Opinion: Term borrowers should make hay while the sun shines

By Roger J Kerr

With the speed and direction of short-term interest rate movements over the next 12 months pretty much set by the RBNZ as a mechanical process to remove the emergency 2.5% OCR stimulus back to 5.0%, the focus is on what longer term interest rates will do.

Not too many would have anticipated 10-year swap rates returning to 5.30% at this time, given the amount of supply of Government Bonds still to be issued over coming years by all and sundry.

The rush by global investors over recent months to the safety and security of US Treasury Bonds is way overdone in my view.

One can understand the fund manger nervousness when sharemarkets are plunging, however they will quickly become bored with 3.00% US bond returns as being insufficient to keep their investor clients happy.

With both households and now Governments running higher debt levels everywhere except Asia, my take on the demand/supply equation for Government bonds is that increased supply will swamp an increase in investor demand and drive the yields higher (bond prices lower).

The current rally down in US Treasury Bond yields has been caused by weaker US economic data following the end of the stock rebuilding phase that provided an artificial boost to both manufacturing output and investment markets from June 2009 to March this year.

The European-related market shocks back in May certainly scared investors out of equities and from taking credit risk in the fixed interest markets.

Those investors who purchased US Treasury Bonds as their safe-haven will eventually re-assess their investment strategy and are more likely to be sellers of Treasury Bonds going forward as they look for higher returns.

My viewpoint is of course predicated on the firm assumption that the global economy will not fall into a double-dip recession and will grind its way slowly back to positive growth.

Borrowers who have the capacity to fix a much larger proportion of their debt for periods from five to 10 years must be taking advantage of the current window of opportunity and locking into the attractive base swap rates from 4.75% to 5.30%.

Borrowers who are unsure of their debt forecasts and therefore are reluctant to commit to long-term swaps at this time, must do the next best strategy – buy swaptions (for the period until they have more certainty) to ensure they do not miss out on the low rates.

--------------------

 * 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