RBA's 'significant downgrade' to its inflation outlook pushed local rates lower, and pressures the RBNZ to cut its policy rate further

By Jason Wong

US Treasury yields initially fell on the headlines showing weaker than expected employment growth and a higher than expected unemployment rate, but once the lift in wage inflation was digested, the rally proved short-lived. 

Nevertheless the soft employment data all but ruled out a June Fed rate hike.

Expectations further out the curve were little changed, with December Fed Funds still pricing in a slightly better than even chance of a 25bp rate hike.  In an interview with the New York Times, Fed Vice-Chair Dudley downplayed the significance of slow jobs growth. 

He said it didn’t do much to change his economic outlook, believing that it was still a reasonable expectation that the Fed could raise rates twice this year.  The US 10-year Treasury rate ended the day up 3 bps at 1.78%, with lots of expected supply this week contributing to the sell-off.

The RBA’s significant downgrade to the inflation outlook contributed to a sharp rally in Australia and NZ rates on Friday. With the RBA expected to struggle to reach its inflation target over the next couple of years, a number of analysts changed their calls to predict further rate cuts.  A fresh Bloomberg survey showed 17 out of 23 analysts expecting the RBA to cut its cash rate another 25 bps to 1.50% by August.

NZ’s bank bill futures strip showed implied yields of 4-11 bps lower across the curve, with the smaller fall at the near-term contract (Jun-16) and the largest fall at the longest (Mar-18) contract.  An RBA easing is likely to put pressure on the RBNZ to cut rates, with the rising NZD/AUD cross rate putting upward pressure on the TWI.  The OIS market is pricing in a high chance of a 25 bps cut in June (78% probability) and a more than 50% chance of a follow-up 25 bps cut by November. 

NZ’s 2-year swap rate closed 6.5 bps lower at 2.155%, while the 10-year rate fell by 10 bps to 2.825%.  NZ’s 10-year government bond rate fell by a chunky 11 bps, taking it to yet another record low of 2.61%.  Expect a quiet day ahead with nothing of note on the economic calendar.