The above statement was my final comment in this column two weeks ago and despite generally stronger NZ economic data since and a more upbeat RBNZ assessment of the economic outlook last week, the interest rate market today prices three year swaps at a whole two basis points higher at 3.82%. In my view the markets remain as complacent as the RBNZ on the NZ growth and inflation outlook.

 

Despite the RBNZ signalling a likely earlier and faster increase in the OCR, the term interest rate markets are seemingly reluctant to reflect the higher inflation risk going forward. The lack of response by the markets has perhaps more to do with corporate borrowers having fixed all they want to fix and the banks having very weak demand from their home mortgage borrowers to fix their interest rates. For three year interest rates to move up it does require a higher volume of “fixed-rate payers” (borrowers) active in the wholesale swap market than “fixed rate receivers” (investors). It seems that swap rates will not shift upwards until the banks need to off-lay the risk associated with their home mortgage borrowers fixing.

 

It seems that the housing market recovery and maybe household perceptions about the economy/interest rates have not yet got to the point where the case for fixing the mortgage is compelling. However, I expect this point to be reached over coming months. It may take stronger residential property market activity levels and positive credit growth numbers to convince households, the interest rate markets and the RBNZ that current interest rate levels are too low. Whatever way you look at it, the time is getting closer to when three-year swap rates reverse sharply upwards.

 

One would have to be very pessimistic on the outlook for the NZ economy not to agree with a forecast of three-year swap rates being 0.50% higher in six months and 1.00% higher in 12 months time. Stronger than expected consumer confidence indices and retail sales (Q1) numbers this week may start to jolt the interest rate markets out of their complacent slumber.

 

The spike upwards in the Kiwi dollar to new record post 1985-float highs of 0.8300 last Thursday night following the RBNZ’s monetary policy report has again sparked calls from all and sundry that someone (i.e. the Government, the RBNZ) should do something about the “out of control” currency value and currency market. The reality of life is that the NZ dollar is constantly out of the control of any one entity, its value every day reflects natural daily market supply and demand and expectations of future supply/demand. The aggressive buyers of the Kiwi dollar over recent weeks are clearly convinced that the NZ economy will out-perform others due to the high export commodity prices we are enjoying. The buyers must also believe that NZ interest rates will be rising in six months time (which I agree with) and that the US dollar itself will be sold heavily in global FX markets (which I disagree with). Heavy overseas investor demand for NZ Government bonds also continues as a positive for the Kiwi. In addition, the buyers of the Kiwi dollar are also clearly in the international investor camp of “risk-on”.

 

Looking ahead, I continue to hold a view that a stronger US dollar and lower commodity prices will bring the NZD/USD rate down over the next few months. Recent economic/financial market developments that support this view include:-

 

§         Global FX markets sold the USD against the EUR to $1.50 last month. Those weaker USD levels could not be sustainable in the face of continuing sovereign debt problems in Europe. The Europeans think that the Euro can withstand a Greek debt default – “yeah right!” Watch for the EUR/USD exchange rate to go below $1.40 in the short-term.

 

§         The US monetary quantitative easing policy (QE2) is not being replaced after 30 June. US core inflation forecasts will need to be revised upwards as house rentals are no longer falling at the rate they once were. US short-term interest rates are still likely to increases sooner and faster than European interest rates.

 

§         Monetary policy continues to be tightened in China and India as their inflation tracks uncomfortably upwards. Global financial and investment markets focus heavily in Chinese economic data nowadays and slower growth seems likely.

 

§         Oil prices are headed back down as the Saudis walk away from OPEC production agreements. Other commodity prices are unlikely to move the opposite to oil.

 

§         The golden run upwards in global sharemarkets since the GFC in 2008/2009 underpinned by monetary stimulus policies (i.e. super low interest rates) has now run out of steam as the central banks withdraw the stimulus and start tightening.

 

§         The rising commodity prices/high AUD currency value environment has come to an end. The AUD/USD exchange rate holds a very high historical correlation to copper prices. Copper prices have been declining in a jagged fashion since March . A drop below $8,600 in copper prices over coming weeks breaks the uptrend line since late 2008. The AUD does not remain out of synch from copper prices for very long, and currently it has some catching up to do! The AUD appears particularly vulnerable to a sizeable sell-off when $1.0500 against the USD is decisively broken.

My assessment is that the NZD is currently over-bought against the AUD at 0.7800 and when the AUD depreciates on lower commodity prices over coming weeks, the NZ dollar selling will be faster and further than AUD selling.