both corporate borrowers and banks to “pay-fixed” in the swaps market as both large corporate and small mortgage borrowers see the risks ahead with rising market interest rates in 2014.
Amid all the recent debate about the residential property market and the impact the LVR speed limits on banks will have, the real determinants of when and by how much interest rates will increase next year come back to the old perennials of the exchange rate, inflation, capacity utilisation, GDP growth and US bond yields.
On the exchange rate question, a Kiwi dollar at 0.7500 to the USD in early 2014 would allow Graeme Wheeler to push the OCR up without gazumping the export sector, while a 0.8500 exchange rate average would keep inflation low and delay interest rate increases.
Two big issues loom on the horizon for the Kiwi dollar next year:-
· How far the USD itself strengthens on the world stage from a current USD Index level of 80.00?
· When and how international investors, traders and hedge funds factor in 'political risk' onto the NZ dollar. If the Labour/Green coalition starts to build a lead in the political opinion polls, the risk of dramatic changes to economic policy and the independence of the Reserve Bank will scare overseas players out of their NZ dollar holdings.
The exchange rate level is the wild card in the equation as capacity utilisation, GDP growth and US bond yields all look very certain of heading just one way, and that is up.
To subscribe to our daily Currency Rate Sheet email, enter your email address here.
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