Swap spread recovery to be tested by supply
• The RBNZ is expected to reduce the OCR by a further 50bp at the February Monetary Policy Statement. Beyond this, the pace of easing will likely moderate and become increasingly data dependent. On-target inflation and still weak activity, suggest the RBNZ will cut rates to at least the mid-point of its 2.5% - 3.5% estimate, for the long-term neutral OCR.
• We have a modest downside bias for front end rates, though note the easing cycle is increasingly well priced. Longer end rates are likely to trade in a broad range. The 2y/10y swaps curve looks set to extend beyond the 70bp January high, as the RBNZ easing cycle progresses, and term premia build.
• Strong investor demand for NZGBs in January, after the seasonal issuance lull, has contributed to a sharp recovery in the 10y swap spread. Confirmation that the tap syndication of the May-2035 nominal line will take place in February, should contain the move higher in swap spreads, with the current level near -45bp likely to mark the top end of the trading range.
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Rates Strategist: Easing cycle to support a further fall in terminal OCR pricing
• The front loaded RBNZ easing cycle is set to extend into 2025. Weak activity and on-target inflation opens the way for the OCR to decline toward the RBNZ’s 3% estimate for the long-term neutral OCR. Short end rates are likely to make fresh cycle lows.
• A resilient economy and uncertainty about the impact of the new administration’s economic policies, point towards a cautious Fed easing cycle, and limits the downside for UST yields. Already tight 10Y NZGB-UST spreads to constrain NZGB performance.
• The NZ curve flattening over the past two months appears complete. Curve valuations, which were significantly stretched have now normalised, and we expect the curve to resume steepening as the RBNZ easing cycle progresses.
• Commentary from government officials has set the scene for increased funding requirements when the NZGB borrowing programme is updated alongside the HYEFU. 10-year swap spreads have returned to the multi-year lows. Bonds appear cheap, but lack a catalyst for a reversal, amid heavy issuance from the fiscal deficit and quantitative tightening.
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