10-year US treasury yield jumps on non-farm payroll data; NZ yield curve flattens further; market still pricing in OCR cut by November

By Jason Wong

The knee-jerk reaction to the strong headline increase in US non-farm payrolls was a sharp move in US 10-year Treasuries to 1.425%, but at that level investors were attracted back into the market.

The softer details of the report, particularly the softer than expected wage inflation, encouraged a rally, seeing the 10-year rate fall back down to 1.36% at the close.  The movement in the 2-year rate suggested little change in the outlook for US monetary policy, with the closing level of 0.6050 the same as the level prevailing just before the report.    The market sees little chance of a higher Fed Funds rate over coming months and assigns just a 24% probability of a 25bp hike by December.

In local trading on Friday we saw a reasonable flattening of the yield curve, with the 2-year swap rate up 5bps to 2.23% and the 10-year rate up 1bp to 2.50%. The sharp move at the short end reflected the reaction to RBNZ Deputy Governor Spencer’s housing market speech on Thursday night after the close. The market focused on one comment buried on page 13 of the speech which said that “…further reductions in the OCR could pose a risk to financial stability through their effect on credit growth and house prices….the trade-off against financial stability risk needs to be carefully considered”.

OIS pricing showed a 6bp jump in the August meeting from 2.09% to 2.16%, suggesting that the market-implied probability of a 25bp rate cut had fallen from 64% to 36%.

Indeed, one major bank changed its call to “no-change” for August. We believe the market over-reacted to the speech. The market didn’t seem to pay attention to the comment in the speech that the “outlook for CPI inflation will ultimately determine the future path of monetary policy”. 

If the Bank is true to its word then the probability of rate cut had increased, particularly since the recent strength of the TWI materially reduces the chance of the Bank meeting the mid-point of the target range in 2-years without further policy action.  Indeed the lower end of the target range 18-24 months ahead is now threatened, with the TWI almost 9% above the level assumed by the Bank for the current quarter.

Despite the sell-off, the market still prices in another rate cut, with a 25bps cut almost fully priced by the November meeting (2.02%) and the OCR priced down at 1.93% by March. Consistent with very flat yield curves around the world, NZ’s government bond curve is priced at or below the current OCR level out to 2027.

Little data will be released during local trading hours to drive the market today.