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David Chaston summarises how the recent run-up in longer-term wholesale interest rates is affecting the cost of money, and for who. He also shows how the FLP is distorting these market moves

David Chaston summarises how the recent run-up in longer-term wholesale interest rates is affecting the cost of money, and for who. He also shows how the FLP is distorting these market moves

By David Chaston

Much has been said elsewhere about the remarkable improvement in our economic fortunes in the past three months.

This short article summarises how benchmark interest rates have behaved in that time.

At the November Reserve Bank (RBNZ) Monetary Policy Statement, no new programmes were announced except the Funding for Lending Programme (FLP).

$28 billion was assigned by the RBNZ for trading banks, at the Official Cash Rate of 0.25%, to ensure money was available for borrowers at low interest rates.

Since then only $1.14 bln has been drawn, by three banks. Only The Co-operative Bank has been transparent about their $40 mln. The other two are trying to hide their involvement.

But the central point is that so far, very little of this money has been drawn, on its own, certainly not enough to make a difference in lending activity.

But household borrowers are in fact lining up to borrow, especially for higher priced houses. The asset-price bubble is expanding fast, especially for housing.

And savers have seen the returns on their deposits at banks collapse. The one thing the FLP did do was speed up the retreat from term deposits.

Term deposit interest rate offers have been falling sharply since March 2020 (the trend got started in March 2019, but gathered speed as the pandemic took hold). These rates have moved down in the past three months, but that hasn't been the main effect. The main effect is that term deposit savers have given up on that savings tool and just rolled their investment over into non-interest earning current accounts. But they didn't take the money out of the banking system, exactly the reverse. This effectively converted the funding for banks to zero interest - ironically lower than the FLP funding promise from the RBNZ.

So the main impact of the November 2020 RBNZ MPS decision has been on the psychology of savers and their willingness to tie up funds at a fixed term. On the other hand, the one thing left that the RBNZ FLP does do for banks is give 'term' certainty for their long-term lending. If they just relied only on savers, they would effectively be borrowing very short (at call) and lending long (one, two or three years for home loans). Borrow-short, lend-long is a dangerous position for any financial institution to be in. Saver behaviour has raised these danger risks for banks.

Banks can attract wholesale funding at longer fixed terms but that now comes with the higher interest rates demanded by wholesale investors. And these are rising like the benchmark rates. A proxy for these increases can be seen in swap rates. Apart from the one year rate, these are all showing new rises, and they are higher for longer durations.

Here is what is happening at the benchmark end of the market. In this case, these benchmarks are what investors offer as yield for New Zealand Government bonds on the secondary market.

As long as the FLP option is around, it is unlikely that short-term retail interest rates for either bank deposits or borrowing from banks will rise.

But these new long term benchmark yield rises are now of a scale that they will affect other parts of the economy.

Company treasurers will be watching. It may motivate some of them to bring forward bond issues before these yields rise even further.

And the Government will be looking sideways at them too. Their bonds on issue are now $140 bln and that will be growing for some time yet, even if the "new issuance" plan is being scaled back.

Every +0.1% rise in yield will cost $140 mln additional per year in interest cost, on top of the current $3.5 bln per year. That is more than twice what central government currently spends on our largest District Health Board.

Of course, the RBNZ can keep buying Government bonds on the secondary market at bids that keep the rates low for Treasury.

But from the yield track over the past 90 days, that hasn't stopped the rise in long term rates. It may have slowed them, but investors have the option of other risk-free alternatives from other sovereigns and they are rising too.

The global sovereign debt market is enormous and 'efficient' in this way - there is no way New Zealand Government bonds can avoid these trends for very long. Remember, the RBNZ buys on the secondary market; actual investors bid in primary markets. If they bid and win at say a 2% yield and the RBNZ stands in the secondary market to buy at a price that tries to push that down, then all the RBNZ is doing is guaranteeing a bond price gain for investors. They will take that every day, essentially free money. The RBNZ is likely to tire of doing this very quickly.

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Should be interesting.


Whenever & however it might happen, bet you your bottom $, mortgage rates go up faster than those of term deposits.

So we shouldn't worry too much until the trading banks start taking big chunks of the $28b? Because until then the assumption is their funding elsewhere (retail customers) is even lower? So until then no real pressure on mortgage rates - am I reading correct? But say $20b-$25b drawn down and interest rate rises in the mail?
I am trying to understand as I have been watching swap rates rising while bank quotes to me still falling.

Obviously RBNZ is using QE to hold bond prices up and long-term yield down. Once you step into this space of controlling yields it is tough to back out. See Japan who have been doing this for years - and squishing anyone stupid enough to take a run at them.

Two points of challenge...

Firstly, I would seriously doubt that primary investors are going to challenge the Treasury / RBNZ by submitting below-price bids at auction (i.e. pushing yields up) because (a) their reserves are sat earning 0.25% so anything above that is a win, (b) they are not flush with other options, and (c) other sovereign states have shown how to handle this - e.g. the Bank of England and UK Treasury quietly reminded primary investors a few months ago that they had an unlimited ability to regulate prices and yields (i.e. play the bloody game and buy the bonds or we will come in hard).

Secondly, how do you work out that an interest rate increase will increase the amount that Govt has to pay out? There might be $140bn of bonds on issue but only about $2bn are on index-linked rates - the rest are on fixed coupon. Or have I missed something?

Ive got 1.2m rolling over next moth that is currently at 3.99%.
Im considering locking in a 5 years rate at 2.99% which will save me about 12k per year.
I asked a few months ago on a FB group but almost all the advise was to fix for 12 months? They all said lock in for 12 months and see what happens as it "could" be lower but from a risk perspective 2.99% fixed for 5 years is amazing and Ive never experienced rates that low before?
Ive also go another 1.2m rolling over in March 2022 to think about...
Ive got about 3m in lending and to me locking in for 5 years at these rates are amazing!
Im asking here as Im convinced the the facebook site I mentioned is all mortgage brokers tell people to lock in for 12 months and not being transparent that they are brokers and could have vested interests!
So Ill ask here... Lock in for 12 at 2.29% or lock in for 60 months at 2.99.

It depends. Would you rather have a guaranteed 2.99% rate for 5 years? Or lock in for 1 year at 2.29% and recognise that rates may rise when you re-fix?

Why not split it? Lock in 60% for 5 years and the remaining for one year. you save money and can still benefit from any reductions that may occur in the next 12 months. Rate rises are likely to be insignificant until March 2022 with a bit of a lead up.
I will be in the same boat (but with a 10th of you amount haha) in december. riskier for me to go for 12 months as we are likely to see rate increases next year IMO. So I am planning to split it into a 1, 3 and 5 year mortgages.
Kind of annoyed with ANZ's rates atm when compared to BNZ.
ANZ 1)2.29 2) 2.69 3)2.79 5)3.99(!!!)
BNZ 1) 2.29 2)2.59 3)2.79 5) 2.99
Would consider changing banks, depending on if it saves me money after having to give back my 3k sign up bonus.

Im already split on multiple terms and for the last few years they have been trending down at each roll-over. I can't see them going down and even if they do go down a bit more to me thats greed over risk management. The risk to me is what are rates going to be in 3 years, I don't think they will be lower than 2.99.

Have to agree with that. You have done your budget, got a satisfactory formula, stick with it. Too many turn basic planning into too much of a gamble. It should be like the old style foreign exchange contracts, get a rate, one that fits the deal, and neither crow nor cry if the rate then goes either way.

Also I guess in 3 years the upside could be 1% lower ie 1.99% but the downside could be (possibly) 5% higher ie 7.99%. Unlikely, but definitely possible. GL.

Gallo.. if you wanted to switch the new bank may well agree to pay your 3K. I have to move my TDs to a different bank every time they mature just to get the best rate.

Murph.. agree with Gallo. Chunking it up is a good way to hedge. Advised my sister to do this 18 months ago but she fixed it all for 3 years and is now counting down the days (and counting up the lost money) till the end of the fixed term.
Although after reading your post more carefully IMO because your debt is so high the safe way would be to fix at least a good part of it for 5 years unless you are receiving some pretty serious and (almost) guaranteed monthly income.

I have a lot of debt and it is all rolling into P&I in the next 2 months as I wrap projects. Time to lock down.

Every market distortion, will benefit to some & disadvantage for others. Recent attempt of Mr. Trump claimed of election rig/distortion etc. - NZ economic? distortion? .. Tui ads. Even due to lockdown the recent profit performances of many major companies are all up, some claimed subsidy, distortion...seriously? that's not kind comment.

The irony of course is for this risk averse saver, I, on principle have taken all but $200k out of bank term deposits, much of that into bond funds which initially I did well in, but now watching annualised return being destroyed. Before COVID also put some into a commercial property fund, which has all the problems associated with a new paradigm for that asset out of COVID, plus valuations will be pressured by interest rate rises for commercial coming from this yield pressure.

All while I have watched speculators make huge profits.

RBNZ stimulunacy has been an infuriating disaster for me and the prudent. And I think monetary policy - nothing to do with free markets - has been immoral.

We're with you Mark, but there don't seem to be many of us on this forum! We thought we were doing everything right in saving for retirement and maybe help our children a bit when they married and had children, but nobody seems to care about us any more as we watch our savings dwindle. We weren't able to get into the property market (apart from our own house) as husband is disabled and we didn't want to take on any mortgage debt as we neared retirement. I'm surrounded by people who have become very wealthy and are spending up large. Very frustrating and I never thought it would come to this.

Absolutely right Mark. With monetary policy the way it is around the world, being a prudent saver and not having debt is punished rather than rewarded.
The governments back stop the systems so there is no such thing as a loss any more, take what the FED is doing in America for eg, buying bonds straight from companies to keep them afloat. Literally can not fail.
As much as I hate how high house prices are, and that my friends are unlikely to be able to afford their own one anytime soon, I still play the game because I so not see the NZ housing market undergoing any fundamental changes in the next 10 years, with regard to the downward interest rate trends and govt bailing out struggling home owners.

I used to have term deposits, but now I just buy Bitcoin instead. Waaay better long term prospects with an actual positive real rate of return.
Or look at companies with Bitcoin on their balance sheet such as Microstrategy, Square or now Tesla.

Its all a popularity contest and I can not agree with your last statement more. Opt out of their system, buy Bitcoin :)
Use easy crypto if you are looking to buy, and Exodus wallet to store it. Easy as.

I totally feel for you. Fortunately I sold most of my bonds a few months ago, but I still have 3% of my savings left in bonds, which are being decimated.
I personally think that, with the inevitability of interest rates going up in the future (in NZ as well as internationally), the future for bond prices looks quite bleak to me. The only reason why I have not sold all my bonds was to keep some pretense of diversification.
Cautious savers like you should be rewarded, not punished.

Mark...I feel you. I have kept 12 years of spending money safe in TDs but it is hard to watch the irresponsible speculators making huge profits while I have significant TD funds going in reverse as a penalty for being prudent and risk averse.
All I can say is that I have learnt from poker that over the short or even medium term good decisions do not always equate to huge profits (and vice versa). However, over the long term (as the luck evens out and the sample size increases) investors who quantify risk more accurately and build their strategy on minimizing the risk of going broke will have the last laugh on the guys who go all-in blind. Even when the game is rigged and unfair the best players usually still win, it just takes longer. GL

Tony Alexander at a talk yesterday specifically addressed this and his advice was to lock in 2.99 for 5 years. Rates have never been this low, they can't get much lower due to bank margins and there is already upwards pressure building in the background suggesting upwards movement in rates could come much sooner than expected.

If unsure you could do majority on 5 years and some on 1 or 2 years.

He covered lots of interesting stuff in his discussion including all the factors impacting upwards pressure on house prices.

Top article DC, thanks