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.
Risk of a squeeze? Supply and demand trends in NZGBs and high grade NZ fixed income
A theme we have been highlighting for some time is the forecast negative net issuance of NZ government securities over the coming years. At the Budget in May, the NZDMO forecast that net supply of nominal NZGBs was expected to be around -$4b by the end of June 2019 and, in addition, the stock of Treasury bills was forecast to be cut by $2b. The combined $6.2b reduction in nominal NZ government stock outstanding would be the largest on record (see Chart 1). It would amount to an almost 10% reduction in the stock of nominal government securities outstanding over the fiscal year.
Outlook for Borrowers: Post-September OCR Review
At the September OCR Review, the RBNZ said it expected the OCR to remain at an accommodative setting for a considerable period and reiterated that the next move could be either up or down. The message was very similar to the one presented in the August MPS statement. There has been a modest decline in NZ rates today, but mainly in response to overnight moves in the US
Trade Idea: NZ-US 5y5y Widener
NZ-US spreads have tightened aggressively across the curve over the past 12 months. The NZ-US 1y1y spread has declined from +60bps to -105bps, as Fed tightening expectations have increased and RBNZ rate cut expectations have built. Longer-dated NZ-US forward spreads have also tightened aggressively. The NZ-US 5y5y spread has tightened almost 100bps over the past 12 months, to near record tight levels – see Chart 1.
NZ Curve Outlook: Are We Near A Point Of Inflection?
The RBNZ August MPS, the accompanying comments from Governor Adrian Orr in the press conference, and then the subsequent interview Assistant Governor John McDermott gave to Bloomberg were taken by the market as dovish. McDermott said the RBNZ had been pushed “closer to the trigger point” of rate cuts and said that he wanted the market to understand that hikes were off the table for the foreseeable future. Taken at face value, this implies a clear asymmetry around the OCR outlook over the coming year and, reflecting this, the market now prices 7.5bps of cuts by mid-2019