Fed's focus squarely on making progress in the labour market; inflation not a concern

By Kymberly Martin

There was little response by NZ markets to yesterday’s RBNZ statement. More dramatic was the move in US bonds after the US Federal Reserve announcement.

At yesterday’s meeting the RBNZ played a very straight bat, providing little to surprise markets. As expected, it pushed back its implied starting point for rate hikes.

We now formally expect a first OCR hike in December 2013 (previously March). However, the RBNZ provided no discussion of rate cuts despite reference to the persistently high NZD.

The market’s response was minimal. Swap yields closed little changed, with just a 2bps steepening in the 2s-10s curve to 109bps. The market continues to price around a 60% chance of a 25bps rate cut in the coming 6 months.

Bond yields closed 4-5bps higher. The DMO has announced its offer today of $100m of NZGB 15s and $150m of NZGB 23s. Recent demand at weekly auction can at best be described as erratic.

Early this morning the US Federal Reserve announced ‘QEIII’ as the market expected. It announced it will purchase up to $40b of Mortgage Back Securities (MBS) per month. 

‘Operation Twist’ maintains in place (i.e the process of extending the duration of its Treasury holdings). The Fed’s focus was squarely on the lack of progress in the labour market. It will continue or extend policy easing until an improvement in the labour market is seen.

Inflation was not seen as a concern. It also extended the period that it expects the Fed Funds rate to remain ‘extremely low’, to mid 2015 (late 2014 previously). Chairman Bernanke acknowledged improvements in the housing market but stated the economic outlook remains uncertain.

Generally, ‘risky’ assets surged after the announcement. US ‘safe haven’ bonds initially sold-off. This reaction function suggests the market was initially focusing on the potential stimulus the policy will provide to US growth and asset prices.

US 10-year bond yields spiked from 1.72% to previous crucial support levels close to 1.85%. However, this has proved unsustained and yields now sit back at 1.73%. The bond market is likely now more soberly digesting that the Fed’s QEIII policy is aimed at holding down long-term borrowing costs (yields).

Overnight, Italy also managed to sell 3-year bonds at the lowest rate in almost two years, benefiting from the current improvement in mood toward Europe.

NZ data today is low key, and unlikely to be market moving. It is also unclear whether NZ long yields will react much to overnight moves, given the rise in US yields has now faded. Today’s DMO auction will be the more critical driver of yields