STOP, BREATHE DEEPLY, THINK. If you haven't fixed yet ... don't panic. Even with a five-year rate at 7.50% the world won't topple over tomorrow! Interest rate cycles take up to seven years and the Reserve Bank only kicked this one off six months ago.
We are in the middle of a major recession so the Reserve Bank is hardly going to start increasing rates anytime soon. If anything the economy seems to be getting worse, not better. There are some fundamental reasons why long-term rates will track upwards, mostly to do with inflation and bank funding costs. That said, I think we are seeing way more than that at the moment. Simple supply and demand. As more homeowners rush in to lock for five years the interest rates will go up. The reason is that banks will struggle to find investors prepared to pick up the other side and invest in five-year fixed rates. We mentioned that this would happen in our blog Long term rates have bottomed, back in mid-February.
Short-term rates are not going up. You can expect variable, six-month and one-year rates to stay low. The pivot point appears to be the two-year rate, which is hanging around 5.95%. The long-term rates will stop going up when the market finds its equilibrium. With spooked homeowners fuelling demand for five-year fixed, the rates could go up a bit further, especially as everyone dives in. Remember that everyone went into variable rates over the past three or four months, and they are now jumping back into fixed. That's about $10 billion of home loans diving into longer-term fixed rates when there are few investors. You have to ask yourself, is the new equilibrium good value? I was okay with a five-year rate up to 6.50% or 6.75%, but in my mind anything over 7.00% in the midst of a major recession isn't great value. I'd rather get a few years of shorter term rates with five in front of them. Don't get me wrong - I intend to fix for five years, but not until a true economic recovery is underway. I wouldn't advocate this if you are the nervous type - not worth the stress! If rates keep you awake at night then lock in now and add a few years to your life. The Reserve Bank is highly likely to drop the official cash rate again next month - and I'm picking another 0.50%. I also expect the Governor to put the banks under a bit of pressure to pass it on. The 90-day bank bill is sitting around 3.00-ish so at 5.95% to 6.20%, banks are already carrying close to 3.00% margins against historic averages of around 1.30%.
My view? That’s enough fat to cover their higher funding costs. Over the long term, higher inflation will be a global issue. But I struggle to see where it will come from domestically. From what I can see Kiwis are banking their interest savings and not spending them, and our Government seems to be running out of money!
If you are struggling to sleep, or live on a pretty tight budget, then our view has always been to fix long. Another option could be to consider two- to three-year rates at around 5.95%. That will at least give you some piece of mind for the next few years and is fairly good value. The five-year rate, even at 7.20%, probably isn't that bad but it wouldn’t be my first choice. If you are of a conservative nature, don't feel too guilty putting some into the five-year, but always split it with another term to reduce your risk. It really comes down to a classic trade-off between risk and return and everyone will have a different appetite. I'm prepared to stay in short-term rates for a cash flow benefit now. Others will want the certainty of longer-term rates. Or you could sit on the fence and do a bit of both (just not a picket fence!)