Wholesale interest rates here and abroad are at multi-year highs as markets grow more sceptical about central banks’ ability to tame inflation.
The five-year swap rate, which can have a bearing on home mortgage rates, is now at 5.20 per cent - its highest point since 2010.
It’s a similar story across the yield curve, longer-dated bonds feeling more of the brunt.
Two-year swap rates are at 5.69 per cent - back at 2008 levels - as are two-year government bonds, which trade at 5.71 per cent.
Ten-year bonds are at 5.225 per cent, returning to levels not seen since 2011.
Meanwhile, US 10-year Treasuries this week hit 4.625 - their highest point since 2007.
“Essentially markets are reacting to the reality that central banks may have a bit more work to do,” ANZ strategist David Croy said.
“The recent rise that we have seen in oil prices (to close to US$100 a barrel) has exacerbated those fears that there will be an acceleration of inflation,” Croy said.
Even so, it looked as if the US Federal Reserve was doing well in engineering a soft landing for the US economy, and no one there was talking “recession” just yet.
Added to the mix was general turmoil around Italy’s bigger-than-expected budget deficit, which has hit European bond markets, and threats of a US government shut-down over the administration’s spending cap.
Westpac market strategist Imre Speizer said much of the local interest rate market’s moves had been driven by overseas trends.
“The US has led the way - that rise in the US really kicked off in April and has just kept on going and going and going,” he said.
September was notable because it accelerated faster than it had done in prior months, he said.
“Longer-term rates are rising and outpacing any movement in short rates.”
He said bond markets here and offshore are being driven by three big themes.
The first was general market scepticism as to whether central banks can really get on top of inflation.
“Sure, they (central banks) are pushing rates higher, which is doing some of the work, but markets are doubtful that they will do enough.
“So if you end up with inflation still higher than where it should be, that’s going to push up longer-term bond yields.”
The second theme was the now generally accepted idea that interest rates will stay higher and for longer than was previously thought.
“The expectation is that interest rates will, over the years to come, be higher than prior years, so there is a view that your natural level of interest rate now needs to be higher.”
Market expectations are now for America’s highly influential Fed Funds rate - currently at a 22-year high of 5.25 to 5.50 per cent - will stay at least as high over the next year or so.
Earlier this year, the market was thinking 100 to 150 basis points of cuts by the Fed funds rate would soon be on the cards.
“They have taken that out and have got the message from the US Federal Reserve that rates are high and might go higher, and that they are going to have to stay higher relative to what the market had been pricing in, so the market has had to adjust to that,” Speizer said.
Thirdly, there was the sheer weight of new issuance coming on to the market.
In many countries, government finances have deteriorated and governments have needed to borrow more money, which has meant more bond issuance.
More bonds on issue means that yields need to rise to attract buyers.
“That supply story has been evident clearly in the US and in New Zealand.
“Most countries are grappling with their government finances and markets are expecting bond supply to remain high or even increase.”
In New Zealand’s case, the Government’s borrowing has increased three-fold compared with pre-Covid years.
In the five years leading up to the pandemic, the Government was borrowing $7 billion to $8b a year through the bond market.
This year it plans to raise $36b, and $35b in the following year.
The longer end of the yield curve tends to move in step with international trends, whereas the shorter end tends to react to more domestic issues.
On that score, shorter rates are higher but the extent of the gain has been less pronounced than it has been in the long end.
Financial markets are not pricing in a change to the official cash rate - currently at 5.50 per cent - by the Reserve Bank at next week’s monetary policy announcement.
Beyond that is a different story, and the market is not ruling out another rate hike before the Reserve Bank calls its quits.
Financial markets are pricing in a 50/50 chance of a rate hike in November, but the likelihood of an increase is seen as being close to 100 per cent early next year.
“People have under-expected how high rates can go, and they are still climbing, so we are not out of the woods yet,” Westpac’s Speizer said.
“We ourselves thought that by the end of this year that would be done and the markets would be thinking about the next easing cycle.
“That was premature. It’s not going to happen this side of Christmas.”
The general volatility in world bond markets has been made worse by developments in the northern hemisphere.
The Financial Times reports that European government bond prices dropped sharply this week as investors took fright at Italy’s larger-than-expected budget deficit and mounting concerns that central banks will keep interest rates high for an extended period.
Italian 10-year government bond yields rose as much as 0.17 percentage points to 4.96 per cent, their highest level in a decade, after Prime Minister Giorgia Meloni’s Government raised its fiscal deficit targets and cut its growth forecast for this year and next.
The sell-off spread to UK markets, where 10-year yields rose as much as 0.2 percentage points to 4.57 per cent — the biggest daily rise since February — before ending the day at 4.48 per cent.
The FT said US stocks and government bonds are on course for their worst month of the year as investors respond to the Federal Reserve’s message that interest rates are set to stay higher for longer than previously thought.
Wall Street’s benchmark S&P 500 stock index has fallen more than 5 per cent in September — dragging it towards its first quarterly loss in 12 months.
Jamie Gray is an Auckland-based journalist, covering the financial markets and the primary sector. He joined the Herald in 2011.
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