Investors start to seek yield over price gains, even in a risk-off environment. Impact of RBA rate cut may be elusive. Downward pressure in NZ despite higher rates elsewhere

By Jason Wong

In a risk-off environment one would normally expect lower bond yields, but there is a growing view that the recent historically low sovereign bond yields represent little value and the low point might have already passed. 

Japan’s 10-year rate sold off another 6 bps to reach minus 0.08%, its highest closing level in over two months.  Just last week these bonds traded at minus 0.30, so the sell-off has been vicious.

Rates are up circa 6-8 bps across Europe and in the US the 10-year Treasury rate is up 2 bps to 1.54%, after earlier reaching as high as 1.57%, well up from last week’s close of 1.45%.  US data showed slightly higher than expected consumer spending in June, but that reflecting a drawing down of savings, as income growth was softer.  The core PCE deflator remained below target at 1.6% y/y.

The Australian 10-year bond rate closed at a record low of 1.82%, following the 25 bps cut to the RBA’s cash rate target to a record low of 1.5%.  As is typical with a rate cut, the RBA offered a neutral policy bias about the outlook, but most believe that the balance of risk is for further cuts.  The major banks only passed on 10-14 bps of the rate cut to their floating mortgage rates.  Along with the stronger AUD it’s hard to see how the policy announcement would have much economic impact, meaning that in the absence of further cuts meeting the inflation target will likely remain elusive.  The interest rate curve shows an expected cash rate low of 1.25%, around mid-2017, so another full rate cut is currently priced in.

NZ rates were fairly steady yesterday, with less than 1 bp of movement across the whole swap curve.  The RBA cut puts the pressure on the RBNZ to match that.  That would come as no surprise to the market with a full 25 bps cut priced in and some traders are probing with the idea of a surprise 50 bps cut.  That would be highly unlikely in our view.

The RBA rate cut came after the local market close so lower Australian rates could put some downside pressure on NZ rates today, despite higher rates elsewhere.  NZ wage data are released today and they are expected to show wage inflation well contained, despite a tighter labour market.  Overnight the key release will be the US non-manufacturing ISM data.