Roger J Kerr sees interest rate yield curve steepening giving a good opportunity to fix more debt or extend the maturity on existing fixed rate debt

 By Roger J Kerr

The reasons why the NZ interest rate yield curve should steepen (short-term rates lower and long-term rates higher) over coming weeks are mounting up in my view:

1. Under the scenario that the NZ dollar Trade Weighted Index remain above 80 over the next month, the RBNZ will be forced to cancel the planned June/July 0.25% OCR increase or alternatively signal a reduction in future OCR increases as their official  inflation and GDP growth forecasts are lowered. One to three year swap interest rates will decrease as a consequence.

2. Tumbling wholemilk powder prices and a high NZD/USD exchange rate will force Fonterra to drastically reduce their 2014/2015 milksolids payout forecast to dairy farmers from the $8.65/kg payout this season. Fonterra will be delivering the forecast before the end of May and latest indications are that the payout could fall to $7.00/kg. A 20% drop in income from one year to the next for our largest industry is not insignificant for the wider economy.

3. The rally downwards in US 10-year Treasury Bond yields over recent weeks to 2.60% was due to accommodative talk from Fed boss Janet Yellen and safe-haven buying by global investors on escalation in Ukrainian risk at the time. Over coming weeks the US bond market may start to focus on potential future inflationary pressures in the US now that previous tumbling natural gas energy prices are starting to go the other way.

4. Fixed rate swaps paying demand from corporate borrowers is increasing with the flattening in the yield curve over recent months enticing said borrowers to extend the maturity dates of existing swaps with forward start swaps. The swap interest rate to fix for five years in 12 months’ time has decreased from 5.25% in January to 4.75% today. Borrowers can now fix for 10 years on a new swap at 4.80% compared to 5.25% in January. One-sided “fixed rate paying” demand in the NZ swap interest rate market always leads to sharp adjustments upwards in market swap rates.

Borrowers who are dismissing this opportunity to fix more debt or extend the maturity on existing fixed rate debt are really saying that the US economy will fall back into recession and that US inflation/interest rates will move lower from here.

The complete opposite is much more likely, therefore the opportunity should not be missed. 

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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