The trend towards ever lower interest-rates continues but what about bond yields?

A clear feature of the credit crunch world has been lower interest-rates and lower bond yields. This has come in two phases where the first was badged usually as an emergency response to the credit crunches initial impact. However as I warned back then central banks had no real exit plan from such measures and we then found that the emergency had apparently got worse as so many central banks cuts again. So if you like we went from ZIRP ( Zero Interest-Rate Policy) to NIRP ( N is Negative) . Along the way it is easy to forget now that the ECB did in fact raise interest-rates twice but the Euro area crisis saw it cut them to -0.4% and to deployed over a trillion Euros of QE bond buying so far. In the UK Bank of England Governor Mark Carney also retreated with his tail between his legs after a couple of years or so of Forward Guidance about higher interest-rates which turned out to be anything but as he later cut them to 0.25%!

Reserve Bank of New Zealand

Yesterday evening the Kiwis again joined the party.

The Reserve Bank today reduced the Official Cash Rate (OCR) by 25 basis points to 1.75 percent.

I have a theory that the RBNZ regularly cuts interest-rates when the All Blacks lose at rugby union and on that subject congratulations to Ireland on finally breaking their duck. Moving back to interest-rates that makes 40 central banks ( h/t @moved_average ) who have eased policy in 2016 so far which poses a question over 8 years into the credit crunch don’t you think? Central banks used to raise interest-rates when they claimed a recovery was developing.

Also we can learn a fair bit about the modern central bank from looking at the explanatory statement from the RBNZ.

Significant surplus capacity exists across the global economy despite improved economic indicators in some countries.

Perhaps only the Governor can tell us whether that psychobabble is good or bad! Anyway central banks used to cut interest-rates if the economy is either weak now or expected to be so let’s take a look.

GDP grew by 3.6 percent in the year to the June 2016 quarter, and near-term indicators suggest this pace of growth is likely to continue. Annual GDP growth is forecast to average around 3.8 percent over the next year. This strength has been a feature of the Bank’s projections for some time……….. As GDP is forecast to grow at a faster rate than the economy’s productive capacity, the output gap is projected to rise, contributing to inflationary pressure.

Oh well perhaps not. Also there is another (space) oddity if we look at a cut in interest-rates.

The combination of high population growth, low mortgage rates, and a shortage of housing in Auckland has continued to exert upward pressure on house prices…….Outside of Auckland and Canterbury, house price inflation reached a 10-year high in July, but has fallen slightly since.

Ah yes so a cut in interest-rates will help? Oh hang on as we observe this.

Mortgage rates remain around record lows

If we look at the chart we see that it is no surprise that house price inflation has slowed in Auckland because it want over 25% per annum. For some reason ( perhaps someone familiar with NZ can explain) Canterbury saw over 25% around 3 years ago. However the rest of New Zealand has seen a rise to around 10% per annum. Many would call this quite a boom and a central bank would raise interest-rates. Of course these days we are promised policies from long enough in the past that most will have forgotten they were failures back then.

This follows the announcement of further tightening of loan-to-value ratio restrictions in July 2016.

Also with the New Zealand economy growing so strongly it is hard ot avoid the feeling of beggar thy neighbour about this.

A decline in the exchange rate is needed.

The inflation argument is not so strong even for those who believe that 2% is better than 0%. Added to house prices we see this.

Annual inflation is expected to rise from the December quarter,

One area that is awkward for the central bank is this.

 On an annual basis, the net inflow of working-age migrants rose to a new peak of around 60,000 in September

Of course establishment s everywhere tell us how fantastic this will be for economic growth which makes the rate cut even odder. But we see that it will have ch-ch-changes on New Zealand that elsewhere have contributed to not quite the nirvana promised. It is hard as a Londoner not to have a wry smile at this because both socially and in business you meet so many Kiwis some who are here for a while and some end up staying. It is however of course an urban myth that they all live in one camper van in Kensington! But if the mainstream media finally gets something right in 2016 New Zealand may be about to see a flow of American immigration as well.

The RBNZ does not give us GDP per head which would be interesting to see. We do however get something that as far as I know is unique in the central banking world.

We assume that over the medium term the price of whole milk powder will tend towards USD 3,000 per tonne, and that the Dubai oil price will continue to gradually increase to around USD 60 per barrel.

Firstly you get the wholesale milk price as you note it is provided before the crude oil price!

A Challenge to the central bankers

The RBNZ kindly gave us the central bankers view of what happens next.

Policy rates are at record lows across
most advanced economies and are expected to remain stimulatory over coming years. In 2016, quantitative easing by central banks has been at its highest level since the global financial crisis. The degree of unconventional monetary policy is unlikely to increase further.

Of course Forward Guidance from central bankers has been anything but that! Also whilst they may well continue to reduce official interest-rates it looks to me as if there will be trouble elsewhere. This is because inflation looks set to rise and its impact on real or inflation adjusted bond yields. There was an element of this in the rise in the US 30 year bond yield that I pointed out yesterday after Donald Trump was elected.

Putting it another way the chart of inflation expectations below is revealing. However take care as these things are very broad brush as in useful for trends but very inaccurate in my opinion.

That starts to make current bond yields look a bit thin doesn’t it?


Today I have been looking at two opposite forces as the central banking army continues its advance but faces more potential guerilla style opposition. We do not yet know how much inflation will pick-up overall but we do know that unless the oil price falls heavily it will do so. We also know that in some areas we are seeing hints of commodity prices rising again as for example Dr.Copper has been on the move. in response bond yields are rising today and as summer has moved into autumn we have been seeing this overall. For example the ten-year bund yield in Germany is now 0.28% as I type this. This is simultaneously giddy heights compared to recently as well as still very low!

So a clash is coming as I believe that central banks such as the ECB are happy for yields to rise now so they can act again later and claim success. The problem is two-fold. If it is so good why do we always need more and secondly how does this work with rising inflation trends?


9 thoughts on “The trend towards ever lower interest-rates continues but what about bond yields?

  1. The USA has a huge deficit and national debt.The president elect has promised to cut taxes, not that he pays tax ! and threatened to “renegotiate the debt”. How should bond investors react ?

    • You are forgetting that whatever Trump has promised before the election was merely said to defeat Clinton. President Elect’s tune has changed in tenor, tone, and harmony. Americans have subjected themselves to an entertaining next 4 years of presidential power consolidation. Pity about the Supreme Court. Meh.

  2. The bump for Christchurch was likely due to the earthquake in 2011 which is, at a guess, a case of the “broken window fallacy” in terms of redistributing wealth from outside the earthquake zone into reconstruction. RBNZ is probably concerned about how strong the NZD is, as the economy is exports almost everything in USD.

    • Hi flyingkiwiguy and welcome to my corner of the web.

      Of course yes! Also apologies to those who sent me a video of the damage to Christchurch as I should have remembered. I understand the currency strength part but you see central banks invariably have a choice between the exchange rate and the domestic economy. Choosing the exchange rate leaves them with few options if house prices keep rising, also how fast would the economy grow if it went lower?

      The other thing to mull is how an interest-rate of 1.75% seems high in these times of ZIRP and NIRP..

  3. Hi Shaun, sorry, but I’m baffled too. I noticed the local media were quick to point out that the reduction in the OCR to 1.75% wiould not mean mortgage rates would fall because “NZ banks borrow money from overseas where rates are higher”.

    I think it’s simply that the RBNZ want inflation higher and the exchange rate lower.

    There are signs that property prices outside Auckland and Christchurch are now starting to rise after 10 years in the doldrums. Queenstown for example has seen prices rise by over 25% in the last year.

    • Hi Eric

      So there are no tracker ( variable mortgage rates set based on the official RBNZ rate) mortgages in New Zealand? As to the point about bank funding they are presumably referring to this in the Monetary Statement.

      “However, the recent rise in offshore yields (see chapter 3) has caused
      an increase in wholesale interest rates in New Zealand. The 2-year swap
      rate, for example, is around 20 basis points above its level at the time of
      the August Statement. Higher wholesale rates suggest that banks may
      be under pressure to raise mortgage rates. ”

      But later this is somewhat contradicted.

      “but weaker domestic deposit growth is putting pressure on banks to
      compete more aggressively to retain deposits. As deposits constitute
      a large share of total bank funding, this is holding up the average cost
      of new funding for banks”

      • Hi Shaun, I’ve never seen tracker mortgages advertised here, I don’t think they are available. As far as I know the choice is “Fixed” or “SVR” (standard variable rate).

        It’s generally accepted here that NZ borrows money from the rest of the world in order to fund its lifestyle – and milk is more important than oil – and the All Blacks are more important than milk and oil.

  4. Hi Shaun,
    Immense stresses are beginning to develop between official rates and bonds already aren’t they.

    As inflaton takes off in the UK and later in the US it will be fascinating to see how the CB’s deal with it. Keep official rates low and spreads will go massively wide leading to a liquidity problem for the CB’s which as far as I know can only be filled via debt monetisation.

    Increase official rates with inflation and they run the risk of crashing over-indebted economies. Now it really does promise to become an interesting show with the US following where the UK leads (another first!).

    • Hi Noo2
      Yes as your comment came in I was just looking at the 30 year US Treasury Bond yield which has continued to rise and is now 2.95%. I was engaged in an online conversation earlier with someone who had also been on the LIFFE floor and she was saying it was like old times and not QE era times.

      I suspect it may suit Draghi and Kuroda to keep their QE going but for the US it poses a question. Could the Fed start it again as I postulated yesterday?

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