Despite Fed signals, US markets still not pricing in all full rate hikes. Locally, strong bond tender demand did not result in lower yields

By Kymberly Martin

NZ swap and bond yields closed 4-8 bps higher yesterday.

Overnight, US 10-year yields consolidated yesterday morning’s move before trading a little lower, to 1.85% currently.

NZ yields gapped higher on the open yesterday morning following the more hawkish than expected US FOMC Minutes. NZ swap and NZGB curves also steepened. Ultimately NZ 2-year and 10-year swap closed up 4bps and 6bps respectively.

The DMO’s tender of NZD150m of NZGB2020s attracted strong demand with a 4.9x bid-to-cover ratio, likely assisted by the earlier run-up in yields. However, there was no subsequent rally in NZGBs. Yields on NZGB2020s and 2027s closed at 2.21% and 2.71% respectively. The move higher at the long-end of the curve largely kept pace with that in US Treasuries. NZGB-UST27s spreads currently sit at 84 bps after a small downshift in US yields overnight. We continue to expect that these spreads can compress further as the year progresses. We look for compression within a 50-100 bps range.

The AU employment report defied previous volatility, coming in close to consensus expectation. It showed a solid labour market. There was little enduring response from either the AU or NZ rates market.

Fed’s Lacker (hawk, non-voter) and Dudley (voter) captured headlines this morning. The former said there was a strong case to raise rates in June. The latter said June is definitely a live meeting. He said if economic data meet expectations then a summer hike is likely. He added that another variable in the mix is the risk of ‘Brexit’.

Despite these comments and the pronouncements in yesterday’s FOMC Minutes the market remains unconvinced about a hike any time soon. US 2-year yields drifted down from 0.91% to 0.87% overnight. The market prices only a 75% chance of one hike by year-end and less than a 30% chance of a hike next month.

In the ECB’s meeting Minutes released yesterday, the Central Bank expressed concern that governments were not moving fast enough to implement structural reforms that could assist in meeting inflation objectives. It also said there was a need to counter the perception that monetary policy had become impotent in trying to return inflation to the ECB’s 2% target. No easy feat. Overnight, German 10-year yields gave back all of their post-FOMC gain. They traded down from above 0.20% to 0.17% currently.

Kymberly Martin is on the BNZ Research team. All its research is available here.