Sharp widening in credit spreads after markets rush to safety as financials and cyclical sectors feel the pressure. Markets price just one cut in 2016

By Kymberly Martin

With the NZ market closed for Waitangi day, NZ swaps remain where they closed on Friday eve, with 2-year at 2.62%.The market continues to look for RBNZ easing in the year ahead.

Slightly more than 25 bps are priced by the end of the year.

Our central case remains that the Bank will keep the OCR at 2.5% throughout this year. Certainly it has made clear that low headline CPI readings, in themselves, will not be sufficient to prompt cut(s). Still, we do see increasing risk that global ructions, or weakness in the domestic dairy sector, force the Bank’s hand in the direction of cut(s).

Regardless of whether the Bank ultimately delivers, we see it as probable that the market prices up to 50 bps of cuts in coming months. This is consistent with our view that 2-year swap can trade down to 2.5% near-term, before heading higher later in the year.

Friday night was all about US payrolls. US 10-year yields experienced volatile trading. While the headline release (151k) disappointed official consensus, the unemployment rate unexpectedly dropped and hourly earnings increased. Yields across the US curve pushed higher. But they were unable to hold onto gains, ending the week at, or only slightly above, pre-payrolls levels.US 10-year yields closed at 1.84%.

However, yields have pushed lower since the start of the week. US 10-year yields, at 1.75%, are now at their lowest level since early-February last year. ‘Safe haven’ Treasuries remain in demand as US and European equities have continued their retreat. This time their decline is being led by financials and cyclical sectors rather than the energy sector.

Credit spreads also remain under pressure, with CDS spreads gapping wider, particularly in Europe. Peripheral European sovereign spreads to German bunds have also pushed sharply wider, to levels not seen since periods of high stress last year. Closer to home, the Aussie iTraxx index trades close to 160, a level consistent with ongoing widening pressure on NZ credit spreads, including high-grade entities such as LGFA and SSAs.

It is a quiet days on the local data front today. Expect NZ swaps to open lower with the curve flatter, taking its cue from offshore moves.