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Benchmark interest rates fall on Brexit, but rise on 'perphery'. UK to lose AAA status. Markets downgrade chance of US rate rises, upgrade chance of RBNZ rate cuts

Bonds
Benchmark interest rates fall on Brexit, but rise on 'perphery'. UK to lose AAA status. Markets downgrade chance of US rate rises, upgrade chance of RBNZ rate cuts

By Jason Wong

The shock referendum result fed through into interest rate markets as one would expect.

US 10-year Treasury rates traded down to as low as 1.40% in the Asian trading session, and retraced a lot of that move in European and NY trading, closing at 1.56%, down 19bps for the day.  This was about 6 bps higher relative to trading conditions at the NZ market close on Friday.

UK 10-year gilts at the epicentre fell by the most, down 29 bps to 1.08%, with investors putting more weight on a lower-for-longer UK rates in a potentially recessionary environment than worried about credit risk.  Ratings agencies have already indicated that the UK is likely to lose its AAA credit rating.

Peripheral European countries saw 10-rates up 15 bps (Italy), 16 bps (Spain) and 25 bps (Portugal) as investors pondered the chance of an eventual break-up of the EU and euro-area.  Their rise in spread to Germany was even greater, with 10-year bunds down 14bps in yield to minus 0.05%, having traded down to minus 0.17% at their low.

US monetary policy expectations have turned remarkably on the referendum result. The OIS market now prices in the chance of a rate cut from as soon as July, with 3 bps priced in.  No rate hikes are now effectively priced in through the next nine months with the OIS curve fairly flat out to that point.  The 2-year US Treasury rate of 0.63%, down 15bps, is also indicative of the lack of potential for tighter US monetary policy for some time.

The local rates market was swept up amongst the turmoil.  The yield curve flattened, with 2-year swap down 14 bps to 2.185% and 10-year swap down 21 bps to 2.66%, a record low for the latter.  The NZ government bond curve shifted down in a similar fashion.  The Apr-2027 bond yield fell by 23 bps to 2.36%, a record low.

The more uncertain global economic outlook and lack of downward pressure on the NZ TWI increases the chance of further RBNZ rate cuts.  The OIS market prices August at 2.06%, suggesting a 76% chance of a 25 bps cut.  A chance of a possible follow-up move was also priced in, with the OIS curve falling away, down to 1.88% by March.

Over coming weeks, the market will be less focused on data watching and more focused on developments in the UK and Europe.  Indeed, any data releases over the coming month that pre-date the referendum will be heavily down-weighted in their influence on the market.  Political developments will largely set the tone for the markets over coming weeks and many questions remain unanswered. 

Daily swap rates

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

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1 Comments

The OIS market now prices in the chance of a rate cut from as soon as July, with 3 bps priced in. No rate hikes are now effectively priced in through the next nine months with the OIS curve fairly flat out to that point.

I believe this market indicator is moribund. Read more

The 2-year US Treasury rate of 0.63%, down 15bps, is also indicative of the lack of potential for tighter US monetary policy for some time.>

Some claim that which you assert is an indication of a precondition of existing monetary tightness.

It is rote mainstream recitation that low interest rates equal stimulus while high interest rates demonstrate the opposite to some degree of “tightness.” As Friedman pointed out, this is entirely backward as demonstrated conclusively by economic history:

Initially, higher monetary growth would reduce short-term interest rates even further. As the economy revives, however, interest rates would start to rise. That is the standard pattern and explains why it is so misleading to judge monetary policy by interest rates. Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy. Read more

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