NZ Rates Outlook: Scaling Back Our Bearish Expectations
In early November we made the medium-term case for paying NZ swaps. We thought the market would struggle to push out the timing of OCR hikes much further, NZ rates looked expensive on a cross-market basis and in relation to broader macro fundamentals, and the market was positioned long and vulnerable to re-pricing sharply higher in the event macro data made RBNZ hikes look more likely. Additionally, we saw upside risks to global rates and expected the market to ultimately revise up its Fed expectations, helping to push US yields higher.
RBNZ Proposed Capital Requirements: Preliminary Thoughts
Last Friday, the RBNZ released a consultation paper proposing to increase the required Tier 1 capital ratio from 8.5% to 16% for the “Big 4” NZ banks (15% for smaller banks). Additionally, the RBNZ proposed to increase the “IRB scalar” applied to model-based risk-weighted assets (RWAs) from 1.06 to 1.2. This will also have the effect of further increasing large banks’ capital requirements.
Trade Idea: Long NZGB 2029 vs. Pay Swap
After reaching new wides just over a week ago, swap spreads have snapped back over the past week (see Chart 1). The long-end of the NZGB curve has led the underperformance over the past week.
Outlook for Borrowers: Post-November MPS
RBNZ Monetary Policy Outlook
At the November MPS, the RBNZ reiterated that it expected to keep the OCR on hold into 2020. It said the timing and direction of any future OCR move would be data dependent.
Mind the Trans-Tasman Gap: NZ-AU spreads to widen further
NZ rates underperform significantly over the past week – this move ultimately has further to go
Over the last week, NZ 2y swap has increased 15bps, 5y by 26bps and 10y by 23bps. The catalyst for this move was the much larger-than-expected fall in the NZ unemployment rate (3.9% v. 4.4% exp.), to its lowest level since 2008. We see the sharp move higher in NZ rates as largely correcting for the large outperformance of NZ vs. other markets after RBNZ Governor Orr suggested the possibility of rate cuts, which now look remote. Ultimately, we think the NZ move has further to go, and there is scope for the market to price a steeper RBNZ tightening path, albeit rates may now consolidate for a period after such a large move. See our note from last week on the medium-term rationale for paying NZ swaps.
Targeting Wider NZ Swap Spreads Ahead Of Q1 Maturity ‘Wall’
• We have been highlighting the supportive supply backdrop for NZGBs and high grade NZ fixed income for some time.
• This culminates in Q1, when there will be record maturities across NZGBs, LGFA and SSA (over $15b in total). Ahead of this, there has been very strong demand at recent NZDM tenders.
• Swap spreads have tended to widen in the months preceding recent NZGB maturities. Additionally, swap spreads have shown a seasonal tendency to widen in December.
• We would look to use a pull-back in swap spreads ahead of December to position for widening. Our model, in which net supply is a key variable, points to wider 10y swap spreads ahead.
• We target a long position in the NZGB 4.5% 2027 against swap at an I-spread of -28bps or higher.
Making the (medium-term) case for paying NZ swaps
The NZ rates market has been the star performer in 2018. It is the only developed rates market with a lower 10 year swap rate (almost 30bps) than at the end of last year. Below, we outline the medium-term case for scaling into paid positions in NZ swaps.