Investors finding US bonds more attractive than European or Japanese equivalents; NZ yields fall as Fonterra annnounces lower than expected milk price forecast; NZ government cuts bond issuance program

By Jason Wong

US rates have tracked lower since the release of weaker than expected core durable goods orders data.

The 2-year rate is down 5bps to 0.87% and the 10-year rate is down 4bps to 1.82%, at the lower end of the trading range for the past week. 

US bonds remain attractive to Europe and Japan-based investors who face low or negative rates. Foreign demand at US Treasury auctions has been strong this week and last night’s 7-year debt auction showed similar traits.  These bond investors are unperturbed by the prospect of Fed tightening and rising inflation in the US.

In local trading yesterday, the weak Fonterra forecast milk payout for the next season set the backdrop for lower rates, and this trend was fuelled further following the Budget announcement.

The stronger set of fiscal accounts in the Budget allowed the Debt Management Office to lower its domestic bond programme by $2bn per annum from 2016/17 through to 2019/20 to $7bn per annum. Some $5bn-$6bn of this will be for nominal bonds, the rest inflation-indexed.Thus, issuance is fairly limited and this adds an element of “scarcity premium” to bond auctions.

By the 2017/18 year, net issuance (ie. after accounting for maturing bonds), will turn negative. The DMO’s policy of extending the duration of its outstanding debt sees the planned issuance of a new 20-year nominal bond (April-2037) in the second half of this calendar year.

NZ bond yields fell 7-8bps across the curve, with the 10-year rate back down to 2.62% and the record lows seen earlier this month under threat again. The NZ-US 10-year government bond spread fell to around 75bps, a fresh low and a spread not seen since 2006. We expect to see further spread compression, possibly down to just 50bps.

The low Fonterra forecast payout got the market thinking about the prospects for NZ rate cuts. The OIS market showed the August meeting priced at 2.09%, down 3bps, suggesting a 64% chance of a rate cut by then. The June meeting is priced at 2.18%, suggesting a 28% chance of a 25bps cut. NZ’s 2-year swap rate ended the day down 4.5bps to 2.27% while the 10-year rate was down 3bps to 2.89%.  One can expect further downside risk to rates today, following the US move overnight.