Appeal of NZGBs rises. US Fed delays next rate hike, most members see 2 more in 2016. But markets doubt it, push yields generally lower

By Kymberly Martin

NZ swaps and bond yields closed flat to up 2 bps yesterday.

Overnight, offshore yields dipped ahead of this morning’s US FOMC meeting and dipped further afterward.

NZ swap and bond yields traded a fairly distinctive pattern yesterday, declining into early afternoon, before rising into the close. Illustrative was the path of NZ 10-year swap. It traded from 2.75%, down to 2.72%, before rising to close at 2.77%.

Yesterday’s data of non-resident holdings of NZGBs was released, showing a jump from 66.5% to 68.5% in May. While this is still below last year’s high of 70%, it shows the appeal of NZGBs to offshore investors in a low/negative yield world. Yesterday the yield on NZGB ”10-year” bonds closed at 2.48%, having touched intra-day lows of 2.44%.

Overnight, ahead of the US FOMC meeting, offshore yields traded lower. US 10-year yields traded down from 1.63% to below 1.60%. German equivalents traded from 0.01% to -0.01%.

Overall, the US FOMC presented a fairly dovish statement as to be expected. It pointed to a slowing labour market, though also stating that economic activity has picked up. It highlighted that market-based measures of inflation compensation have declined. However, the statement did not put any particular new emphasis on offshore risks. The median forecast of the seventeen policy makers is still for two Fed rate hikes this year. But the number who expects only one has risen to six, from one in March.

The Fed’s dot points were lowered as expected. The median Fed funds rate for 2017 fell to 1.6% from 1.9%, while that for 2018 fell to 2.4% from 2.9%. The long-run Fed funds target sits at 3.0%. After the FOMC’s release, US yields dropped across the curve. 2-year yields plunged from 0.72% to 0.67%, their lowest level since mid-February. US 10-year yields have fallen to 1.58%. The market now prices just 11 bps of Fed hikes by year-end, down from 15bps pre-meeting.

Expect some downward pressure across the NZ curve this morning. However, the release of NZ Q1 GDP will likely have the more enduring impact on the short-end of the curve (see below).

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