NZ 2yr swap at lowest level since November 2012. More declines expected although markets unsure about matching OCR cut

By Kymberly Martin

NZ swap and bond yields closed down 2-3 bps on Friday.

On Friday night, as a better market mood prevailed, US 10-year yields pushed up from 1.66% to 1.75%.

Overall offshore moves remain the primary driver of the domestic market at present. Yields closed down in fairly uniform manner across the NZ curve on Friday, keeping the NZ 2-10s curve steady at 59bps.

NZ 2-year swap sits at 2.54%, its lowest level since November 2012. In mid-2012 NZ 2-year swap reached an historic low around 2.35%. At that time the OCR was at 2.50% and the market priced around 45 bps of OCR cuts for the year ahead (never delivered).  We could see NZ 2-year swap revisiting these levels in weeks/months to come if global ructions continue. However, it is difficult to see it trading beyond this level without delivery of a cut by the RBNZ.

Our central view remains that the Bank will keep the OCR on hold at 2.50% this year. Risks of a cut are building. But we believe a cut would be delivered on some combination of global ructions, dairy sector weakness and/or currency strength as opposed to being a reaction to persistently low headline inflation readings. RBNZ Governor Wheeler has made clear in recent communications that the Bank is willing to look through low headline inflation readings, focusing more on core inflation and inflation expectations. In this context,tomorrow’s Q1 inflation expectations survey will be important.

On Friday night, US yields moved higher in a parallel fashion after the release of a stronger than expected January retail sales report. Yields were further boosted by the massive late-session rally in the global oil price.US 10-year yields ended the week at 1.75%.

This move, mimicked by Australian bond futures, will likely see the NZ curve steepen today. Otherwise look out for the NZ PSI, for evidence of solidity in the services sector of the economy to complement the message from last week’s PMI reading.

Coming up

Today, all eyes are likely to be on China markets as they return from a week long Lunar New Year holiday. There is also a slew of China data due, including the trade balance and new Yuan loans. Tonight, the US will celebrate Presidents Day so there is no US data due, but look out for a scheduled speech by ECB’s Draghi to the European Parliament. Also with the current focus on the JPY, look out for today’s preliminary release of Japan’s Q4 GDP.