GDP growth, Bernanke, Kiwi dollar and all that stuff

 By Roger J Kerr

Looking ahead, I see three issues being the major factors that will determine the timing/level of our interest rates and the shape of the swap interest rate yield curve over the rest of 2012:-

• Whether the very strong current level of business confidence that points to +4% GDP growth rates for our economy in 2012, actually materialises into fact of higher economic activity levels. Construction has taken off over recent months (a sudden mushrooming of new home builds in residential property developments on the edge of Auckland is clear testimony of this) and can be expected to operate at much higher activity levels this year compared to the last three years. Stronger than expected growth over the first half of 2012 will certainly be one factor that starts to change Alan Bollard’s mind (or his successor’s mind after September) about future inflation risks. The June quarter’s GDP figures are not released by Statistics NZ until late September.

• Whether you are a “Bernanke Believer” or not on how the US economy is going to track this year. US 10-year Government Treasury bond yields shot up from 2.00% to 2.38% highs last month as stronger US economic numbers persuaded the financial/investment markets that the Fed Reserve would not have to stimulate the US economy any further with loose monetary policy as it was starting to run on its own steam. The bond yields have since retracted to below 2.20% after Fed Reserve Chief, Ben Bernanke poured cold water on that market expectation by saying that the US economy still needed very accommodative monetary policy to grow permanent jobs i.e. he did not trust the improved economic data as for real. If Ben B is wrong and US economic data continues to print on the stronger side over coming months with a falling unemployment rate, the US 10-year Treasury yields will head back up to 2.50% and our swap interest rates from four years out will increase by 0.50%.

• As stated last week, how the NZ dollar performs against the US dollar over coming months will be a major determinant of the timing of OCR increases this year. A lower NZD/USD rate will ease monetary conditions in the economy and provide the window of opportunity for Governor Bollard to normalise the OCR following the abnormal level we have experienced since the emergency measures were put in place in March 2009. Should the NZD/USD exchange rate stay above 0.8000 over coming months, the OCR will not be increased until much later. A lower exchange rate means the inflation rate is not held down by falling imported consumer product prices.

Higher US long-term interest rates from stronger US economic data off course means a stronger US dollar on world FX markets, which in turn dovetails in with the lower NZD level that Bollard needs to normalise interest rates here.

If the above scenario unfolds into fact, corporate borrowers will not want to risk being run over by the herd as households rush to fix their home mortgage interest rates. The prudent strategy is to move early to fix via swaps and be prepared to pay away the difference in the meantime.

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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