Roger Kerr posted on April 03, 2011 21:54
Local borrowers and investors alike are well advised to keep their eye firmly on market movements in the one to three year wholesale swap interest rates as lead-indicators of what kind of increases they can expect in 90-day rates over coming years. The pricing of the one to three year swap rates are very much a reflection on future expectations for GDP growth and inflation and the likely RBNZ monetary policy response. Over the last two weeks as global investment and commodity markets have taken the opportunity of lower prices caused by the Japanese earthquake, the local moneymarkets have pushed the three year swap interest rates back up to early March levels i.e. before the OCR cut (see chart below).
The trend back up suggests that the moneymarkets over-reacted to the “special” OCR cut on 10 March and have taken on board some of the positive economic news since. January and February export figures where very positive in terms of agriculture production after disappointing numbers in the September and December 2010 quarters. Bank economists have suddenly woken up to the inflation threats around the place with price increases occurring across the board, as we alluded to two weeks ago in this commentary.
The second half of 2011 is going to be a very challenging time for the RBNZ as they debate the timing of interest rate increases and the impact on the economy. It is an academic exercise; however had the Christchurch earthquake not happened, I would suggest that the bank economists would have been by now bringing forward the timing of the first OCR increase in 2011 to the June date we were originally sticking with. The whole timing is now all pushed back six months due to the earthquake, but the extent and speed of the upward movement in short-term interest rates later this year and early next will still surprise many. Three year swap rates may be 3.85% today; my view is that they will be above 4.85% in nine months time.
Interestingly, no reaction by the short-term interest rate markets to the massive fall in business confidence last week. It was expected and of course no surprise. Tomorrow’s NZIER Quarterly Survey of Business Opinion (“QSBO”) will also record a humongous decline in business confidence. However, I would not read too much into the negativity as NZIER (inexplicably!) exclude the dominant and booming agriculture sector from their survey. Expect business confidence to bounce back up over coming months. Government fiscal deficit figures out today will also reinforce the upward trend in our long-term bond yields. Finance Minister Bill English has a major task to keep Standard & Poor’s happy come the budget announcement in a month’s time. Long-term interest rates are only going one way from here (up), particularly if the NZ Sovereign credit rating is downgraded.
Credit spreads in the local government sector already reflecting the new order
Asia-Pacific Risk Management Limited is a prominent debt and interest rate advisor in the local government sector. As many readers will be aware, we have been working with Cameron Partners for Local Government New Zealand to set up a centralised debt issuance vehicle (“bond bank”) with the objective to reduce the credit margin Councils pay above market base rates on their debt borrowing.
The formation of the Local Government Funding Agency (“LGFA”) is well down the path with recent press releases from the Minister of Finance and Minister of Local Government confirming that legislation will be passed this year to establish the new agency. The initiative and plan is already having an impact in the local government debt marketplace with credit spreads reducing by up to 0.50% over the last six months as institutional investors, intermediary banks and debt issuers all realise that the new vehicle will command a strong credit rating and will fund from offshore debt markets as well as the local market. Investor demand has chased Council credit spreads down in the primary and secondary debt markets as they realise there will be a shortage of these quality fixed interest securities in the future when the LGFA is operating. Council credit margins have reduced by 0.50% despite general corporate “AA” and “A” rated securities not really decreasing at all over the same six-month period. The market rules...............
NEW ZEALAND DOLLAR MARKET COMMENTARY
Is the Aussie dollar over-cooked?
The strengthening of the AUD to $1.0400 against the USD has propelled the Kiwi towards the 0.7700 resistance level. The Aussie dollar has certainly been the stand-out star performer in global currency markets over this last week. It is worth examining the forces behind the aggressive AUD buying and whether the gains are sustainable. Where the AUD goes, the Kiwi is following; therefore both local importers and exporters will be wondering whether this dramatic reversal to 0.7700 from below 0.7200 only two weeks is going to continue.
There has not been any particular piece of economic news out of Australia to change the RBA stable interest rate outlook, therefore the Aussie currency is being driven by other factors:-
§ Reducing concerns that Chinese monetary tightening will hurt demand and prices for metal/mining commodities that Australia produces and sells to China.
§ Global fund managers and hedge funds pulling money out of Emerging Markets investment assets this year and re-weighting to currencies/economies like Australia and Canada.
§ Chinese and other Asian acquisitions of Australian resources companies causing a one-sided demand to buy AUD’s. These capital inflows into Australia are significant and much larger than any capital outflows on any given day.
§ Global investor risk appetite is up and “carry-trades” are back on the agenda (well, last week anyway!)
Watch for the minutes of the 15 March US Fed Reserve meeting later this week to perhaps take the gloss off the AUD as the financial/investment markets contemplate rising US interest rates later this year. Commodities (and commodity currencies) may not be so bullish when the “carry-cost” (US short-term interest rates) of holding commodity inventories is no longer close to zero.
Two interesting lead-indicators for the AUD/USD rate in the past have been the JPY/USD exchange rate and the copper price. The charts below depict clear divergence of these correlations as the AUD races away. History tells us the AUD currency value is well over-cooked at these levels.