3-5 year wholesale rates vulnerable to upward pressure, but not the short end. Improving risk appetite pushes up UST 10yr yields

By Kymberly Martin

NZ bond yields closed up 1-2 bps yesterday and swaps up 2-4 bps.

Overnight, US yields have traded higher as risk appetite has improved, taking 10-year yields to 1.82%.

NZ 2-year swap pushed up a further 2 bps yesterday to close at 2.23%. We see this as close to ‘fair value’ based on our view the OCR will be sustained at 1.75% throughout next year, before a gradual hiking cycle takes hold in H1 2018.

We continue to believe it is too early to fear a sustained surge higher in short-end yields. ‘Fear-driven’ hedging of short-end rate risk that could push swaps into ‘overvalued’ territory is likely some way off. That would likely require front-page discussion of impending OCR hikes.

Rather, a 2.10%-2.35% range for NZ 2-year swap seems plausible in coming months. We continue to see the mid-curve (3-5-year) as more vulnerable to upward pressure over the medium-term, as the market reassesses the outlook for the OCR over the full cycle.

Yesterday, the LGFA announced details of its latest tender to be held on Thursday. This has been delayed a day to avoid clashing with the US election results and to be after the RBNZ meeting. The tender size is smaller than usual. Just NZD20m each of LGFA2019s and LGFA2020s will be on offer. NZD50m of LGFA2025s will also be offered.

Following yesterday morning’s FBI headlines, and the improvement in global risk appetite, US yields opened the week higher. However, they failed to push on. US 10-year yields have consolidated just below 1.82%.

There are no domestic data due today. All eyes will be on the US election for the next couple of days. A convincing Clinton win would likely see a further rebound in risk appetite and US 10-year yields pushing higher, and vice versa.

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