NZ 2-year swaps approaching "value" range while 5-year swaps would need to drop 60bps to achieve same

By Kymberly Martin

It was a very quiet day in NZ rates markets. Swap yields edged down 1-2bps with a flattening bias to the curve. While 2-year swap sits at 3.43% the 2-10s curve is a little flatter at 149bps.

We continue to believe that if 2-year swaps move below 3.40% then “value” should start to reappear from a hedging perspective.

However, 5-year swaps rates remain relatively expensive in our view. We believe yields on 5-year swap (4.38%) would have to drop toward 4.00% before compelling hedging “value” would re-emerge.

In quiet trading, NZ bonds yields closed down 1-3bps across the curve. The yield on NZ 10-year bonds now sits at 4.59%, more than 20bps below last week’s pre-US FOMC highs. Still NZ long bonds stand out on a global basis, providing the highest yield amongst peers, excluding Greece and Portugal.

Overnight, US 10-year yields consolidated further around the 2.65% level. The 2nd revision of Q2 GDP showed the Fed’s preferred inflation measure (core PCE) revised down to 0.6%q/q. This is one of the lowest readings in 50-years suggesting, for now, inflation is not an impediment to the Fed maintaining accommodative policy.

In Europe, Italian-German bond spreads have been stealthily widening in recent days. From 234bps last week 10-year spreads are now at 251bps.

In the latest political wrangling, allies of deposed former Premier Berlusconi have threatened to step down if he is expelled from the Senate due to his tax fraud convictions. The coalition government is looking increasingly fragile.

Tonight’s Italian bond auction will therefore provide a good barometer of current sentiment toward its sovereign risk.

The domestic agenda is bare today, so expect a fairly subdued end to the week.