Impacts of falling NZ interest rates?

–So expect bigger fiscal deficits and more interest rate cuts to come. Anything to help keep our head in the sand for just a little bit longer — or until the next election.

–But for Australia, the day of reckoning will come. Our net foreign debt levels will go close to hitting $1 trillion this year. While the economy slows and national income growth grinds to a halt, we’re maintaining our standard of living by borrowing more and more [GSG Note: Likely New Zealand will too].

–In the global search for yield and complete ignorance of risk, our creditors keep lending to us, mainly via the banking sector. The funds then go to the household sector, which bids up the price of housing and clocks the gains up as ‘wealth’. [GSG Note: Same for NZ]

–But as Greece knows only too well, when you’re a debtor you don’t hold too many cards when the proverbial hits the fan.

–In Australia’s case, if our creditors decide to reassess the risk of ‘buying Australia’, two things will happen. Our dollar will be the first to adjust lower. That’s already happening. But it’s happening too slowly. [GSG Note: Another tick – same for the NZ dollar]

–The dollar adjusts lower when the supply of funds coming into Australia doesn’t meet the demand. A lower dollar is the price mechanism to balance the market. It allows foreigners to get more bang for their buck, euro or yen.

–The other adjustment mechanism is market interest rates. A sharply lower dollar will pretty quickly feed through to higher inflation. [GSG Note: As we mentioned earlier today, this is what the RBNZ is wanting too] If the RBA ignores this and keeps cutting interest rates anyway, foreigners might decide to demand higher compensation (higher interest rates) for lending to a country that appears to be losing the plot. [GSG Note: Similar to the US dollar bear trap we mentioned earlier]

–Loss of faith in a central bank or confidence in a currency means the cost to hedge any cross border investment becomes too great — it no longer compensates for the interest rate on offer. So the creditor asks for a higher interest rate as well.

–When that happens, it’s game over for our highly leveraged economy. That’s probably still a year or so away. In the meantime expect more interest rate cuts.
Source.

“Meanwhile, the price of German sovereign bonds, regarded as among the safest credits in the world, have been falling hard. Colleague Tim Price, in London, has the story:

Our favorite “risk-free” reference rate is the yield on the German government 2.5% bond maturing in August 2046. Since mid-April, the yield of this bond has risen by just over 1 percentage point, from 0.46% to 1.54% at the end of last week.

Sounds relatively innocuous, no?

That rise in yield equates to a fall in price of roughly 36%. In just over a month. We thought the collapse in Bund prices was grisly, until we spotted the carnage unfolding in the Austrian government bond market.

Ladies and gentlemen, we give you the Austrian government 3.8% bond maturing in January 2062. The price of this “risk-free” asset has fallen from roughly 220 to 162 as of the end of last week. That is a fall in price of nearly 60%.

If euro zone government bonds are collapsing, can U.S. Treasurys be far behind?”

“According to the Bank for International Settlements (BIS), on the eve of disaster at LTCM in June 1998, there were about $70 trillion in total world derivatives.

In June 2007, prior to the meltdown of Bear Stearns and the ultimate demise of Lehman Bros. a year later, there were roughly $510 trillion in derivatives outstanding — up 628% from the risky decade before.

By June of last year, by one estimate, total world derivatives were $1.5 quadrillion — that’s 14 zeros — an increase of 294%. What will happen the next time these geniuses fail?”

“One fascinating indicator of the past seven years is the direction of interest rates during periods of quantitative easing. The Fed has conducted three programs of quantitative easing since 2008, known as QE1, QE2 and QE3.

The stated purpose of each QE program is to lower interest rates, especially on intermediate-term securities. The idea is to make the yield so low that investors channel funds into other asset classes, such as stocks and real estate.

The higher prices on stocks and real estate are supposed to create a “wealth effect” that causes people to spend more. More spending will then result in higher money velocity and higher nominal GDP. Everything about this theory is flawed, but the Fed believes it, so we need to pay attention if we want to understand Fed policy.

The chart below shows the path of interest rates on 10-year Treasury notes over the past seven years. The shaded areas are the periods of quantitative easing. The red arrows show what happened to 10-year note yields during the QE periods.

Incredibly, note yields did not decline during QE. They rose all three times! There was some volatility along the way, and there were short periods when rates did decline, but the overall impact of QE was to increase rates, not decrease them.

The shaded areas in this chart are periods of quantitative easing, or “QE,” by the Fed. The red arrows show that interest rates on 10-year Treasury notes actually rose during periods of Fed easing.

Equally important for present purposes is that rates declined when the Fed was not doing QE. This is also apparent from a glance at the chart.

Why do rates rise when the Fed is easing and fall when the Fed is not easing? The answer has to do with investor expectations. The Fed may believe the economy is getting stronger, but investors and everyday Americans know better — the fundamentals are weak and getting weaker.

When the Fed prints money (that’s what QE is), investors expect inflation, and therefore rates rise. When the Fed stops printing money, investors expect deflation, and therefore rates fall.”

“It is difficult to see how the Fed can raise rates in 2015 without sinking markets and the economy completely; therefore, a rate increase should not be expected. The only things that will change this outlook are if the Fed blinks and admits it cannot raise rates or if it starts to talk about QE4. We’ll be watching closely for indications and warnings on both of those events.

How can investors benefit from the huge gap between what the Fed expects and what markets expect? This is a good time to take another look at gold, especially high-quality gold mining stocks.

Gold has two ways to win. If low rates persist, gold becomes more attractive because costs of carry and opportunity costs of holding an asset without yield decline. Conversely, if rates go up, that means inflation is on the way, and the gold price benefits from that also.

Gold mining stocks have been beaten down to the point where stock prices will either go up or the miner will go out of business. That’s why it’s important to stick to the high-quality names in the major indexes.”
Source.