By Roger J Kerr
Global event risk has caused our long term interest rates to plumb new lows over recent weeks as the heightened uncertainties in Europe have a seen a wave of safe-haven buying of US Treasury Bonds, which has driven US and NZ bond yields lower.
The return of US 10-year bond yields to 1.82% is at odds with the growing evidence of the US economy recovering under its own steam.
Historically, there has been a reasonable good correlation between US 10-year Treasury bond yields and US employment growth.
However, as the chart below depicts, over the past two years this linkage has completely broken down with the three-month average Non-farm Payrolls employment figures back in the +100,000 to +250,000 region, while bond yields have gone the other way.
In normal market circumstances stronger jobs growth in the US is associated with higher GDP growth, thus some inflationary pressures and higher market bond yields.
The massive divergence and gap that has opened up does not make a lot of sense if you just look at the US domestic economy in isolation (yields should be much higher).
What is happening is that global investor worries about Europe have driven investment funds into the security and safety of Uncle Sam’s IOU’s.
The small matter of investment bankers, J P Morgan losing US$2 billion in market proprietary trading does not help investor confidence much either.
If you subscribe to the view that Europe completely collapses and the US economy heads back into recession you would expect US bond yields to stay below 2% for a long time yet.
However, if you see the current market sentiment as relatively short-term and it will blow over within a few weeks, the more positive US economic picture does point to their long-term interest rates eventually increasing (and taking our three to 10 year swap rates up with them).
Decisions by NZ corporate borrowers to hedge their future debt/interest rate risk at the current record low swap interest rate levels, or not as the case may be, is totally based on the future direction of US bond yields and has very little to do with the RBNZ and the NZ economy.
If you think the US and global economy is doomed you will not fix interest rates at the current record low levels.
If you believe the US economy is back on track (as I do), it cannot be a difficult to decision to fix higher percentages for longer.
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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
4 Comments
How many years is it you've been saying this, Roger?
It's no use looking at fundamentals anymore. The entire interest rate market is now so heavily manipulated by the Central Banks, the Fed have even come right out and said they'll do whatever to hold rates low right through to 2014!
Besides these gains in US employment, (the 100,000 to 250,00/month you speak of, that's just over 2 million/year) are not even making up for a population that's increasing by over 3 million/year. The US economy is not improving. On a per capita basis and deducting Government borrowing in the high single digits they are going backwards.
Europe is falling apart and China is one huge bubble. Higher interest rates soon? I don't think so.
My feeling is that there is a good chance of a further rate cut in the OCR by the RBNZ next month. Current weak economic conditions in New Zealand would certainly favour such a move, and I think that what emerges out of Europe, China and Australia over the next 2-3 weeks will decide whether a cut comes about or not. The banks appear to be pricing in a rate cut. International conditions are weak; growth in the US is tepid. Certainly I don't see any room or reason for a rate hike in the current economic climate that we are facing. Therefore I wouldn’t be rushing to fix right now. I'd wait and see what the Reserve Bank's next move is and what its policy statement says before I'd fix.
BTW I don’t have a mortgage, so my views on the matter should be read with that in mind. If I’m wrong, to me it doesn’t matter a damn.
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