Tightening and flattening of rate curves continues with long end falls continuing

By Kymberly Martin

NZ yields were lower and curve flatter yesterday in response to heightened risk aversion offshore on Tuesday night.

Last night, US 10-year yields traded from 2.05% up to 2.10%, ahead of this morning’s US FOMC meeting (8am NZT).

Given the severe negative sentiment offshore the previous night (our global risk appetite index had fallen below 30%) NZ yields opened lower. NZ 2-year swap closed down 2 bps at 3.78% while 10-year closed down 6 bps at 4.12%.

Similarly, the NZ bond curve flattened as 2015 maturity bonds closed unchanged at 3.52% while NZGB27s declined 5 bps to 3.82%.

It is striking that there is now only 30 bps between these two maturities. Yields on short-end maturities out to 2019 are now only fractionally above the OCR (3.50%). So any further decline in offshore yields can only really be expressed at the long-end of the NZ bond curve.

In this respect, this morning’s US FOMC meeting will be crucial. Ahead of this, US 10-year yields have pushed off lows to trade around 2.10% currently. This occurred in the backdrop of improved market sentiment overnight, led by a rebound in the oil price, the ruble and equity markets.

The market appears to be expecting a slightly more hawkish Fed.

The Fed will likely therefore need to deliver a removal of the “considerable time” phrase; some firming of its dot points for the Fed funds rate; and show some willingness to look through the disinflationary impact of the recent plunge in the oil price, in order not to disappoint the market.

Anything less and US yields may drop back toward their recent lows. This is especially so, as CFTC speculative short positions in US 10-year Treasuries are at their most extended since March 2012. i.e. already positioned for higher yields.