By Roger J Kerr
How the interest rate markets ultimately respond to last week’s very effective RBNZ jawboning down of the NZ dollar value may take some time to evolve.
The US interest rate markets have not yet really reacted to the prospect of the Federal Reserve being forced to lift their short-term interest rates more aggressively in 2015 as the economic growth and inflation both increase.
The foreign exchange markets have bought up the US dollar over recent weeks as they price-in well in advance rising US interest rates next year.
The US bond market has not yet followed the currency markets and the 10-year bond yields remain anchored between 2.5% and 2.6%.
Global geo-political concerns prompting safe-haven investment flows into US Treasury Bonds are (for the meantime) continuing to outweigh the prospect of stronger US economic growth and thus elevated inflation risks. Have the FX markets picked it correctly and the bond market got it wrong?
Time will tell.
However, my preference is always that currency markets price future economic changes well in advance of other financial and investment markets.
Therefore, do not be surprised to see a rapid increase in US 10-year bond yields by over 0.50% at some point over coming weeks/months.
Our three to 10 year swap rates follow the US market tick-for-tick, so our interest rate yield curve will be sharply steeper in slope when that occurs.
The US employment figures for the month of September this Friday night should be considerably stronger than the lower than expected 142,000 increases in jobs recorded for August.
The Reserve Banks of NZ are taking a calculated risk that the desired depreciation of the NZ dollar does not push the annual inflation rate above their forecast of 1.70% through 2015 and 2.00% through 2016.
The interest rate markets will be watching for any sign of higher prices on imported consumer goods as a result of the weaker NZ dollar value.
While many importers are more highly hedged than normal that should delay and mute the increases in tradable inflation, there is always a sneaking suspicion that the importers/retailers will adjust their selling prices to the lower spot NZD/USD exchange rate and pocket the FX gains as additional profits. The retail sector however may just be too competitive for that to occur.
One thing is for sure is that petrol pump prices will be moving up (the oil companies do not hedge the currency risk to any material degree) and with that freight prices in general.
One reason for the lower NZD/USD exchange rate is renewed strength of the US dollar globally. Generally commodity prices have an inverse relationship with the US dollar, so lower commodity prices should work to offset some of the inflationary impacts of a weaker NZ dollar over the next six to 12 months. However, it could be argued that oil and hard commodity prices have already decreased over recent months and further large falls from current levels are unlikely.
A stronger US dollar against its major currency pairs as measured by the USD Index reflects expectations of a stronger US economy, rising inflation and increasing US interest rates down the track.
As the chart below shows, the US bond market generally lags the fast moving currency markets, however eventually it catches up and therefore higher bond yields seem inevitable.
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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
4 Comments
The US interest rate markets have not yet really reacted to the prospect of the Federal Reserve being forced to lift their short-term interest rates more aggressively in 2015 as the economic growth and inflation both increase.
Really?
As rates fell last week, speculators in 2Y Treasury Notes added aggressively to their short positions. Positioning in 2Y Notes is now at its most short since mid-2007 (as 10Y Bond positioning surged to its most long in over a year), and if history is any guide to what happens next, rates are set to tumble. Read more
Good work SH. Robert Peston at the BBC has an item "The End of Growth in the West" at the moment too. He makes the point (and lots more) that investors are prepared to loan huge amounts to Western governments for nothing - even a small loss, just for "security" in the new Stagflation world.
At the first sign of serious finacial trouble, the US and UK will be back to Mugabe style QE like druggies to dope.
Regards, EP
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