By Roger J Kerr
Since the RBNZ OCR review statement on 25 July the local moneymarkets have pushed one to three year wholesale market swap interest rates downwards by 0.20%.
The forward market for 90-day rates is now priced at just one 0.25% OCR increase by June 2015.
With the current three-year swap rate at 4.24% and the 90-day sitting at 3.67%, the markets are telling us that they only expect another 0.50% of OCR increases over the next three years.
That market interest rate pricing is far too low in my book.
It suggests that the “new normal” for 90-day floating rates has been re-rated to about 4%.
Most pundits would see the new norm for 90-day interest rates averaging 4.5% to 5% based on a 2% inflation rate and GDP growth above that each year.
What do the investors and borrowers (who have pushed the three year swap rates down) know about future economic conditions and forces that I have missed?
The markets now seem to be pricing a much lower economic growth path and thus inflation track than what the RBNZ and bank economists are currently forecasting.
There has not been any poor NZ economic data apart from the plummet of dairy prices to suddenly support a much weaker economic outlook.
Part of the explanation for the reduction in three year interest rates is the extraordinary rally downwards in US 10-year Treasury bond yields to below 2.40% over recent weeks.
The lower US yields have pulled our three to 10-year swap rates down with them, as usually occurs. The US bond market has responded to the weight of global investor money seeking a safe-haven from the various geo-political events dominating the newswires in recent weeks.
Over the same period US economic data has generally been stronger with home building and manufacturing indices moving higher.
My view is that the spooking of investors by geo-political ructions generally blows over, while the US economic improvement is more permanent as a bond market influencing factor.
US bond yields could easily increase by 0.6% to 3% over coming months, lifting our three year swaps rates with them.
Therefore borrowers have another unexpected bite of the cherry to lock-in term fixed rates only marginally above current OCR levels. The two year swap rate gap to the 10-year swap rate has closed up to just 0.60%, a new six year low (refer chart below).
You have to go back to the 2004 to 2007 period when Alan Bollard pushed monetary policy to extreme tight levels at 8.25% and caused an economic recession to find the last time 2-year swap rates were the same or above the 10-year swap interest rates.
The yield curve is now super-flat and the extra premium cost of fixing for a 10-year period has completely dropped away and borrowers need to take advantage of this interest rate market pricing anomaly.
A decision not to increase long-term fixed rate borrowing at current swap market levels is tantamount to saying that the New Zealand and US economies are both going to weaken back to much lower growth rates or even return to recession.
I cannot find any credible economic commentators who have that view as the evidence of the upward momentum is just so compelling.
It just needs Janet Yellen at the US Federal Reserve to be convinced about the recovery in the US labour market and the long-term swap rates will be a lot higher than the current 4.45% to 4.7% levels.
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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
11 Comments
With the current three-year swap rate at 4.24% and the 90-day sitting at 3.67%, the markets are telling us that they only expect another 0.50% of OCR increases over the next three years.
Show the crowd the 33x36 FRA rate as a valid point of comparison rather than a conversion of the 3 year/3mth FRA stack to reflect the semi annual bond equivalent yield swap rate.
Good to know the Middle East is now successfully resolved, Iraq, Syria, Egypt, Lebanon, Iran, Jordan, Yemen, Pakistan, Afghanistan etc all have good government with peace and stability. Phew.
And that Russia has re-joined the family of nations. While the Eurozone now all have growing thriving economies with no forebodings reminiscent of WWII.
And Yellen has taken her foot off the interest rates brakes due to a full USA recovery.
And the reward for all that success will be floating rates of 8% for NZ.
Or maybe not.
You know after 6 years of being pretty consistently wrong, you would think some ppl would get it, obviously not.
You talk about interest rates recovering and have been for 6 years as have the bank economists. Surely after this length of time you should be considering that the short term free market economics model you worship is broken?
You consistently ignore the longer and even medium term issues,
a)The mountain of debt that with,
i)Peak crude oil
ii)Over-population.
iii)Lack of resources
iv) Crop failures from climate change on a scale that is frightening.
Cannot be paid back and has to be defaulted on.
b)That we are on a finite planet and cannot grow for ever.
c) The perilous state of enough nations such as Pakistan that any degree of stability is a bad joke.
Really I wonder how you can be for real.
regards
And steven, with his doom, gloom and despondency character, persistently underestimates... na, he writes off... the human spirit.
Don't worry steven, the 'new normal' will not be normal forever. .. the human condition and the world's economies will boom again... interest rates will rise again.
PS: The free-market economy is much better than having the miserable ones telling us what to do.
Pray all you want, the human spirit cant replace oil. That takes scientists and engineers and not disciples, and then we'll see that the acolytes at the temple of the free market find ppl cant pay.
In terms of telling you, I suspect the future will be indeed you will get told. Whatever you pray for as the free market is an illusion, takes too much (US in particular) Govn subsidy to maintain. So when there are enough ppl who cant pay the Govn will change, Kunstler points out your (Im being metaphoric here) probable method of demise.
Sure I guess if Roger acts like a stuck clock he'll be right eventually. Meanwhile take a look at the projections for the OCR, 4.5% maybe a peak, maybe one day, hardly "inflation'. In the meantime the Austrians promising runaway inflation so buy gold...gold,....god (maybe not so much a typo). convinced it was going to $3000 even $5000 have lost thier shirts, down 2/3rds, ouch. So sure you can wait for inflation, or may consider whats going to happen first and act on that.
regards
.Wouldn't "plummeting" milk prices be a pretty major piece of evidence in regards to nz's economy?? Correct me if I'm wrong but don't drought conditions put the brakes on nz's economy every time it happens? Or is the feedback loop caused by lower rates enough to compensate for lower income on our major export? DGMW I respect Rogers analysis and his track record is excellent IMHO.... I look at the yield on the 10 year bonds over a decade and the amount of debt racked up WW and think how can rates really start to normalise? Is thinking about increasing rates akin to actually increasing them these days?
Timely advice...oh right ... articles out toay show retail interest rates dropping today....
Also, recently Roger said above 84c USD unsuswtainable, NZED must come down and all the stops would be trigegr a cascade as the inevitable fall was going to happen.....
....and then you call for lifting of OCR ?? ie tighten money supply. Last time I checked that would push NZD UP ?
Why is it that the bloggers who got it the most wrong about interest rates over the past two years are always the first to respond to an interest rate article, especially those that don't understand the difference between a bank margin move compared with the more substantial OCR and swap rate moves that are actually what dictates the direction of rates ...strange, but then I guess it is a truism about broken clocks
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