Expect upward pressure on local rates today as curve steepens on reassessment from US Fed minutes

By Kymberly Martin

NZ swaps closed up 1-2bps yesterday.

Overnight, US 10-year yields pushed up from 1.78% to 1.87%.

It was a reasonably quiet day in local rates markets. Yields closed modestly higher across the curve, taking 2-year swap up to 2.24%. This is around the middle of the range it has traded for the past couple of months. The market now prices slightly less than a 50% chance of an RBNZ cut at the June meeting. It prices around a 1.9% trough in the OCR within the year ahead.

Longer-dated NZGBs outperformed swap yesterday. NZ 10-year swap-bond spreads now sit above 30bps. However, we think these can still push out to test the top of the 5-35bps range of recent months. This afternoon’s DMO auction of NZGB2020s will provide the latest test of demand for NZGBs. NZD150m are on offer, in the first tender of mid-curve bonds for a month.

In the early hours of this morning, US yields pushed higher ahead of the release of US FOMC Minutes. From 1.77%, US 10-year yields traded up to 1.82%.

The Minutes were more hawkish than most had expected. They stated that a few participants judged it appropriate to increase the target range for the FFR at the April meeting. Furthermore “most” participants judged that if economic developments warranted, it would be appropriate to raise the FFR in June.

But “some” were concerned that the market had not properly assessed the likelihood of a June hike. They saw pricing of a June hike as “unduly low.” Ahead of the Minutes this prospect was priced at less than 20%. This probability has now pushed up toward 30%.

However the meeting is still a month away. Past performance of the Fed shows that between now and then, US data will not only need to hold up, but financial market volatility remain low, if it is to have the courage to pull the trigger. It will also need to work to nudge up market pricing to avoid undue volatility on a ‘surprise’ hike. In this regard the Fed Minutes emphasised the need for clear communication inter-meeting.

But the FOMC also intended to leave its options open and remain flexible in its decision-making. Some participants noted that global financial markets could be sensitive to the upcoming British referendum or to unanticipated developments associated with China’s management of its exchange rate. So a June hike is far from a done deal, but likely still under-priced by the market.

US 2-year yields have pushed up from 0.85% to 0.91% on the release of the Minutes, their highest level since mid-March. US 10-year yields have extended their early morning rise to sit at 1.87% currently.

Expect some upward pressure on the NZ curve at the open today with associated curve steepening. Today, the release of the AU employment report will be the key influence on AU, and by contagion, NZ rates.

Kymberly Martin is on the BNZ Research team. All its research is available here.