Interest Rate Strategy

A quantitative model for NZGB ASW spreads

Stuart Ritson -

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

Stuart Ritson -

• 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.

Full Interest Rate Research is available to BNZ Wholesale clients upon request, please email bnz_research@bnz.co.nz to subscribe.

Rates Strategist: Pace of RBNZ easing to slow

Stuart Ritson -

• 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.

Full Interest Rate Research is available to BNZ Wholesale clients upon request, please email bnz_research@bnz.co.nz to subscribe.

Swap spread recovery to be tested by supply

Stuart Ritson -

• 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.

Full Interest Rate Research is available to BNZ Wholesale clients upon request, please email bnz_research@bnz.co.nz to subscribe.