Yields vulnerable to pull-back if US Fed Chairman Bernanke ramps up dovish rhetoric

By Kymberly Martin

NZ swap yields pushed higher yesterday, to close 6-8bps higher across the curve. Bond yields remain contained.

The market now prices little chance of RBNZ rate cuts in the year ahead, but that the OCR will be around 10bps higher in 12 months’ time.

This has taken short-end swap yields right to the top of the range they have traded for the past 8 months. 2-year swap closed at 2.87%, nudging at the top of its 2.50-2.90% range.

The pricing out of global tail risk appears to be the key driver at present, as opposed to specific domestic developments.

Overnight, US yields were boosted by better-than-expected US durable goods orders. US 10-year yields broke higher, touching 2.0% for the first time since April. Our end of year target for US 10-year yields is 2.25%.

Still, we think it will likely be a bumpy road to get there. A pullback in yields is likely if/when current elevated global risk appetite fades.

Equally, yields are vulnerable to a pull-back if US Fed Chairman Bernanke ramps up dovish rhetoric in an attempt to stop markets ‘getting ahead of themselves’. In this regard, Thursday morning’s FOMC meeting will be critical.

Thursday’s RBNZ meeting will also be crucial to whether NZ yields can convincingly break higher. The Bank’s statement is expected to be balanced. But the risk is that markets latch onto any hawkish strains, pushing yields higher.

Despite our view that the OCR will be 25bps higher by year-end and 2-year swap yields 50bps higher at 3.40%, we doubt it will be a one way path higher in yields from here. We see plenty of opportunity for dented global risk appetite to knock yields lower.

For today, we suspect the overnight rise in US long yields should see upward pressure on the long-end of the NZ curve.