By Roger J Kerr
Short-term 90-day wholesale interest rates set to stay below 3.0% for another 12 months provided the NZ dollar currency does not completely tank and depreciate.
Significant NZD currency falls appear highly unlikely judging by recent offshore demand for a safe and secure currency that has an economy with GDP growth rate of +3%.
With the NZDS/USD exchange rate likely to sit in and around 0.8000 over the next 12 months as the highest probability scenario, it is a particularly difficult decision for any major borrower to fix interest costs via swaps at 3.68% for a 10 year term.
The pain of the payments away under the swap contract (difference between 3.68% and the 90-day wholesale BKBM rate) for the first 12 months dissuades many from making that decision.
However, those borrowers who can see past the currently popular Kiwi dollar, the real risk is not NZD/USD or 90-day bank bill interest rate movements. The real risk is whether US 10-year Treasury Bond yields move lower, stay where they are at 1.63% or move higher.
Our three to ten year swap rates are totally driven by US Treasury Bond interest rate changes, provided you make the assumption that the NZ bond to swap spread stays at 25 basis points and the US:NZ Government Bond spread remains at 180 basis points.
Add the three components together and you get NZ 10-year fixed rate swaps at 3.68% (1.63% + 0.25% + 1.80%).
The US Treasury Bond yield at 1.63% has the biggest propensity to change over the next 12 months.
My view is that the 1.63% base rate is far more likely to increase than decrease; therefore corporate borrowers should not be afraid to take a 10-year view and pay away the gap over the next 12 months.
If the borrower waits for a year before fixing, to be sure NZ 90-day rates are rising, the US Treasury Bond yields may well be 1% higher at that time, thus the 10-year swap rate here will be 4.68% (an even tougher decision to make!)
Reasons why US bond yields are more like to increase from 1.63%, than decrease are based around:
- Relative to equity prices, bonds are very expensive at 1.63%. Investors in US Government bonds are more likely to be sellers than buying more bonds as they allocate and re-weight in favour of investment asset classes with more upside.
- Whichever way you look at it the US fiscal cliff in early 2013 is negative for bonds. US budget deficits remain very large and new issuance bond supply remains at record highs.
- Renewed monetary stimulus around the globe lowers the probability of a global double-dip recession. Eventually GDP growth will return with associated inflation risks. A return of 1.63% is already below the US annual inflation rate and producing negative real returns.
- US corporate borrowers with more confidence the economy will now recover with QE3 operating are more likely to fix increased volumes of debt.
- The buying of US Treasury bonds as a safe haven away from European risks has reduced as the risk in Europe have decreased with banking market, fiscal and monetary policy reform progress.
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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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7 Comments
Totally agree Roger - this will have nothing to do with what the Fed thinks it will do with the Fed funds rate. It will inevitably have no choice but to raise it when it's money printing eventually leads to a loss of control over inflation some years down the track - with the money printing now formally unlimited, velocity will not remain low forever, especially when the inevitable inflation scare makes it self fulfilling. We will inherit much of that inflation through much higher commodities prices
The rise in rates will eventually make the Deflationists like Stephen right, but not before the inflation has hurt many like minded cash up investors looking too early for cheap assets, and the eventual inflation suffocated borrowers who's mind set is for a 5% mortgage rate forever.
On what credibility are you basing your view? Can you at least tell us when was the last time you are actually correct with regards to your prediction. This low mortgage market is just what every hard working middle class needs. This scare mongering don't do any justice when nothing really happens and ends up just trapping the scared bloke next door in rushing to the bank and fixing their mortgage. Lots of people did this from my memory during the GFC and they are not happy camper at the moment.
Did you suffer, I guess not!!! So please Pause, Stop and Open up only when you are absolutely sure already. I will be the very first one to follow your advice if that time will come.
Roger is right to suggest a collapse in bond value...a rise in the cost of credit. Fools who borrowed should fix. Bigger fools who bought bonds should sell now if they can.
Property values in aus are falling for good reason. Don't assume the auk bubble will not pop.
Rising rates will kill off the credit stuffed bubbles and the weakest bank will be forced to freeze all deposits..just a matter of time.
The pain of the payments away under the swap contract (difference between 3.68% and the 90-day wholesale BKBM rate) for the first 12 months dissuades many from making that decision.
Don't they and the Auckland ratepayers know it.?
Until the Fed signals an upward bias in rates best to stay with the knitting.
The pain of the payments away under the swap contract (difference between 3.68% and the 90-day wholesale BKBM rate) for the first 12 months dissuades many from making that decision.
Don't they and the Auckland ratepayers know it.?
Until the Fed signals an upward bias in rates best to stay with the knitting.
Roger must be the gold medal bottom picker of global financial markets....fix under 6%, fix under 5.50% ..oops fix under 4.50% ..oops now fix at 3.68% .....well for 4 years floating has done well .......this guy has zero credibility ......... and yesterday talking about F&P and their good job FX hedging ...thats rich ...didn't F&P appliances almost go broke when it lost 10's of millions of dolllars on hedges ..and surprise suprise Roger was advisor .... his problem is his views are right sooner or later ..as they have to be if you say the same thing long enough ..... pity about destruction in the interim ......risk manager my butt he's just a very poor market picker and unfortunately others take the hit !
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