Steeper NZ rate curve provides opportunities to hedge; BNZ sees flattening potential

By Kymberly Martin

Over the past few weeks, in thinner Christmas/New Year markets, NZ swap yields have continued to trade within established ranges.

Yields are now at the upper end of ranges, with 2-year at 2.79%.

The market now prices only a 20% chance of a 25bps cut from the RBNZ in the year ahead.

We do not expect cuts, but rather a first hike at year end.

Still, we believe that over H1 the market will likely still periodically move to price increased chance of rate cuts. This will occur either when: perceptions of global risk rise; when markets extrapolate expected further RBA cuts across the Tasman; or when NZ data is underwhelming.

These times may provide opportunities to incrementally add to hedges.

The NZ 2s-10s curve has steepened from the long-end, as it has followed US (and AU) long yields higher. The curve is now 113bps steep, approaching levels we would re-position for flattening. US 10-year yields rose into early New Year.

Still, on Friday night, 10-year yields were knocked back from 8 month highs to sit back at key levels just below 1.90%. It has marked the top of the range since August.

This occurred as the US unemployment rate was shown ticking up from 7.7% to 7.8%, once again raising doubts regarding how quickly the Fed can reign in very loose policy.

We expect this debate will continue for some time, and US long yields are not on a one-way path higher. However, we do see 10-year yields higher at 2.25% by year end.

This should help limit flattening pressure on the NZ curve, otherwise induced by approaching OCR hikes.

The spreads of peripheral European bonds to German counterparts have narrowed in recent days on the back of broader market optimism. This has taken Italian-German spreads to their tightest level in around 16 months. A key upcoming challenge in this region will be the Italian election scheduled for late February.

This week, is fairly thin on the ground for market moving domestic data. Globally, a number of data will add colour on the state of Europe. The EU unemployment rate is released tomorrow and expected to pick up to 11.8%. German industrial production is released on Thursday. On Thursday night, both the BoE and ECB are expected to announce interest rates.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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