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Roger J Kerr says interest rate risks are moving for more than just the geopolitical aspects; expectations of Yellen's next signals are part of it as well, he says

Roger J Kerr says interest rate risks are moving for more than just the geopolitical aspects; expectations of Yellen's next signals are part of it as well, he says

 By Roger J Kerr

Last week I opined that global geo-political events were unlikely to intensify further and thus US and NZ bond interest rates would not remain at the low levels for long and that stronger economic numbers would ultimately drive interest yields higher.

I would still expect to be correct in the medium term, however in the short term the view was 100% wrong!

Strong investor sentiment for the security and safety of US Treasury Bonds has pushed 10-year yields down another 10 basis points to 2.34%, contemporaneously lowering our 10-year swap interest rates to six-month lows of 4.65%.

The investor flight to quality and safe haven buying of bonds around the global we are seeing right now however appears to me to be more than just concerns about Gaza, the Ukraine and Iraq.

It also must partially reflects investor risk mitigation strategies against what could happen to share markets when Janet Yellen alters her rhetoric and provides the steer to the markets as to when and how US short-term interest rates will be increased by the Federal Reserve.

At these much lower interest rate levels the bond markets are essentially pricing much lower global GDP growth and inflation.

The big-picture economic outlook has not changed that much to be so negative.

Excluding the QE anomaly period of 2011/2012, US “real” interest rates (nominal interest rates minus core inflation) are at a very low point of less than 0.50% and eventually bond investors must realise that the real return is far too low for a normalised position going forward.

The other way of looking at the current situation is that Ms Yellen now has more flexibility with providing the interest rate increase signal as US 10-year Treasury Bond yields could move up 0.50% without increasing home mortgage lending interest rates in the US.

The Federal Reserve remain very conscious not to cause market or economic disruptions by their actions, the much lower bond yields give them extra wiggle room in this respect.

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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

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