ECB President Draghi commented inflation subdued and German economy no longer insulated from European debt crisis

By Kymberly Martin

NZ swaps opened up yesterday following the RBA remaining ‘on hold’, but drifted off later. Overnight, US yields declined after Obama was re-elected.

Yesterday, NZ swaps opened up in sympathy with the rise in AU yields the previous day after the RBA left its cash rate on hold.

However, a reversal occurred intra-day. 2-year swaps rose as high as 2.75% before drifting off to close at 2.70%. The market now prices just over a 50% chance of a 25bps RBNZ cut in the year ahead.

Today NZ employment data will be delivered. We expect the unemployment rate to tick down to 6.6% from 6.8% in Q2, but the volatility of the series suggests notable risk of a further tick up.

This would likely prompt the bigger market response as the market increases RBNZ rate cut expectations. We have therefore taken profit on our 2-year payed swap position ahead of the data.

As the US election result was announced, the market turned its attention to the looming US ‘fiscal cliff’. The yield on ‘safe haven’ US 10-year bonds slipped from 1.75% to 1.62%. Key resistance for these bonds is seen at 1.60%.

Yields on German equivalents also slipped from 1.46% to 1.38%. The decline in yields was also assisted by comments from ECB President Draghi that inflation was subdued and that the German economy is no longer insulated from the European debt crisis.

Expect NZ yields to open down today, with an initial flattening bias due to the sharp decline in long-yields seen off-shore. Thereafter short-end yields will likely take their cue from the employment data release.

Tonight, the BoE and ECB both announce target rates. Spain also returns to markets to sell bonds, which will act as a good barometer of current appetite for sovereign risk.