RBNZ rate cut foregone conclusion according to market; BNZ believes realistically around 35% chance of cut

By Kymberly Martin

Swap yields slipped a little lower yesterday, closing down 3-4bps across the curve.

2-year swaps closed at 2.58%, close to the 2.55% level we have long suggested as a good level to pay. Yesterday’s lacklustre PSI (49.6) added to a recent array of less than inspiring domestic data.

The market now prices more than a 100% chance of a 25bps RBNZ rate cut in the year ahead. As outlined in our ‘Weekly Markets Outlook’ yesterday, we see the probability as closer to 35%.

We therefore continue to believe 2-year swaps are close to attractive paying levels. Still, we expect today’s Q3 CPI release may provide the opportunity to pay swap at lower levels. The market looks for a 1%y/y CPI outcome and we formally have a 0.9%y/y forecast.

Thereafter, we see inflation picking up to a 1.6%y/y rate in Q4, before continuing to build next year. The market may however, extrapolate a low-side outcome to a continued downward trend in inflation. It may thereby increase expectations of RBNZ rate cuts, and short-end swaps will slump further.

5-year swap sits almost at all-time lows. At just below 2.99%, it is close to the bottom of its range since mid-May this year. We expect the 2.90% to 3.35% range on 5-year swap should continue to hold. We therefore also see value in paying 5-year swap around these levels.

Last night, US retail sales data surprised to the upside. This underpinned an inch higher in US 10-year bond yields to 1.67%. Tonight, all eyes will be on the German ZEW survey of the economy, to gauge the ongoing effects of the European crisis on its ‘core’.

US CPI data will also be released, but is expected to remain contained below 2.0%y/y. It is some years out that the market is beginning to price higher US inflation as a potential implication of prolonged monetary stimulus.