Outlook for Borrowers: Post-November MPS
The RBNZ threw another significant surprise to financial markets yesterday, in keeping the OCR unchanged at 1%. Prior to the decision, the market had priced around a 75% chance of a rate cut, a view shared by a large majority of economists (ourselves included). There was a significant market reaction, with wholesale interest rates rising by up to 16bps and the NZD appreciating by 1%.
The beginning of the end? NZ long-end rates outlook
NZ longer-term rates hit record lows at the start of last month, with the 10 year swap reaching 1.1% and the 10 year NZGB yield briefly traded below 1%, before recovering over 30bps over the remainder of October. The massive decline in rates this year has been more a global story than a NZ-specific one (notwithstanding the RBNZ’s 50bp OCR cut in August). 10y NZ-US and NZ-AU spreads have been broadly range-bound this year (see Chart 1). In this note we recap recent developments and set out our medium-term outlook for the NZ long-end.
The two key drivers of NZ long-end rates are global rates, especially the US and Australia, and the RBNZ outlook.
BNZ RV Chart Pack
NZGBs have underperformed on a cross-market basis over the past fortnight as the market has pared back OCR expectations.
Swap-bond spreads appear to have found a base, albeit near multi-year lows. Short-end spreads have moved wider, as we had expected.
NZGB 2029s have cheapened vs. 2027s and 2033s. The 29s remain rich, albeit less so than before.
NZ 10y BEI makes new highs for the year as nominal bonds have sold off.
Modest widening in long-end LGFA-NZGB spreads ahead of tender tomorrow.
Trade idea: Pay the belly of 2s5s10s
The RBNZ OCR decision next week looks delicately balanced, with the market pricing around a 60% chance of a cut (having been more than fully priced for a 25bp cut only a month ago). Given current pricing, kiwi duration positions are effectively a binary play, at least in the near-term, on the November meeting outcome. While we see a November cut as the most likely outcome, our conviction levels are low, and we, like the market, are still learning about the RBNZ’s reaction function under an MPC (November will be just the committee’s fifth meeting).
BNZ RV Chart pack
After hitting multi-year lows, swap-bond spreads have bounced a little.
The long-end of the NZGB curve has steepened more than global peers.
The 2033s and 2027s are cheap on the curve; the 2029 NZGB is expensive.
NZ BEIs increased after a strong CPI release, but remain within established ranges. Valuations still very attractive and carry is favourable until late-March.
Some modest widening in mid-curve LGFA-NZGB spreads.
Outlook for Borrowers: Post-Sept. OCR Review
As widely expected, the RBNZ left the OCR unchanged at 1.0% at the September OCR Review, following the shock 50bps easing in August. The Bank has evidently maintained an easing bias and we continue to project another 25bps cut to 0.75% in November. With a softer growth outlook our central view now embeds a final 25bps rate cut in February to 0.5%.
Limits to falling NZGB yields – a supply and demand analysis
The NZ government is in a very strong fiscal position by international standards, with net core Crown debt of around 20% of GDP. The strength of the government’s finances is illustrated by the fact that the stock of total NZ government securities was lower in June 2019 than what it was three years earlier. The decline in nominal securities (bonds and bills) has been even more marked than the total, with the amount outstanding of inflation-indexed bonds having increased over that time.
Basis risk with NZ OIS under unconventional policy
In a recent media interview, Governor Orr expressed a preference for negative interest rates over QE, and our working assumption at this stage is that this will be the initial unconventional policy option, if the need arises.
Negative Interest Rates A Real Possibility
As the RBNZ’s cash rate moves ever lower, the possibility of a negative cash rate, or unconventional monetary policy, gets ever higher. Investors, borrowers and savers alike need to start pondering the implications of this now because, if we are to head into this uncharted territory, the process may evolve much sooner than many expect.