Interest Rates Jump Up

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.

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