Roger J Kerr says borrowers have finally realised that short-term interest rates in New Zealand are now more likely to increase by 2% over the next 18 months

 By Roger J Kerr

One-sided demand from borrowers to fix their interest rates in the swap market, against the absence of fixed interest investors on the other side of the market, has driven term interest rates higher.

Recent increases in the five to 10 year swap interest rates have been over and above increases in the US 10-year Government Treasury bond yields over this past week (refer chart below).

It is not surprising that more and more large borrowers in the New Zealand marketplace are belatedly fixing the interest rates on their debt.

The strong economic data just continues to roll in with wholesale PPI prices increasing sharply last week, adding to the already higher forward picture for inflation in 2014.

Borrowers have finally realised that short-term interest rates in New Zealand are now more likely to increase by 2% over the next 18 months and term swaps rates, as always, are increasing well ahead of that timing.

The penny has finally dropped that 100% floating rate risk for a large borrowers is no longer a safe place to be.

Of course, the borrowers who are now late in fixing are paying much higher fixed rates than those who were active in the earlier part of the year when term swap rates were 0.50% to 1.00% lower than where they are today.

The false economy of borrowing floating for rate as long as possible and delaying any fixing has been proven yet again.

A swag of delayed US economic on construction/housing could well push US long-term bond yields higher this week and manufacturing/jobs data next week should add to that upward momentum.

Those borrowers who have yet to fix should stay away from eight to 10 year swaps which are now above 5.00% and look at tenors in the five to seven years.

Given the situation in the US with the potential for their 10-year bond yields to move considerably higher from the current 2.74%, our swap rates are still on track to be 0.50% to 1.00% higher again in six to 12 month’s time.

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Roger J Kerr is a partner at PwC. 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