NZ curves steepened sharply yesterday.
Short-end yields remained contained, as the RBNZ cut the OCR, but long-end yields rose by 20-25 bps, following offshore moves.
Overnight, the rise in US 10-year yields has extended. Yields currently trade at 2.08%.
True to its word, the RBNZ cut the OCR yesterday morning, to 1.75%. We believe this will mark an historic and cyclical low. The Bank’s accompanying statement implied a fairly neutral bias. Near-term, it still seems marginally more likely the RBNZ might cut than hike, though it would be reluctant to do so. The Bank’s published OCR track, which flat-lines at 1.7%, implies a 20% chance of a further OCR cut. Overall the Bank discussed myriad risks to both sides of its central OCR projections.
The market is now pricing a first OCR hike by H1 2018.
This is aligned with our own forecasts. We expect the OCR will be sustained at 1.75% throughout next year, before a gradual hiking cycle takes hold in H1 2018. Consistent with this view, we see NZ 2-year swap (which closed 4bps higher, at 2.24%) as close to ‘fair value’.
The sharp rise in NZ long-end yields was driven by post-election moves in US yields. After a 21 bps move to 2.94%, NZGB 2027 yields are now at their highest level since the start of April. NZ 10-year swaps have risen 24 bps, to 3.13%, their highest level since mid-March. However, NZ-US long-end spreads have still narrowed in the process.
The rise in US long yields continued overnight. US 10-year yields briefly traded above 2.12%, now at 2.08%. The circa 30bps rise in US 10-year yields over the past few days has been driven mostly by a rise in the long-term inflation expectations component. US 10-year inflation break-evens, derived from US TIPS, have increased 22 bps. Alternatively, US 5y5y fwd inflation swaps have risen 33 bps over the period.
This shift in inflation expectations has not been mimicked in other regions. This has contributed to widening in US 10-year spreads to key peers. For example, US-German 10-year spreads have widened from 164 bps to above 180 bps, now close to historic highs. We see these spreads acting as a brake on further rises in US long yields.
However, we now see US 10-year yields potentially trading a fairly wide range of 1.75% to 2.25% around a 2.0% mid-point (previously a 1.6-1.9% range around a 1.75% mid-point) in the months ahead.
These revised projections imply a slightly higher range for NZ 10-year yields and a steeper NZ curve. We see a 175-2.25% range on US 10-year yields as consistent with a 2.90%-3.30% range on NZ 10-year swap. We maintain our view of a steeper NZ 2y10y curve. However, we suspect this may now trade toward 100 bps in the months ahead, as we have exceeded our previous target of 80 bps.
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Kymberly Martin is on the BNZ Research team. All its research is available here.
3 Comments
The sharp rise in NZ long-end yields was driven by post-election moves in US yields. After a 21 bps move to 2.94%, NZGB 2027 yields are now at their highest level since the start of April. NZ 10-year swaps have risen 24 bps, to 3.13%, their highest level since mid-March.
I just hope that some of the mortgage holders more vunerable to rate rises take a look at their situation and take at least some protection via fixed rates even although there will be a cost to pay - at least you will survive. The argument seen here often that basically rates cant go up because too many will be hurt (i.e, me) is naive to say the least. The low is every every likely now in place for a number of reasons, and anyone who thinks, including me, that they know the timing and extent of the next fixed or floating movements is even more niaive.
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