RBNZ says further reductions in the OCR could pose a risk to financial stability; S&P puts Australia on notice with negative sovereign outlook

By Kymberly Martin

NZ swaps and bonds experienced a period of relative consolidation yesterday. Overnight, US 10-year yields have traded between 1.36% and 1.42%.

Yesterday NZ 10-year swap consolidated just below 2.5%. Although our core view is for slightly higher yields by year-end, in a note published yesterday we asked what it would take for NZ 10-year swap to trade down 2.0%. We see this eventuality as consistent with the market pricing a 1.75% OCR but US 10-year yields falling toward 1.0%.

In turn, US 10-year at 1.0% would likely require the market to re-price US Fed cuts, increased concerns of ‘Brexit’ contagion and/or a further slump in yields outside the US.

This scenario seems more likely, than one which required aggressive OCR cuts; we continue to see a high hurdle to the RBNZ cutting below 1.75%. Currently the market prices around a 1.85% trough in the OCR within the year ahead. Consistent with this, NZ 2-year swap closed yesterday at 2.18%. Broadly, we continue to see 2-year swap in a 2.0-2.4% range in the months ahead.

Last evening after market close, the RBNZ released a speech by Deputy Governor, Grant Spencer, on “macro-prudential policy and housing market risk”. As anticipated, it detailed the dilemma the Bank faces as it grapples with broadening house price pressures, but low CPI inflation.

This was neatly captured in the following statement; “Conversely, further reductions in the OCR could pose a risk to financial stability through their effect on credit growth and house prices. While the outlook for CPI inflation will ultimately determine the future path of monetary policy, the trade-off against financial stability risk needs to be carefully considered.” This casts a cloud over the odds of an August cut, which we had seen as being pretty high. This could help support NZ short-end yields today.

The other key local development yesterday was the decision by rating agency S&P to place the Australian sovereign AAA rating on negative outlook. This denotes a one-in-three chance of a formal downgrade within the next two years. The decisions reflects S&P’s view that; “the prospects for improvements in budgetary performance have weakened following the recent election outcome”. AU bond yields showed little response to the announcement. The spreads between NZ and AU 2027 maturity bonds remains at 31bps.

Overnight, in the backdrop of stable risk appetite and a solid US ADP employment report, US yields pushed off their lows. US 10-year yields rose from 1.36% to 1.42%. However, they have slipped back in the early hours of this morning alongside a sharp fall in the WTI oil price. US 10-year yields now trade at 1.38%.

Tonight, all eyes will be on the US payrolls report, to gauge whether the weak May report was a ‘one-off’. Ahead of this the market prices just 3bps of Fed rate hikes by year-end.

Daily swap rates

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