Roger J Kerr says pre-emptive interest rate action is likely to reward

By Roger J Kerr

Complacency about interest rate risk for borrowers is understandable after eight years of a very low and stable rate environment.

There have been too many false starts of interest rates increasing over this time to dissuade such borrowers out of that complacency.

The RBNZ’s current monetary policy stance to not think about lifting the OCR until actual inflation is above 2.00% (and confirmed above 2.00%) for some time also has a whiff of complacency about it.

However, given all the false starts on inflation increasing over recent years (only to fall back again for various reasons), the complacency may be defended.

Pre-emptive action is a central tenet of risk managing financial market variables such as interest rates.

Moving early with hedging action and averaging-in progressively to the desired level of fixing is always a lot easier to manage than being forced into big decisions because the market is suddenly moving against you.

The trade-off with these interest rate hedging strategies is always “how much extra interest cost am I prepared to pay today for the security and reduced volatility of interest cost in the future?”

Borrowers who have continuously extended their fixed rate swap books in term through the last five years are now starting to see the benefits of their consistent strategy as longer-term interest rates increase.

Whilst there may not be risks associated with 90-day to two-year swap interest rates increasing for the next  12 to 15 months (first OCR lift from the RBNZ mid-2019), borrowers who wait may find the term swaps rates up to 0.50% to 1.00% higher in 12 months’ time when they finally decide the risk is with them.

Paying 0.50% more over five years is not good economics against paying away 0.70% over the next 12 months (the difference between 90-day floating rates and term swap rates).

The risk that our three to 10-year swap rates suffer a “double-whammy” increase of US 10-year Treasury Bond yields moving above 3.00% and the NZ:US bond spread reversing from its eight basis point low point is a very real one indeed.

Borrowers need to be considering these risks in the separate and independent long-term interest rate market and implementing hedging strategies accordingly.

The incoming RBNZ Governor, Adrian Orr would be expected to lean towards pre-empting inflationary pressures getting out of the bag, than merely waiting for the higher inflation to arrive and then it is too late to do anything about it.

The local financial markets will be looking very closely for any slight change in wording or innuendo from the RBNZ on this aspect once the new Governor is in the chair.

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Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. 

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While I agree with Roger Kerr's sentiments , one cannot ignore the likely , and possibly unintended consequences of increasing the OCR .

Firstly , it could well strengthen the Kiwi $ ( to the detriment of our exporters) and secondly inward flows of hot money chasing yield could end up neutralizing any Reserve Bank moves to influence interest rates .

The net effect of further overseas money coming here in pursuit of yield , is that much of the money coming in ends up speculating in the market , thus distorting asset prices .

Maybe the RBNZ recognizes the world is awash with cash and accept the that the return on money is going to be low for some time yet.

Roger, why do economists continually go on about increasing interest rates?
Interest rates are going to remain at these levels for many years.
There may be the odd rise and then drop but they will remain about the same as now.
U.S.mcant afford to raise them as that will put too much pressure on the system over there

Do you make a habit of betting against Central Bank market signals?

Because its what they do, not what they say they will do that matters.
Interest rates are only going one way... check out figure 8

What about figure 8?
Interest rates seem to go both ways in that graph.

TM2 - have you ever looked at interest rates from a historical perspective? (like not just the last 10-20 years, but the last 100+..?)

Also interest rates in non-anglo-saxon countries, say Japan where the rates have been pretty much zero for 30? years.

Er, hello, interest rates are rising worldwide, this is not under the RBNZ's control:

"Moving early 8><--- because the market is suddenly moving against you"

So lets review the last 8 years, if you had hedged you would have been burnt on multiple occasions, potentially throwing thousands away.

Then lets review "suddenly" there is also its essential brother "substantially" So to get burnt you are going to have to see a sudden and substantial increase in rates and neither are very likely.

Fixed mortgage rates are lower now than 12 months ago.
Where are the predicted hikes?
Weren’t NZ & Aus supposed to get hikes last year?