Wholesale interest rates have collapsed – but retail home loan rates are likely to follow at a slower pace.
Kiwi Bank economists noted that the two-year interest rate swap hit a low of 4.19% last week, the lowest it has traded in less than two years and well below its recent peak of over 5.2%.
This is due to market expectations that the Federal Reserve plans to cut interest rates much more quickly than it has previously indicated.
Market traders are now pricing in 15 basis points. [basis points] “The cuts in August were expected,” Kiwi Bank economists said.
“The odds of a rate cut in just two weeks are 60%. Looking ahead, traders have priced in a 75 basis point rate cut by November. That’s three rate cuts.”
They said this made sense in the context of weaker economic data – but the Reserve Bank was unlikely to be willing to change its tone and cut interest rates so quickly.
They said that if the central bank wanted to see inflation return to its target range of 1% to 3%, November would be the earliest it would cut interest rates.
Chris Tennent-Brown, senior economist at National Australia Bank, said he could not argue “at all” with the direction wholesale markets were moving, although his team still expected rate cuts not to start before November.
“The risk is always there at times like this, once you are convinced that rate cuts are coming, you think why not do it now and why not do it in large quantities?”
Once the cuts start, there is unlikely to be a “straight line down,” he said.
“We think every meeting is live and we’ve changed significantly to price a lot of the action over the next year or so — people are scheduling very short periods of time, which makes sense as a strategy.”
He added that retail prices will not fall significantly until the official interest rate changes.
“I think we’ll see some movement later this year and then more steadily over the course of next year.”
But he said the five-year rate probably wasn’t likely to move much, because it had already fallen by about a full percentage point and hadn’t risen as much as some other rates initially.
The average borrower doesn’t need to worry about what’s happening in the wholesale markets, Kerr said.
“Survive until 2025” is still our motto
Much of the move was driven by foreign hedge funds that placed “very large bets” that the Fed would cut interest rates.
“There wasn’t much, if any, offsetting flow,” Kerr said. “If we were getting a mortgage flow in two years, we would be paying the two-year rate like the banks, but we’re not getting that, we’re getting a six-month to one-year flow, so we don’t need to hedge with six-month or one-year swaps, because we’re getting six-month to one-year deposit rates. That’s a big part of the market that’s missing.”
“When hedge funds come in and make big bets, there’s not much on the other side, so the moves are exaggerated.”
He said he could not imagine the Fed cutting interest rates in August given that it was considering raising rates in May.
“We’re playing with the man, not the ball, here, and that’s sure to lead to some interesting discussions.”
He said most households and businesses would probably stick with the “survive until 2025” mantra — knowing that a rate cut was very likely on the horizon.
“For me, it’s not so much about timing as it is about size, how many cuts are they likely to make? We’re saying they could easily make 200 [bps]”.”