Rates Strategist: Lower rates amid subdued rebound
• Headwinds from the global growth downshift, combined with subdued domestic high frequency activity indicators, skew the risks for front end NZ rates lower. The RBNZ is expected to cut rates by 25bp at the May 28 Monetary Policy Statement, signal room for further easing, and shift its modelled OCR path lower.
• Curve steepening is likely to resume now the April overshoot has corrected.
• The compensation for taking duration risk is improving. 10Y NZGBs offer the highest FX hedged yield within developed markets. Although the backdrop for duration appears favourable, we have a higher conviction for shorter maturities.
• NZ swap spreads are expected to consolidate ahead of the borrowing programme update alongside the Budget on 22 May. A pre-Budget speech by Finance Minister Willis implied continued fiscal pressures amid downward revisions to growth forecasts by the Treasury.
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A quantitative model for NZGB ASW spreads
NZ asset swap spreads (ASW) have exhibited distinct price action since the pandemic, compared with prior years. While spreads have historically exhibited mean-reverting behaviour with NZGBs trading at a premium (lower yield) to the respective swap yield, the post-Covid period has seen increased volatility, driven by supply dynamics, central bank interventions, and evolving risk sentiment, leading to a period of persistent deviation from the previous mean.
Growth trumps inflation
• The odds of a global recession are rising amid the significant escalation in trade tensions. The backdrop is fluid but risks for rates are skewed to the downside even after the recent large moves lower.
• We had a lower bias for rates ahead of the escalation and the market’s terminal OCR pricing now aligns with our 2.75% forecast. The RBNZ is expected to reduce the OCR by 25bp at its Policy Review this week and signal further easing ahead. Without a de-escalation in trade tensions, we expect the market to price an even lower terminal rate.
• The NZ yield curve, which is already elevated in a global context, is expected to steepen further as the RBNZ easing cycle proceeds.
• We have a positive view on duration further out the curve and expect 10Y NZGBs to retest the cycle lows from last year. The final significant supply event is complete for the 2024/25 fiscal year. NZGB swap spread spreads are expected to maintain a higher trading range.
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Rates Strategist: Pace of RBNZ easing to slow
• After three consecutive 50bp reductions in the OCR, the pace of RBNZ easing is expected to moderate going forward. We expect sequential 25bp cuts to 2.75% by the August MPS. Our forecast is below market pricing for the terminal cash rate, and we maintain a modest downside bias for front end rates. Governor Orr’s unexpected resignation doesn’t materially alter the outlook for monetary policy.
• Bank balance sheet pay side flow in the swap market is picking up as 2-year fixed mortgage rates reach a fresh low for the easing cycle. Even accounting for the large skew in the aggregate mortgage book towards short tenors, we are sanguine about the potential market impact. Monthly data going back over twenty years doesn’t suggest a significant relationship with 2Y swap spreads when there are large composition shifts towards longer fixed rate mortgages.
• NZ Debt Management will launch a tap syndication of the May-2032 nominal line before the end of April. The execution window aligns with technical NZGB demand associated with the April-2025 maturity alongside coupon flow. The swap spread widening trend paused after the announcement, with the market again focussed on upcoming supply, relatively soon after the May-2035 tap in February.
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