US retail sales and University of Michigan confidence data disappointed; US 10-year bond yields fall

By Kymberly Martin

It was a fairly subdued end to the week. NZ yields closed up 3-5bps across the curve.

The yields on 2 and 5-year swaps closed at 3.57% and 4.55% respectively, new cyclical highs for both. The market now prices almost 100bps of OCR hikes in the year ahead and close to 200bps in the coming two years. This is close to our own expectations that the OCR will peak at 4.50% in mid-2015.

This limits the outright ‘value’ that we see in hedging at current swap levels. i.e based on our OCR forecasts we are close to ‘break-even’ on 2 to 5-year swaps.

However, hedging does mitigate the risk that we are under-estimating the rate at which the OCR will peak. The RBNZ’s most recent forecasts hint the peak in the OCR may be higher than we currently expect, though at a later date.

The NZ 2-10s curve closed the week at 156bps. Near-term the fate of the curve remains largely in the hands of US Treasuries. However, next year we see this curve flattening to 60bps as OCR hikes get underway.

On Friday night, US 10-year bond yields slipped from 2.95% to 2.88%, as both US retail sales and University of Michigan confidence disappointed expectation.

There is no shortage of domestic or global events to potentially impact on markets this week. Domestically, the highlight will be Thursday’s Q2 GDP where we expect a 0.2% contraction.

Although we expect a 1.3% rebound in Q3, a negative Q2 outcome may cause the market to question it’s now fairly assertive OCR track. The offshore highlight will be the much anticipated US FOMC meeting early Thursday morning (NZT).

For today, the domestic focus will be the NZ PSI and REINZ house price and sales data. The latter have taken on greater importance since the RBNZ has made house price appreciation a core focus of its financial stability mandate. The introduction of Loan to Value Ratio restrictions for banks is imminent (1 Oct).