Markets calm ahead of key central bank decisions

Little expected from US Fed or RBNZ by markets, but they do expect major action from the Bank of Japan, which may bolster 'curve steepening'

Bonds

Little expected from US Fed or RBNZ by markets, but they do expect major action from the Bank of Japan, which may bolster 'curve steepening'

21st Sep 16, 7:57am by Kymberly Martin

By Kymberly Martin

NZ yields pushed higher by 1-3 bps across the curve yesterday. Overnight, core 10-year yields declined, with US 10-year trading down to 1.67% and German equivalents back in negative territory.

Market expectations for RBNZ activity are relatively unchanged as we head into tomorrow morning’s meeting. The market prices virtually no change of a cut tomorrow but ultimately looks for the OCR to be cut to around 1.70% in the year ahead. i.e. it fully prices one 25 bps cut and assigns a 20% chance to a further cut.

NZ 2-year swap trades at 2.11% and the 2-10s curve at 52 bps. NZ 5-year swap, at 2.27%, now trades modestly above the bank bill rate. However, we still see it as attractive to those who value medium-term interest rate certainty but prefer to minimise upfront costs relative to floating rates.

The long-end of the NZ curve will continue to take its cue from offshore moves. It might feel a bit of downward pressure at the open given overnight moves. Overnight, US and German 10-year yields both traded steadily lower in the backdrop of otherwise fairly calm markets ahead of today’s event risk (BoJ, FOMC meetings). German yields are back below zero, trading at -0.02%. The softer than expected tone in US housing data, early this morning, enabled the decline in US yields to extend unimpeded. US 10-year yields now trade at 1.67%.

The US OIS market still, bravely, prices just over a 20% chance of a Fed hike tonight (6am NZT). It prices 17 bps of hikes by year-end. We would be staggered if the US Fed delivered a rate hike this week, though it may look to actively prepare the market for a December hike. A ‘no hike’ decision this week and some further nudging down of the Fed’s ‘dot point’ (as has become de rigueur) will likely be enough to keep a cap on US 10-year yields (in the absence of a surge higher in Japanese yields). We see continued resistance to US 10-year yields breaking above 1.75% in the near-term.

The Bank of Japan’s meeting has potential to influence Japanese long yields that have been undergoing a sharp (30-50 bps) rise over the past couple of months. Today, we expect the BoJ may condone the curve steepening if, as widely expected, it announces it will shorten the duration of its asset purchases. Otherwise the market is looking for the BoJ to announce something else (further rate cuts?) to aid in achieving its elusive CPI target. The market risks being disappointed if something bold is not forthcoming.

Daily swap rates

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Source: NZFMA

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

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1 Comments

by Stephen Hulme | 21st Sep 16, 10:38am 1474411088

The market has been disappointed for more than a while, given the raised economic growth expectations Ben Bernanke spoke of were never realised for the majority.

As then-former Chairman Ben Bernanke wrote in November 2010 explaining why QE2 was in his view necessary:

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

You should notice the weasel word in his phrasing: “can” also spur spending. The reality is that economists don’t really understand how this might actually work. As with all statistically-based models, there wasn’t a whole lot of data to fill out all possible ranges of scenarios in order to produce truly robust models of correlations between asset prices and consumer spending under all conditions. Most of the econometric work was taken from the 1980’s and 1990’s where asset prices were rising and so was spending. Rather than view that as perhaps an accident of mere circumstances unique to those times, this “wealth effect” was instead, as usual, given status as a core economic “truth.”

The central myth of all central banking is that if it happened during the Great “Moderation” central banks could make it happen again by mere policy. Understanding, then, actual money evolution and potential would have disproved the idea at its very start. Read more