Spain to auction more junk bonds testing sentiment toward peripheral European risk

By Kymberly Martin

NZ swap yields, climbed gently over the course of the day, leading into the RBA meeting, closing up 2-4bps. Still, yields across the curve, remain not far off the lows of their trading ranges of the past few months.

The 2s-10s curve has steepened a little to 110bps. We continue to target levels approaching 120bps to position for curve flattening.

The RBA cut rates by 25bps yesterday afternoon, as expected. Weakness in non-mining investment and the strength of the AUD were factors behind the decision to cut.

As the cut had largely been priced, the response in AU fixed interest markets was fairly minimal. The RBA has left the door open for further cuts.

The market continues to price up to a further 50bps (which would take the cash rate down to that of the RBNZ’s, at 2.50%).

We see this pricing as reasonable, though our NAB colleagues suspect a next cut would not come before Q2 next year. The RBA will likely take some time to assess the impact of recent cuts on the economy through Q1.

Post the RBA meeting the market looks for around 25bps of RBNZ cuts in the year ahead, but still limited (15%) chance of a cut on Thursday.

We do not expect a cut but for the RBNZ’s tone to be more dovish than previously.

The Bank of Canada left its target rate unchanged at 1.0% last night, as expected by the market. It maintained the exact language from previous statements, that a modest withdrawal of stimulus is likely needed over time.

Overnight, there was little on the data front to impact markets. US 10-year bond yields dipped a little, back toward 1.60%, as the market remains in limbo given the lack of progress in US fiscal cliff negotiations.

In Europe, peripheral spreads to German bonds narrowed further (Italian spreads are at the lowest level since March).The market remains optimistic the recently announced Greek government buyback of bonds will be successful.

Tonight, Spain will auction bonds as a further test of current sentiment toward peripheral European risk.

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