Headline article from the BNZ Weekly Overview.
INTEREST RATES JUMP UP
This week’s WO is shorter than usual for three reasons. One, at the time of writing this on Thursday afternoon we still
did not know if war had started as such. Two, we’ve been busy with lots of work on. Three, its hard to say anything in
the current environment where, as we have been predicting, rate volatility has jumped up because of the war factor.
Over the past week we have seen the NZD get lost in the wash a bit as investors have clamoured back into USDs amid
optimism about a quick war and the return of certainty of a sorts to the markets. Oil prices have plunged now that
traders can see a scenario where security of flows will eventually increase. And of interest to borrowers here is the
large jump in long term interest rates around the world as investors have moved back into equities where the Dow has
soared 713 points or 9.4% from a week ago. Over the past week we have seen the cost to us banks of borrowing funds to
lend fixed for three years jump from 5.77% to 6.11%. This is the biggest one week jump in this benchmark rate since
December 1998 and is why we have argued that borrowers should be wary of following fixed rates down from already very
low levels in the hope of getting even lower rates. In the minds of many people the outbreak of war would seem an
especially bad thing which would cause investors to sell shares and invest in long term fixed interest assets. However
exactly this sentiment has been at work in the markets for many months now, so the actual outbreak of war does not
necessarily bring new information. In fact it is being used as a good reason in many quarters to take profits on the
rally in fixed rates in anticipation of the war premium going out of the market in a few week’s time.
This is the nature of the financial markets. They are forward looking and the latest news is often less interesting than
what it signals may be the main news item in the future. In this case the market view is that the US-led forces will
succeed in installing an alternative regime in Iraq very quickly and the alternative less certain scenario of
procrastination and appeasement no longer applies. That latter scenario was seen as extending the current period of
weakness in business and consumer confidence around the world and generating extra downside risk to consumer spending,
business capital expenditure, and jobs growth.
Will the rather sudden jump in fixed interest rates be reversed in the near future? Probably not given the likely war
outcome, but that is not the same thing as saying rates will trend steadily upward from here. Once the war ends we will
have to wait for insight into the true extent to which it was affecting sentiment around the world. It is possible that
it merely hid underlying major worries about economic growth and once those worries reappear interest rates will fall
back again. This seems to be the attitude of the US Federal Reserve which during the week said it could not form a view
on which direction the risks to economic growth now lie.
Locally we see those economic growth risks as mainly downward in light of the rising currency and fall in export incomes
generally. That is why one cannot entirely rule out the Reserve Bank cutting interest rates here. But the earlier
optimism in the local market about that easing has diminished substantially, causing the 90-day bank bill yield to end
the week near 5.87% from 5.82% one week ago and 5.74% two weeks ago. Unless things go very bad overseas or there is
especially strong evidence of an easing in capacity pressures in the economy we stick to our view that a rate cut is not
a foregone conclusion.