US Treasuries test historic lows, then rise after good factory data, UK Gilts close at historic lows. Push higher by NZ swaps unlikely to be sustained

By Kymberly Martin

NZ swap and bond yields closed down 2-5 bps on Friday.

Over the weekend, US 10-year yields re-tested historic lows below 1.40% before rebounding to close at 1.44%.

NZ 2-year swap closed for the week at 2.20%, in the lower half of its range of the past few months. We continue to expect it will maintain a 2.10-2.35% range in coming months. A sustained push higher is unlikely until the turn of the year, at the earliest. Equally a prolonged break lower would require the market to price a sub-1.75% OCR. That is not our central view.

Currently we expect the RBNZ to cut the OCR to 2.00% at its August meeting with some chance of a further cut thereafter. The market currently prices almost a 60% chance of an August cut and a 1.88% trough in the OCR within the year ahead.

On Friday night, US 10-year yields briefly dipped to touch their 2012 historic low, just below 1.38%. The rebound in yields, into the close, was assisted by the release of a stronger than expected US manufacturing ISM. Yields closed for the week at 1.44%, having traded a 10 bps range on the day. UK 10-year Gilt yields closed at a record low of 0.86%, after trading sub-0.80% earlier in the night.

In the wake of the UK referendum the market now prices around 35 bps of rate cuts from the Bank of England (from its current level of 0.5%). It also prices just 3 bps of rate hikes from the US Fed by year-end. In this light, Friday’s US payrolls report will be particularly important. Recall, that ahead of the UK referendum, it was the weak May payrolls report that initially set the market questioning prospects for further Fed rate hikes.

In the backdrop of modest positive equity returns on Friday, measures of credit default risk have narrowed further. The spread on the Markit iTraxx Europe Crossover index (European high yield), is now back within pre-referendum ranges. The Markitt iTraxx Australia index is now out of ‘danger’ territory, back at the lower-end of its year-to-date range. These moves should help to limit upward pressure on NZ credit spreads.

It should be a relatively subdued start to the week as the US market is closed for Independence Day. However, local news will likely be dominated by the Australian Federal election which looks to remain undecided until at least Tuesday.

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