Wholesale interest rates ‘collapse’

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Wholesale interest rates have “collapsed” – but retail home loan rates are likely to follow at a slower pace.

Kiwibank economists have pointed out that the two-year swap rate hit a low of 4.19 percent last week, the lowest it had traded in just under two years and well below the recent peak of more than 5.2 percent.

That is being driven by a market expectation that the Reserve Bank is planning cuts to the official cash rate (OCR) much more quickly than it has previously signalled.

“Market traders are now pricing 15bps [basis points] of cuts in August,” Kiwibank’s economists said.

“That’s a 60 percent chance of a rate cut in just a couple weeks’ time. And looking ahead, traders have priced in just over 75bps of cuts by November. That’s a whopping three cuts.”

They said it made sense in the context of weaker economic data – but it was unlikely that the Reserve Bank would be willing to change its tone and cut so quickly.

If it wanted to see inflation back within its 1 percent to 3 percent target band, November would be the earlier rate cuts could happen, they said.

ASB senior economist Chris Tennent-Brown said he could not argue “at all” with the direction that wholesale markets were moving, although his team also still expected rate cuts not to begin until November.

“The risk is always at times like this once you get convinced that rate cuts are coming you think why not now and why not go heaps?”

Once cuts began, it was unlikely that there would be a “straight line all the way to lower”, he said.

“We think every meeting is live and we have swung around quite a bit to price in a lot of action over the next year or so – people are fixing for quite short terms, which makes sense as a strategy.”

Retail rates would not move markedly lower until the official cash rate shifted, he said.

“I think we’ll see some movement later this year then more steadily though the course of next year.”

But he said the five-year rate was probably not likely to move a lot, because it was already down by about a full percentage point and had not risen as much as some of the other rates to begin with.

Kerr said the average borrower did not need to worry about what was happening on wholesale markets.

A lot of the movement was driven by foreign hedge funds placing “very large bets” that the Reserve Bank was going to cut.

“There hasn’t been much, if any, offsetting flow. If we were getting mortgage flow in the two-year, we would be paying the two-year rate as banks but we’re not, we’re getting six-month to one-year flow, so we don’t need to hedge that with six-month or one-year swaps, because we are getting term deposit rates for six months to one year. That’s a big part of the market missing,” Kerr said.

“When hedge funds come in and place large bets, there’s not a lot on the other side, so the moves have been exaggerated.”

He said he could not imagine the Reserve Bank cutting in August given it was contemplating an increase in May.

“We’re playing the man not the ball here, it certainly makes for some interesting discussions.”

Most households and businesses were probably sticking to the mantra of “survive until 2025” – knowing that interest rate cuts were very likely on the horizon, he said.

“For me, it’s not so much the timing as the magnitude, how many cuts are they likely to deliver? We’re saying they could easily deliver 200 [bps].”