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Yield curve steepens as long rates rise. Markets see low chance of an OCR hike next week. But offshore benchmark rates trending up

Bonds
Yield curve steepens as long rates rise. Markets see low chance of an OCR hike next week. But offshore benchmark rates trending up

By Jason Wong

US 10-year Treasury yields extended their recent rise, reaching a high of 1.89% overnight, their highest level since late March. 

They are currently up 3 bps at 1.87%.

While oil prices were softer overnight, their recent strong rally and improvement in risk appetite is leading to investors to reassess the outlook for Fed policy.

An extra 6 bps of tightening has been priced into December Fed Futures this week, taking the implied rate to 0.57%, suggesting a 75% chance of a 25 bps rate hike by the end of the year.

Supporting the weaker bond market sentiment was an unexpected fall in weekly jobless claims, taking them down to their lowest level since 1973, indicative of the strength of the US labour market.  The unexpected fall in the Philly Fed business outlook index was over-looked, as it retraced a spike up the previous month.

Bond markets across Europe were also weaker.  Germany’s 10-year rate was trending higher leading up to the ECB’s policy announcement and the rise was extended a little further after the announcement – it ended the session up 8.5 bps to 0.24%, the highest level since mid-March.

As widely expected, the ECB made no new policy initiatives following the series of measures announced in March, which are still to take effect.  Draghi commented that he sees rates “at present or lower levels for an extended time”.

The ECB unveiled its corporate bond buying programme, targeting non-bank paper of maturity between 6-months and 30-years, up to a maximum of 70% of each bond, casting a pretty wide net in the process.  These measures will help support the corporate debt market, with some spillover into other jurisdications.

In local trading yesterday we saw a steepening of the yield curve, as global forces drove long term rates higher, while growing expectations of further RBNZ easing kept the short end underpinned.  The 2-year swap rate closed 0.5 bps lower at 2.24% while the 10-year rate increased by 5 bps to 2.98%.  OIS pricing for next week’s OCR review shows a rate of 2.1625%, implying a 35% chance of a 25 bps tightening.

Indicative of strong demand for yield, the government’s latest tender of $150m 2020 bonds was well received, with a bid-cover ratio of 5.3.  Furthermore, Westpac issued $700m of 5-year fixed-rate bonds at a spread of 130 bps over swap.

Daily swap rates

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Jason Wong is on the BNZ Research team. All its research is available here.

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