Slowing US housing market and fiscal policy constraints mean no tapering yet for Fed

By Kymberly Martin

NZ swap yields closed up 2-3bps and bond yields down 1-2bps yesterday, resulting in some widening of swap-bond spreads.

Despite the relatively small moves it was a fairly busy day in swaps with squaring of positions into today’s RBNZ meeting.  Payers in the short-end looked to be tidying up risk ahead of the OCR Review.  Overall yields edged up, ending the day 2-3bp higher. 

NZ 2 and 5-year swap closed at 3.41% and 4.25% respectively. On a relative basis the 5-year point of the curve still appears ‘expensive’ to us from a hedging perspective. We see better ‘value’ in the 2-3-year part of the curve.

Overnight, markets were in wait and see mode ahead of this morning’s US FOMC meeting. US benchmark 10-year yields slipped below 2.50% as the US ADP employment report for October came in slightly below expectation (130k vs. 150k) while US inflation was shown to be contained.

At the meeting the FOMC stated that economic activity has continued to expand at a moderate pace. However reference was made to some slowing in the recovery of the housing sector and the constraint that fiscal policy is having on economic growth.

Overall the Fed sustained a similar central line to last statement. It maintained asset purchases at $85b per month (i.e. no ‘tapering) and reiterated the Fed funds rate will remain exceptionally low as long as the unemployment rate remains above 6.5%.

The initial response of US 10-year yields was to push up to 2.53%. The statement seems to have served as a reminder that QE ‘tapering’ has been postponed rather than cancelled. In broad terms we continue to see a 2.50%-3.00% range on 10-year yields as appropriate for the year ahead, though near-term acknowledge the risk of some time spent testing the lower bound.

Heading into today’s RBNZ meeting the market is pricing a first OCR by April next year and almost 90bps of hikes by the end of next year. Recall the RBNZ’s own 90-day track implies a first hike mid next year and up to 100bps of hikes by the end of next year. This is the closest market pricing has been to the RBNZ’s track in a long time. The Bank will therefore have little incentive to try to nudge pricing in either direction.

Rather, we expect the OCR Review to affirm the tightening tenor of the September meeting, and the statement “OCR increases will likely be required next year.” The recent up-turn in CPI may also gain a nod.

Elsewhere, economic indicators are at least as strong as at the previous meeting. On the impact of recent LVR restrictions the core message is likely it’s too early to tell. 

As for the NZD TWI, despite its run-up during the intervening period, it now sits at a similar level as it did at the last RBNZ meeting i.e. just above 76.00. This is clearly still higher than the RBNZ would prefer but is unlikely to come in for too much additional attention.

It will be a busy day domestically with the ANZ business survey and the RBNZ’s weekly mortgage approvals also scheduled for today.