Markets starting to doubt Fed can raise rates if Trump stumbles. Markets also increasing doubts the RBNZ can raise its rate anytime this year

By Jason Wong

Global bond yields are lower, supported by reduced risk appetite.

German 10-year bunds are down 5 bps to 0.40%.  US Treasury yields are lower across the curve with the 2-year rate down 1 bp to 1.25% and the 10-year rate down 2 bps to 2.40%.

If Trump doesn’t pass his health bill then that delays or significantly reduces the scope of his tax reform package, reduces the chance of a deficit blowout and reduces the need for the Fed to tighten policy as much as feared.  All of that is supportive for US Treasuries.

The local yield curve flattened yesterday, with traders not keen to take the 2-year swap rate any lower ahead of the RBNZ announcement this morning, while global forces drove rates down at the longer end of the curve, taking the 10-year swap rate down 4bps to 3.455%.  Thus, the 2s10s spread has contracted to 109 bps, down some 20 bps or so over the past week.

Ahead of the RBNZ meeting, the OIS curve is pricing little chance of a change in the OCR over the next six months, with the November meeting priced at 1.845%, suggesting a 38% chance of a hike by then.  This probability has been creeping down over the last week or so, after spending a full month around the 50% mark.

The market has lost some faith that the RBNZ will be ready to hike this year.

The first full hike is not priced until March next year, obviously still a lot earlier than the RBNZ believes (some 18 months earlier) and only a fraction earlier than BNZ economists believe.

After the RBNZ announcement is out of the way, the market will be anticipating Fed Chair Yellen’s speech tonight, although she is unlikely to reveal any fresh insights following last week’s press conference.  More important for the market will be how Trump’s health bill vote is looking.

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