Double Shot Interview: HiFX's Dan Bell reviews the week's global currencies action, including the Italian bond meltdown; He sees RBNZ cut of OCR now possible

I agree, the OCR will need to be cut. The risks of inflation or any kind of economic overheating is far far lower than a complete stall of the NZ economy.  After killing the economy with outrageously high interest rates in 2008, and now noone spending, businesses not investing, we might start addressing the slow downward spiral ....   

I dont see a way out of defaltion and debt destruction and a banking crisis. We know from overseas experience that low interest rates can create more problems than it solves.  We need to keep funding our consumption as our exports are not enougfh to satisfy, so we may find ourselves at the mercy of the bond markets and no longer in control or the illusion that we ever had control stripped away. Tuesdays fonterra auction will be interesting.

Why do I get the impression that Mr Bell has just started reading the same stuff most of us have been following for the last THREE YEARS (and why didn't he make millions in the fx market over the last 3 years!)

He cannot see that an ocr cut can cause the drop in activity to accelerate...that the problems are not costly credit but            fear and debt.

The fear comes slowly for the financially slow and that's most of the pop but they are waking up and the piigs fiasco is speeding that process. They hear Bollard and see a cut and they stop spending...they avoid the cheaper credit...they try harder to pay off debt...the whole mob moves to reduce activity even further....leading to what? ...I wonder here if Mr Bell has the answer !

Meanwhile the financially capable with savings in NZ quickly move capital out of the country....leading to what? ....another one for Mr Bell.

And oh gosh look at the govts tax revenue flow...no longer a torrent as in Labours' bubble times of 06 hell no....now it's a dribble and turning to a drippy leak. But but the welfare payments are exploding higher...AND HIGHER....whatever could be causing that...where will go to....quicky quick...cut the ocr again.....CUT THE OCR ALAN HURRY HURRY...DOH

"Crikey John...Alan's said he's going to cut again...activity is dropping off at a faster pace"

"That's good isn't it?.....I know some blokes with ears the size of footy grounds so you better whisper Bill"

"Maybe we should raise the gst again and say cut paye like last time"

"Why did we do that?"

"Cos it was Party policy John"

"oh yeah....but it was good right?"

"Err well sort of....the problem is the peasants have stopped new building and cut their renovation work by so much ....we've had Fletchers on the phone every day...."

"But they have more cash ..the lower tax..the earthquake rebuild.."

"John there is a timelag between getting an extra dollar in the hand an hour and saving the extra eight thousand in gst on a new house.....and it'll be years before any chch kickup arrives"

"Oh....won't raising gst make that worse Bill?"

"I didn't think of that"

Of more importance:

"..There is a reluctance of the mind to admit that cutting interest rates increases the burden of debt contracted in the past, because it contradicts one’s intuitive expectation that it should decrease the burden of debt to be contracted in the future. To be sure, cutting interest rates does increase the burden of debt contracted in the past because liquidation value is calculated by capitalizing the stream of future interest payments. Since at the lower rate the present value of that stream is smaller, a shortfall is created that has to be amortized upon liquidation."  -  Antal E. Fekete 

There are those that will scoff at such insouciance, nevertheless, one has only look at the level of outstanding interest rate swaps contracts (USD 150 trillion) assigned to the five largest US banks to come to an understanding of the enormity of the problem.

For every dollar of these IR swaps there is a counterparty payer of fixed interest for a fixed tenor. The minute interest rates fall the present value of the fixed payments increases relative to the new value. 

Businesses, local bodies, whoever, have to wear the relatively higher funding costs for the contracted period beyond the rate cut. This causes costs to rise on a relative basis compared to those not so encumbered. Bankruptcy and illiquidity are common symptoms.     

The penalties to break these contracts under ISDA agreements are unusually harsh as the likes of a bankrupt Jefferson County found out to it's cost. History is littered with more casualties.

The nominal size of the interest rate swap market in New Zealand remains elusive, even to the RBNZ - but one can surmise the recent tenor additions to broker quotes indicates it is active. And while there are few public instances of IR swap related financial failure in New Zealand you can be sure our banks are on the receiving end of the fixed side and benefit hugely every time rates fall.   

Great insights Stephen....  

@ Steven

Philisophical bias aside the mathematical outcomes in terms of greater NPVs of interest rate swaps after an interest cut are irrefutible. Not much deflation for the receiver of the fixed leg of the swap but agonising deflationary costs for the payer.

Where on earth do you think alll these huge investment house bonuses come from?

Just a fews basis points on longer tenor IR swaps on trillions is significant - and represents money lost through costs to business meeting higher collateral calls. - which is certainly deflationary.

The linked aricle from Stephen Hulme is really interesting...  Written by Antal Feke

In fact...  it is scary reading.

What he is saying is that without the "serial cuts in interest rates" , US Treasury paper is unsaleble.

ie. US Treasury debt is a toxic asset and the only ones buying it are Speculators.

These speculators expect to reap risk-free profits when they turn around and dump the paper in the lap of the FED.

The Capital gains they make ( liquidation value of the debt) can only happen with the continual lowering of interest rates.

In simple english...I think what he is saying is that the US Govt Bond mkt is the biggest bubble of all time.....  and it truely is a Ponzi scheme.

The end result is massive deflation  OR   Hyper Inflation as the Fed monetizes the debt.

Gosh...  this is Alice in Wonderland stuff.

Stephen H...   Can u comment on my interpretation..???

Cheers  Roelof