High expectations Fed will announce asset purchases will continue after year-end, essentially extending QE3

By Kymberly Martin

Swap yields rose 2bps across the curve on Friday, following their big run-up the previous day, after the RBNZ meeting. At 2.70%, 2-year yields are back in the middle of their 2.50%-2.90% range that now appears firmly entrenched.

The range is consistent with the market moving between pricing around 30bps of rate cuts, and a maximum of 10bps of rate hikes in the subsequent 12 months.

At present, the market prices around a 50% chance of a 25bps cut in the year ahead. We do not expect cuts, and believe the RBNZ’s threshold for cutting is high.

Still, we suspect the market will continue to veer in the direction of pricing cuts in the year ahead. Such times may be used as opportunities, by those needing to undertake rate hedging activity.

The 2s-10s swap curve is also fairly mid-range, having closed the week at 104bps. The long-end of the NZ curve continues to be very much influenced by off-shore rates.

In this regard, Friday night’s US November payrolls gave US long yields a shot in the arm. US 10-year yields gapped higher following the release, from 1.57% to 1.62%.

After the excitement of last week, this week’s local data is of second tier importance. Expect NZ short-end yields to consolidate recent moves. At the long-end there are some key global events to potentially impact on yields. Tomorrow evening, the German ZEW survey of the economy is released.

The week’s highlight comes with Wednesday’s US FOMC meeting. There are high expectations the Fed will announce its asset purchases will continue after year-end, essentially extending QE3.

As the Fed’s key focus is currently the US labour market, President Bernanke’s comments in this area will be dissected. The market will be particularly focused on whether last week’s employment data is seen to be distorted by Hurricane Sandy.