US influence continues on NZ interest rates

The latest source of confusion comes out of the United States – not in terms of the stronger than expected economic data noted last month but the collapse/takeover of the Silicon Valley Bank and issues for two others as well. Worries about a broader rout in the banking sector have caused not much sustained weakness in share prices but some definite declines in wholesale interest rates.

These declines in the likes of the US two year Treasury bond yield from 5.1% to just over 4% come about because of expectations that banks will newly restrict their lending in order to reduce reliance on deposits. Their focus on deposits has arisen because the cause of SVB problems was not bad lending but bad management of deposits and poor liquidity policy.

That is why US interest rates have fallen. The markets believe the Federal Reserve might only need to raise their overnight interest rate one more time and that before the end of the year they will start cutting the rate.

This matters here in New Zealand because while our Reserve Bank has close control over the levels of floating interest rates, as we go further out along the yield curve to one year, three year, five year fixed rates the levels of these rates offshore matter more and more.

Thus, we have seen the likes of the cost to banks in New Zealand of borrowing money at a one year fixed rate to lend to you and I fixed for one year fall from over 5.6% before the SVB collapse to now around 5.25%. The three year bank borrowing cost has fallen from 5.25% to near 4.6%.

This raises the question then of whether fixed mortgage rates here are about to fall by 0.3% - 0.6%. No, for two reasons. First, when banks last changed their rates a couple of months ago the one year borrowing cost was about 5.25% and the three year cost about 4.5%. These costs went up in response to strong US data discussed last month and now have gone back broadly to where they were because of the US banking situation. Such is the US influence here on fixed interest rates.

The second reason is this. Wholesale borrowing costs are highly volatile and if a bank initiates a round of rate cuts in this environment they risk having to put them up again quickly because their cost of borrowing could jump 0.3% overnight. There is reputational damage in cutting rates only to then raise them a few days later.

That implies a slightly better outlook for our interest rates than was the case before SVB fell and that makes me even more confident that NZ fixed mortgage rates peaked a couple of months ago.