Roger Kerr posted on October 31, 2010 15:57
Unexpected developments in the wholesale swap market last week saw interest rate yields increase across the curve. At first blush it seemed that local borrowers were adding more long-term fixed rate hedging in volume and were pushing the market upwards. That was a bit surprising, as it appeared that most who wanted to fix rates long-term had already done so some weeks ago. There is also a question whether the large NZ borrowers who are tapping the US Private Placement debt market at this time are swapping back to fixed or floating rate NZD borrowing. There has not been any further USPP debt issues announced since Vector and Transpower; however several others are known to be in the pipeline. The fixed-rate paying activity in the swaps market seems to be an offshore investment bank unwinding a trading position and once again forgetting how small and illiquid the NZ swaps market is for the amounts they are used to dealing. The fact that a large overseas trader in our interest rate market does not see rates going any lower (hence unwinding a long position) confirms my view that our term interest rates have well and truly seen their lows.
The ten-year swap rates increased from 4.90% to 5.15% last week, as the unwinding of the trading position by the investment bank in the two-year part of the curve was required to be spread across all the maturities to clear the risk through the inter-bank wholesale market. The 10-year swaps are largely driven by the US 10-year Treasury Bond yields, which increased initially from 2.50% to 2.70% last week, however they have since returned to 2.60%. Whether the swap rates hold up at these higher levels, or return to where they came from, as always, depends on the upcoming economic data.
The most important piece of data this week is the US Federal Reserve FOMC meeting on Thursday morning. If the QE2 monetary stimulus package amount is lower and more spread over time than the USD1 trillion the bond market expects, the future Fed buying of bonds will be lower and bond yield should increase from current 2.60% levels. In terms of domestic economic data due out this week, the labour cost and employment figures may turn out to be somewhat more positive than the gloomy RBNZ outlook on the domestic economy. Recent immigration and business confidence indicators were certainly pointing to the economy doing somewhat better than the RBNZ’s current flat projection. The accompanying statement to the RBNZ’s “no change” OCR review last week still suggests that the RBNZ will be lifting rates when the economic outlook justifies it.
They always like to have a bet each way; however my view is that they will be forced to adjust their 2011 economic outlook to a more upbeat assessment before the end of the year. So much revolves around consumer spending activity for the RBNZ and a small opening of wallets by households around Christmas, after two years of belt tightening, appears more than likely to me. A lower unemployment number this Thursday may encourage Joe and Josephine Public that their own job security is somewhat better than the unjustifiable gloomy picture painted recently by the media, the RBNZ and Wellington-based economic forecasting groups.
NEW ZEALAND DOLLAR MARKET COMMENTARY
Has the “Hobbit Hedge” prickle forced the Kiwi to temporarily fly?
Local importers should be on their bikes today ringing their banks to put in place additional hedging of forecast USD payments over the next six months. The sudden and unexpected spike up in the Kiwi dollar last Friday night to 0.7650 provides an opportunity to secure very acceptable rates on top of what hedging is already in place. The independent and separate NZD strength is not expected to be maintained as it appears solely related to a particular single NZD/USD transaction for a sizeable amount that went through the forex market in US trading on Friday night. Rumours are that the NZD buying was related to Warner Brothers hedging (buying NZD) their NZD film costs for the Hobbit movie that is now certain to be made in New Zealand. Typical of large American multi-national corporations who have little understanding of exchange rate risk (they only know and trade in USD’s) they are now hedging at 0.7500 after budgeting on a 0.5500 exchange over 12 months ago! Warner Bros complained to our Government about the NZD exchange rate going against them, making NZ less attractive as a film-making destination. Our exchange rate has not appreciated, their currency, the USD has depreciated and they were exposed to that financial risk. Perhaps our Prime Minister as a former currency trader himself gave them some gratuitous advice last week about foreign exchange management. Looks like they have bitten the bullet and hedged their NZD costs at the highs! Unfortunately for our exporters selling in USD’s, the large hedging transaction hitting a thin and illiquid offshore NZD FX market has propelled the Kiwi sharply higher.
The longer the NZD/USD rate stays above 0.7500 the greater the negative impact on our export led recovery to stronger GDP growth next year. The high agricultural commodity export prices still point to 3.5%/4.00% GDP growth in 2011, however a prolonged period of the exchange rate above 0.7000 is certainly taking the gloss off that positive outlook. Nothing much anyone in New Zealand can do about it, it all comes back to the USD value and direction on global currency markets.
Whilst the last 1½ cents rise in the Kiwi dollar is NZ specific, so much of the near-term direction depends on what the USD does against the major currencies post the US Federal Reserve QE2 announcement this week. We should know on Thursday morning whether the markets are happy or disappointed at the size and timing of the US monetary stimulus. There appears to be plenty of room for disappointment and thus the unwinding of sold USD FX market positions once the detail is known. The EUR/USD rate has not been above to push on above $1.4000 and looks prone to a sharp correction downwards after the QE2. The Australian dollar has recovered back to 0.9850 on higher commodity prices after dipping to 0.9650 at one point last week. Last week’s lower than expected inflation data in Australia may mean that the RBA is thinking hard about the merits of another official interest rate increase at this time. There appears to be heavy political pressure on the RBA not to increase as mortgage rate increases, mega bank profits and the high AUD hurting non-resource sector exporters are attracting a lot of media attention in Australia. A decision by the RBA tomorrow not to increase will be negative for the AUD, and thus the NZD.
Unemployment statistics for NZ on Thursday will be closely watched by the financial markets. The historical data series for the March and June quarters looked real dodgy with a big reduction in the unemployment rate to from 7.1% to 6.0% and subsequent increase to 6.8%. A lower rate (our forecast is 6.3%) on Thursday will make the RBNZ think again about their quite negative outlook on the domestic retail and housing sectors.