Although interest rate markest may be treading water at present, it will not be plain sailing as volatility lurks. Non-residents reduce exposure to NZGBs

By Kymberly Martin

It was a fairly quiet day in NZ markets yesterday.

Overnight, US 10-year yields traded from 2.21% to 2.29%, before drifting back toward the lower level.

NZ 2-year swap closed down a further 1 bps, at 2.26%. This remains close to ‘fair value’ on our view that the OCR will remain at 1.75% throughout next year, before a gradual hiking cycle begins in late H1 2018. Around this level we see a 2.10-2.35% range likely sustaining in coming months. It is not until mid-next year, around 12 months out from the first OCR hike, that we anticipate 2-year swap will break sustainably higher.

NZ 10-year swap closed down 2 bps, at 3.26%. The 2-10s curve hovers at 100 bps, close to its highs since March 2014. The curve has now steepened around 75 bps since the start of July.

NZGB yields were little changed yesterday. The yield on NZ generic 10y bonds sits at 3.08%, about 5 bps below last week’s highs. We see yields trading up toward 3.30-3.40% in the year ahead, consistent with our view that US 10-year yields trade toward 2.50%. However, we do not expect plain sailing. Increased volatility could see a very wide range around any point forecast.

We noted yesterday, the most recent data for non-resident holdings of NZGBs. These had fallen below 64% in October. A firm downtrend now appears in place since highs early last year of 70%. In recent years, proportional holdings dipped as low as 59%, in late 2011.

Overnight, long yields in core offshore markets made highs around midnight, before drifting lower in the early hours of this morning. From intra-night highs of 2.29%, US 10-year yields have traded back below 2.21%. German equivalents followed a similar trading pattern. This should help keep a cap on long-end NZ yields today.

The local highlight today will be the release of the AU employment report. Ahead of this, the market prices only around a 20% chance of a further RBA cut in the year ahead. In the early hours of tomorrow morning, Fed Chair, Yellen will testify to the joint Economic Committee.

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