Yields plunge and chances of a rate cut rise as the RBNZ revises its market signals. US Fed's tame statement did not stop US yield falls too

By Kymberly Martin

The RBNZ’s comments elicited a strong fall in NZ swap and bond yields yesterday.

US yields fell after yesterday morning’s Fed meeting but have grappled higher overnight.

Contrary to our expectations, the RBNZ moved to direct neutral position yesterday, explicitly stating that its next rate move could be either up or down.

This simply spurred on market pricing that had already been pricing around a 50% chance of a rate cut in the year ahead.

The market now prices a 75% chance of a 25 bps cut by year-end.

We still think it is highly unlikely the Bank will cut rates this year. But in coming months we believe low-side inflation indications and a probable RBA rate cut will push the market in the direction of increasing its pricing of cuts.

We continue to see 2-year swap trading down to at least 3.50% before rebounding later in the year. Yesterday 2-year swap closed at 3.57% and 10-year at 3.62%.

NZGB yields have also plunged.

The yield on NZGB23s fell 14 bps to 3.18%. Demand for NZD rates products will likely remain strong in the near-term and we expect the DMO’s $300 mln nominal bond auction next week will be well received.

Despite the US Fed’s even-handed delivery yesterday, the initial response by US Treasury yields was to fall back toward January lows. However, overnight, they have subsequently rebounded modestly. From 1.72%, US 10-year yields now trade at 1.76%.

Today there is a smattering of tier 2 NZ data releases including net migration numbers. But tonight the focus for rates markets will be the release of US Q4 GDP. Consensus looks for 3.0%q/q ann.

The US Q4 employment cost index may also gain some attention. Absence of US wage pressures to date, is a key reason the market is pricing such a gradual path for US Fed rate hikes.

Fed fund futures see the FFR at just 1.1% at the end of next year. We expect a higher rate by this time.