Roger J Kerr says interest rate risks have shifted from the short-end to the long-end of the yield curve; rates will rise as the geopolitical risks recede

 By Roger J Kerr

Local economic data has been a real mixed bag of late; the housing market has cooled as expected under the weight of higher mortgage interest rates and the plummet in dairy prices has slammed rural cheque books shut.

Employment growth numbers last week for the June quarter were not as strong as prior forecasts and fewer people are looking for a job (too cold?).

RBNZ and bank economists are right to be more circumspect on the economic outlook.

The Christchurch rebuild underpins the impetus in the economy, which makes you think that we would not be looking that flash without that one-off and unique boost.

As identified in this column several months ago, the two risks to the rock star economy were lower dairy prices and higher mortgage rates.

Both risks have eventuated; therefore the current pause from the RBNZ is entirely appropriate.

Thus short-term interest rates are across the page for the next six to nine months and then the extent of increases from there will be highly dependent upon where the NZ dollar currency value is at that time.

While the risk of immediate adverse movements up in market interest rates is lower for short-term interest rates, borrowers are still very much at risk of long-term interest rates increasing substantially over coming months.

Global geo-political events (Iraq, Ukraine and Gaza) have driven US 10-year Treasury bond yields lower to 2.42% due to safe-haven investor buying, despite US economic data continuing to print on the stronger side.

The lower US bond yields are completely out of whack with increasing GDP growth, inflation rising above 2% and the Federal Reserve not too far away from signalling to the market how and when they will start to increase short-term interest rates.

It is hard to see our 10-year swap rates remaining at 4.7% for too long given the increased risks of increasing US bond yields.

There are no immediate resolutions for the geo-political issues in Iraq, Ukraine and Gaza, however how much more can the crises intensify to scare investors even further?

Eventually the economic fundamental factors have to re-emerge and they all suggest sharply higher bond yields over coming months.

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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