Opinion - Has the interest rate market already turned?

Velocity and momentum are important variables in financial market pricing and direction. The break-neck speed of the reductions in market interest rates over recent months has been caught-up in its own momentum that a massive over-shoot to the downside is looking more likely by the day.

It may be easy for investors and borrowers to be sucked-in to the local bank economist view that NZ interest rates need to fall another 1.00% to 2.50% to save the economy. These “celebrity” economists generally do not like being reminded of what they were telling the RBNZ to do only 12 months ago i.e. push rates higher to 9.00%??

However, the longer-term player (borrower or investor) should be examining what is happening in the US Treasury Bond market over the last few weeks as a far more accurate guide to future interest rate direction in NZ. The 10-year US T-Bond yields have increased from record lows of 2.00% in December to 3.00% today. That interest rate market is telling us that rates did go too low and that the funding of the fiscal stimulus packages will require a massive increase in supply of Government debt onto the markets. When supply increases, bond prices fall (yields increase). The US bond market may also be reflecting that some of the key lead indicators for the US and world economies (eg: the PMI) have stopped crashing down over the last month.

The RBNZ is moving a fair distance away from its sole 1% to 3% inflation mandate if it is slashing our interest rates just because the rest of the world is doing that to save their banking institutions from oblivion. Our (Australian) banks are not in the same position. The RBNZ would argue that they are slashing our interest rates to record and unprecedented historical low levels because the global economy is tanking and New Zealand economy will stay in recession longer.

The risks around that view are considerable in my view, but right now the market is dismissing them. Or are they? In the last two trading days market swap interest rates have increased by 20 to 30 basis points, up from their record lows. It may be a brave person that calls last week as the bottom in our interest rate collapse, but as time moves on that bottom may become more and more evident.

Wholesale and retail Investors are flocking to the multitude of corporate bonds now on offer in the marketplace. Their desire for 6% and 7% returns on corporate risk instead of 3% and 4% returns on Government guaranteed bank risk is very telling. Borrowers are fixing to the maximum as well through the swaps market - that is, the market traffic is all one way from here in my view – rising interest rates, not further reductions.

I find it hard to see what the next big negative for the NZ economy will be from here. Export commodity prices are stabilising and the fiscal/monetary stimulus in 2009 is huge. We will not have the massive jobs lay-offs in 2009 that other economies are experiencing. Several of our productive industries (manufacturing, fishing, forestry) went through that downsizing in 2006/2007 as a result of the inappropriately tight monetary policy at the time.

Our unemployment rates will rise from 4.6% to 7.5%, but the impact on the economy will not be as negative as many other countries. Forecasters looking at employment trends in NZ for some guide on future GDP growth are looking at the wrong indicator. Employment trends always lag the economy by 12 months. GDP growth will return to positive well ahead of employment improving. The NZ economy is driven by export commodity prices and most of those are still above long-term average prices, despite the rapid plunge in some prices over the last 9 months. Let’s hope the RBNZ focus on this in their early March MPS report, rather than just extrapolating the global recession directly into the NZ economy.

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Posted: 11 Feb 2009

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