Market lukewarm on the prospect for any further US Fed rate hikes, but expects RBNZ to cut soon with 50 bps priced in

By Kymberly Martin

NZ swap and bond yields closed up 2-3 bps yesterday ahead of this morning’s RBNZ economic update.

Overnight, US 10-year yields traded up from 1.55% to 1.58% currently.

It was a relatively subdued day in the local market in the absence of any further surprises or scheduled data releases. There appeared to be a bit of profit-taking in short-end swaps after the previous day’s large fall in yields.

NZ 2-year swap ended the day up 3 bps, at 2.12%. The market prices an 80% chance of an OCR cut next month and around a 1.75% trough in the cash rate within the year ahead. This is aligned with our own central view.

However, the RBNZ’s intra-meeting economic update at 9am NZT has potential to influence market pricing. We believe the Bank will have little choice but to highlight that if the NZ TWI sustains its current level (6% above the RBNZ’s projected average for Q3), the Bank’s medium-term inflation projections are under threat.

Further OCR cuts would be required as an offset.

It would be fortunate if this message were to induce downward momentum in the NZD. However, the market is already pricing 50 bps of OCR cuts. Therefore for the NZD to head lower (even temporarily) would likely require the Bank to suggest that the OCR could be cut below 1.75%.

Yesterday’s LGFA (Local Government Funding Agency) tender attracted a solid 2.2x bid-cover ratio, with demand weighted toward longer dates. Today, the NZDMO will auction NZD150m of NZGB2025s. Yesterday the yield on these bonds closed up 2bps, at 2.16%. We expect solid demand today, given the depressed yield backdrop globally and relatively constrained NZGB supply outlook.

Overnight, in the backdrop of solid gains in equity markets, US Treasuries sold off. US 10-year yields again nudged toward 1.6%, but now sit below 1.58%. The market remains lukewarm on the prospect for any further Fed rate hikes. A full 25 bps hike is not priced until about this time next year.

Tonight the ECB will meet although no change is expected to its policy settings at this point.

Daily swap rates

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