Roger J Kerr says a combination of global factors with the perception that the next RBNZ interest rate cut may be the last helps firm the view that we have finally seen the bottom of the cycle

By Roger J Kerr

Stronger than expected US GDP growth in the September quarter has sent US Treasury Bond yields higher to 1.85%, up more than 10 points from a week ago.

The bounce back in US economic growth from the disappointing June quarter’s result was not really a major surprise as the inventory run-down by businesses in the June quarters was always going to require a significant stock rebuilding in the next quarter.

However, the annualised GDP growth rate in September at +2.9% was above prior market expectations of +2.5%. The stronger economic growth does mean that probability of a US Federal Reserve interest rate hike in December increases yet again.

On the proviso of a Clinton victory in the US Presidential election on 8th November, the probability of further increases in long term interest rates increases with stronger economic growth, higher inflation and rising short-term interest rates.

Whilst there are fears in investment markets about a major correction downwards in equity values, fixed interest and bond investors are also fearful of a major loss in portfolio values as bond yields increase.

The increase in US 10-year Treasury Bond yields over recent months from the 1.50% record lows to the current 1.85% already indicates that more and more fixed interest portfolio managers around the world are already reducing their duration i.e. selling longer dated bonds to reduce their risk of loss on marked-to-market valuations and thus negative returns to their investment clients/sponsors.

Do not be surprised to see this interest rate market momentum build on itself over coming months.

The rise in long term yields in the US (thus here in NZ) is to a degree underpinned by the stance taken by the Bank of Japan recently to not allow their long-term interest rates fall to below zero thus maintain a positive/upward sloping yield curve. Central Banks and Governments around the world are belatedly realising that super low interest rates is not the panacea for increased consumer spending and improved economic growth.

The combination of all the above factors and the perception that the next RBNZ cut to the OCR may well turn out to be their last (although they should not say that yet) helps to firm the view that we have finally seen the bottom of the interest rate cycle.

Borrowers who have been holding off from fixing any interest rates in recent years may well now have sufficient evidence that the direction is now up and hedging future interest rate risk is the prudent action to be taking.

Daily swap rates

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Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com