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Flattening of the yield curve as the short end continues to rise; market now fully pricing in OCR hike by March 2014

Flattening of the yield curve as the short end continues to rise; market now fully pricing in OCR hike by March 2014

By Mike Jones

Yields closed down 2-3bps on Friday. However, the bigger theme from last week was a flattening of the swap curve.

The 2-10s swap curve flattened by 9bps to 142bps, as long-end yields ticked down while the short-end continued pushing higher. NZ 2 and 5-year swap closed the week at 3.69% and 4.53% respectively.

The market now fully prices a first OCR hike by March next year and almost 125bps of hikes by the end of next year. We also see the OCR being 125bps higher by the end of next year and 200bps higher (at 4.50%) by the end of 2015.

As positive domestic data has helped NZ short-end yields push higher, NZ-AU 2-year swap spreads have widened. From lows below 45bps at the start of November, the spread now sits at 81bps. We see this spread continuing to widen to peak around 120bps mid next year.

While we see RBNZ hikes next year, we see the RBA keeping the cash rate low for longer than the market currently prices. The market prices some chance of an RBA hike by the end of next year. This would be too soon in our view.

On Friday night, US benchmark yields traded a tight range between 2.74-2.76%. We continue to see a 2.50-3.00% range containing yields in the year ahead.

We expect today’s domestic data (terms of trade) to continue the recent positive data tone, taking terms of trade to a 40-year high.

Today’s HSBC manufacturing PMI for China will likely complement the official version released over the weekend. We see little locally therefore to undermine current market pricing for the NZ OCR.

Tonight, the offshore focus will be the release of the November US ISM.

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