NZ 2-year swap yields highest close since April 2012; market now prices 45% chance of 25bps OCR hike by year-end

By Kymberly Martin

NZ swaps closed up a further 2-3bps across the curve on Friday. US 10-year yields ended the week at 2.02%.

NZ 2-year swap yields ended the week at 2.91%, their highest close since April last year. The market now prices a 45% chance of a 25bps OCR hike by year-end.

We forecast a first hike in December, with steady hikes thereafter, to take the cash rate to 4.25% by end 2014. Based on our expectations current ‘fair value’ for 2-year swaps is around 3.40%.

Still, we believe it will be some time before the market moves to price our view.

In the meantime, the next key domestic data to watch will be Thursday’s Q4 Household Labour Force Survey (HLFS). We and the market expect the unemployment rate to tick back down to 7.1%.

This would align better with trend-improving labour data shown elsewhere, compared to the unexpectedly weak Q3 HLFS.

An outcome in line, or better-than-expected could nudge short-end swaps higher this week. We still see the greatest risk of a pull-back in yields coming from a souring in current ebullient global sentiment.

Friday’s DMO bond auction was once again lackluster. The average bid-to-cover ratio was a modest 2.7x and successful bids were above mid yields at the time. Bonds sold off 4bps on the day. Relative to offshore equivalents and swap we think they have further to go.

US 10-year bond yields initially dipped lower after US payroll headlines came in below expectation. But the deeper story was in upward revisions to previous data. US 10-year yields then rose from 1.93% to end the week at 2.02%, at ten month highs.

Higher US yields should continue to exert upward pressure at the long-end of the NZ curve. US 10-year yields then rose from 1.93% to end the week at 2.02%, at ten month highs, following positive surprise to US ISM data.

Attention will move back across the Atlantic this week, with the BoE and ECB meeting on Thursday. Ahead of this, the local focus will be on tomorrow’s RBA meeting. The market prices a 20% chance of a cut at the meeting.

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