Long-term rates have reached their lowest point and will rise from here

By Roger J Kerr

The “flight to quality/safe haven” in financial and investment markets over recent weeks, due to the turmoil in Europe and global share markets, has driven down US long-term interest rates. The US 10-year Treasury Bonds rallied down in yield from 4.00% to 3.25%.

I don’t see that trend continuing with their yields going below 3.20%.

Banks and fixed interest fund managers may hold more Government Bonds in their portfolios these days than before the GFC; however I would expect that most would be re-positioning to be “short” duration, rather than long i.e. a greater expectation that US bond yields move upwards from here rather than rallying lower in yield.

The lower US Treasury Bond yields are good news for the residential real estate sector in the US as current rates will allow reduction in mortgage lending interest rates. Many areas of the US economy are now clearly improving, but the household property and retail spending areas need all the help they can to round out the US economic recovery.

Also at these US long-term yields, the Asian Governments and Sovereign Wealth Funds who have been massive buyers of US bonds are more likely to be holding-off than buying more at this point.

US 10-year treasury bonds moved no lower than 3.25% (and rebounded up again) on two previous occasions over the last 12 months. It appears that this level will prove to be the bottom of the range again.

Key lead-indicators for the direction of US long-term bond yields - capacity utilisation, employment growth and ISM Index (forward factory orders) - all point to yields nearer 4.00% than 3.00%.

Once the current turmoil and turbulence in Europe settles, one can see a reasonably sized correction back upwards in US bond yields. The implications for our NZ long-term interest rates is that the rally lower in 5, 7 and 10 year swap rates seen over the last two weeks have probably run their course. I do not see 10 year swap yields going any lower than their current 5.75% level. A return to 6.00% is far more likely than further pushes lower. Likewise 5 year swaps no lower than their current 5.20%.

* 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