By Roger J Kerr
Unexpected developments in the wholesale swap market last week saw interest rate yields increase across the curve.
At first blush it seemed that local borrowers were adding more long-term fixed rate hedging in volume and were pushing the market upwards.
That was a bit surprising, as it appeared that most who wanted to fix rates long-term had already done so some weeks ago.
There is also a question whether the large NZ borrowers who are tapping the US Private Placement debt market at this time are swapping back to fixed or floating rate NZD borrowing. There has not been any further USPP debt issues announced since Vector and Transpower; however several others are known to be in the pipeline.
The fixed-rate paying activity in the swaps market seems to be an offshore investment bank unwinding a trading position and once again forgetting how small and illiquid the NZ swaps market is for the amounts they are used to dealing. The fact that a large overseas trader in our interest rate market does not see rates going any lower (hence unwinding a long position) confirms my view that our term interest rates have well and truly seen their lows.
The ten-year swap rates increased from 4.90% to 5.15% last week, as the unwinding of the trading position by the investment bank in the two-year part of the curve was required to be spread across all the maturities to clear the risk through the inter-bank wholesale market.
The 10-year swaps are largely driven by the US 10-year Treasury Bond yields, which increased initially from 2.50% to 2.70% last week, however they have since returned to 2.60%. Whether the swap rates hold up at these higher levels, or return to where they came from, as always, depends on the upcoming economic data.
The most important piece of data this week is the US Federal Reserve FOMC meeting on Thursday morning. If the QE2 monetary stimulus package amount is lower and more spread over time than the USD1 trillion the bond market expects, the future Fed buying of bonds will be lower and bond yield should increase from current 2.60% levels.
In terms of domestic economic data due out this week, the labour cost and employment figures may turn out to be somewhat more positive than the gloomy RBNZ outlook on the domestic economy. Recent immigration and business confidence indicators were certainly pointing to the economy doing somewhat better than the RBNZ’s current flat projection.
The accompanying statement to the RBNZ’s “no change” OCR review last week still suggests that the RBNZ will be lifting rates when the economic outlook justifies it.
They always like to have a bet each way; however my view is that they will be forced to adjust their 2011 economic outlook to a more upbeat assessment before the end of the year. So much revolves around consumer spending activity for the RBNZ and a small opening of wallets by households around Christmas, after two years of belt tightening, appears more than likely to me.
A lower unemployment number this Thursday may encourage Joe and Josephine Public that their own job security is somewhat better than the unjustifiable gloomy picture painted recently by the media, the RBNZ and Wellington-based economic forecasting groups.
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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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