By Roger J Kerr
Short-term swap interest rates (two and three years) have returned to their record low levels of 2.70% and 2.90% respectively following the threat from Governor Bollard last week that he would cut rates unless the NZ dollar came down.
The Governor is absolutely correct to single-out the currency as the critical determinant of future interest rate direction, however there is no point in threatening monetary policy changes unless you are prepared to follow through and actually do it.
In not selling the Kiwi dollar lower after the RBNZ jawboning, the forex markets clearly do not believe that the Governor will follow through on his threats.
It is a high risk strategy for Bollard as even if he did cut the OCR there is no guarantee the NZ dollar would be sold down.
Some pundits correctly argue that even lower interest rates would be highly stimulatory to the domestic economy, ensuring stronger growth, higher inflation and a need to increase official interest rates later.
There are just too many other more important key drivers of the NZD/USD exchange rate value than NZ official interest rate levels.
The OCR has been at record lows of 2.5% for three years now and the NZ dollar has generally appreciated over that time, so interest rate differentials are not seen as very important anymore for NZD exchange rate direction.
Global factors should push the NZD lower over coming months (stronger USD, weaker US share markets, weaker AUD, lower commodity prices and slower Chinese economic data) and when that happens one would expect the two and three year swap interest rates to go no lower and start to increase.
Confidence by the banks that our official interest rates will stay lower for longer is confirmed by Kiwibank offering 4.99% for one-year fixed rate mortgage lending rates. It appears to be a classic “loss-leader” to get borrowers to switch their business to Kiwibank in a period when the housing market is picking up. Kiwibank’s lending margins will be squeezed if the NZD/USD exchange rate starts to reel off and travel towards 0.7700/0.7800.
Because 75% of home mortgage borrowers are now on floating rate, Governor Bollard (or his successor after September) can probably afford to be late in lifting the OCR, as he knows there will be more potency and impact on the economy when he finally does increase rates.
However, corporate borrowers should not be complacent about this timing as the market-driven swap rates will be increasing well before the belated RBNZ response as the swaps market will be correctly anticipating and pricing-in a mad rush of mortgage fixing away from the floating risk.
Yet again, borrowers should be using this current window of opportunity to extend the maturity dates of existing fixed rate swaps or entering forward start swaps off current market rates. Once the NZ dollar starts to fall the swap rates will be moving up rapidly.
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* Roger J Kerr runs Asia Pacific Risk Management. 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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