2-year swaps hit levels last seen in March 2012 while 10-year swaps close at 4.4% (up 19 bps)

By Kymberly Martin

There was a huge response in the NZ market to the post-FOMC sell-off in US Treasuries. Overnight, US 10-year yields have moved up further, above 2.40%.

NZ swaps closed up 8-19bps with a notable steepening to the curve yesterday.

2-year traded as high as 3.17% intra-day before closing at 3.15%. This is equal to the highs in March last year.

The market now prices 50bps of RBNZ rate hikes in the year ahead. We continue to see 75bps of hikes by a year’s time after a first hike in March 2014.

While there will still be dips along the road to higher swap yields across the curve by year-end, we think such dips may prove short-lived. This is due to the fact that we now see a steady weight of money from the ‘real’ economy (mortgage book, businesses) wanting to hedge against future rate rises.

Meanwhile, 5 and 10-year swap closed up 8 and 19bps respectively. As the 10-year closed at 4.40%, the 2-10s curve has steepened to the top of its ytd range, at 125bps.

Given the further surge higher in US long yields overnight, the top of the range may blow-out today. Still, we do not see this as the start of a sustained steepening trend.

Rather, we would be looking for opportunities to position for flattening once US yields find a new range, as the NZ short-end factors in further OCR hikes.

Meanwhile NZ bonds yields closed up a striking 12-28bps with a sharp steepening of the curve. The yield on NZ 10-year bonds closed at 4.07%, its highest level since April last year.

Not surprisingly, yesterday’s DMO tender was weak. Similar to the LGFA tender the previous day, the bid-to-cover ratio was acceptable at 2.9x, but the range of successful bids was wide at 7bps, and well above the market at the time. This resulted in the entire NZ bond curve re-pricing over the afternoon.

As a result of these moves NZ swap-bond spreads have collapsed. 10-year spreads are now at 33bps. Given further moves offshore overnight, spreads could narrow a little further today.

However, we are likely approaching levels to look to position for widening. We see a 35-60bps range as justified over the medium-term.

US 10-year yields had a fairly volatile night trading between 2.36% and 2.47% before returning to trade at 2.39% currently. This is above their highs achieved when yields surged higher last March, and now the highest level since August 2011.

Expect another fairly volatile day in NZ markets to end the week.

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