US treasury bonds sold off following release of disappointing payroll data

By Kymberly Martin

NZ swap yields closed up on Friday with slight curve steepening. 2-year swap yields remain very much mid-range at 2.72%. The market continues to price around a 50% chance of a 25bps RBNZ cut by year’s end. Locally, all eyes this week will be on Thursday’s RBNZ meeting.

We expect the MPS will confirm the next rate move is likely to be up rather than down, with a starting point around mid next year. This may prompt some further upside to short-end yields. However, we expect the top-side for 2-year swaps will be capped by the 2.90% level, for now.

The NZ 2s-10s swap curve appears to be stabilising around the 110bps level. The longer end of the NZ curve will take its cue from moves in US 10-year bond yields. These in turn will be significantly impacted by this Thursday’s US Federal Reserve meeting.

On Friday evening US 10-year bonds yields initially dropped around 12bps after the disappointing payrolls data. Thereafter they stabilised around 1.67%. If the Fed does not meet market expectations for QEIII this week, it will likely provide strong hints further policy easing is imminent.

This should limit any sell-off in US bonds. We would see 10-year bond yields finding support just above 1.80%. This should also limit any near-term steepening in the NZ curve.

However, the weakness in demand for NZ bonds at last week’s DMO auction has already seen a marked 20bps rise in NZ 10-year bond yields. This resulted in steepening of the NZ bond curve.

We will therefore be watching Thursday’s DMO auction closely to see if last week was a ‘one off’ or resumption of weak demand at DMO auctions.

We would expect NZ long yields to open under downward pressure this morning, given the downward move in US long yields on Friday. Similar moves have also been seen in Aussie futures. Thereafter, all eyes will be on Thursday’s RBNZ meeting. There is also no shortage of global risk events to impact on NZ markets this week. Expect some volatility.