RBNZ statement expected to be balanced; any hawkish strains will be latched onto by market

By Kymberly Martin

NZ swap yields followed offshore yields higher yesterday, closing up 3-6bps. The curve has steepened.

NZ 2-year yields closed at 2.90%, close to the highs of its trading range of the past 8 months. The market now prices less than a 10% chance of an OCR cut by mid-year.

Rather, the market prices a 40% chance of a 25bps rate hike by year-end. We expect a first hike in December.

Tomorrow’s RBNZ meeting will 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.

Beyond this, we still see plenty of opportunity for yields to be knocked lower, not least if buoyant global sentiment fades.

NZ bonds sold off further yesterday, with NZGB 23 yields rising 10bps to 3.66%. We believe there is still further for NZ bond yields to rise relative to AU and US equivalents and NZ swap yields.

Overnight, US 10-year bond yields consolidated around 1.97%, failing to revisit 2.0%. All eyes will now be on the US FOMC meeting early tomorrow morning (NZT).

Given the recent surge higher, US 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’.

Friday’s US payroll data will also be crucial, given the Fed has placed labour market indicators at the centre of their decision-making process.

In the current relative calm in European markets, Italian-German bond yields spreads are quietly inching lower. 10-year bond spreads, at 248bps, are now at their lowest level since July 2011.

This is down from 540bps mid last year. Italy’s 10-year borrowing costs are now only 50bps higher than the NZ government’s. Tonight, Italy revisits the market to sell bonds.