Interest Rates Overview 27/09/2012

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If I Were A Borrower What Would I Do?

Tony Alexander, Chief Economist at BNZ, his thoughts are:

I would fix for two years at 5.4% with some of my mortgage left at the floating rate of 5.74%. This I would do because the two year fixed rate is nicely below the floating rate and the chances of the floating rate falling near 0.4% in the next few months to reach the current two year rate are fairly slim – unless as noted above the world economy collapses or the NZD shoots soon to US 90 cents.

I would not fix at the three year rate of 5.9%, not because that is above the floating rate but because the premium to pay over fixing two years is simply too great.

What about something tricky like buying into a scenario that the RB eases and floating now then fixing right after they do? Or fixing one year then fixing three years in a year’s time just before an improving outlook perhaps pushes all fixed rates upward? Or fixing two years but breaking the rate to move into three years or longer if there are signs of rates shooting up?

Someone is going to have the optimal hedging strategy for the next five years for sure. But it is impossible given the huge uncertainties in normal times to be confident that any variant on one of the three strategies just mentioned will be optimal – let alone in these massively uncertain times. As noted for about two years now, you are a fool if you base your interest rate risk management decisions on a particular set of interest rate forecasts. Whatever the forecast is now it won’t be the same in six months time and one cannot even be confident about what the direction of change will be. That is because you need to take views on things such as:
-how high the NZD goes and whether it looks like going higher
-whether the Euro holds together
-whether the American Republicans and Democrats can politely agree on a means of avoiding the programmed in 4% of GDP tightening of US fiscal policy at the start of next year
-whether China’s growth is comfortably slowing to just 7% then naturally kicking back upward or whether this is a large structural change which by holding off from a big stimulus the authorities miss and growth plunges to 5%,
-whether you and I go crazy on stories of housing shortages, sustained low interest rates and rising house prices and start mortgaging to the hilt to taste that beautiful tax-free capital gain. (Not that imposing a CGT would make much difference anyway given the very low returns available on alternative investments and the fact that any such tax would simply worsen the shortage and after an initial small dip contribute to pushing prices even higher).

So putting together all these uncertain factors and so many which we can’t even conceive a probability for at the moment (impact on oil prices of Middle East tensions, impact on oil prices of soaring gas availability and rising oil supplies from new extraction techniques) we are left with simply chasing a low cost borrowing option delivering mild but not high insurance against interest rate movements for the next few years.

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