RBNZ: Narrow yield premium on NZ bonds vs US may widen

RBNZ's Spencer says narrow yield premium on NZ bonds vs US may widen again

By Rebecca Howard

Feb. 8 (BusinessDesk) - Reserve Bank acting governor Grant Spencer says the narrow yield premium on New Zealand government bonds versus their US counterparts may not last - despite the divergent interest rate tracks between the central banks.

New Zealand 10-year government bonds are currently yielding 17 basis points more than comparable US Treasuries compared to a historical norm of 100-150 basis points. The yield gap, or premium, has narrowed because the yield on 10-year US Treasuries have gained more than 40 basis points over the past year to reach a four-year high of 2.83 percent, while the yield on NZ 10-year bonds has dropped 22 basis points to 3 percent in the same period.

Spencer said the narrowing spread is "pretty extraordinary" but despite the shrinking premium to hold New Zealand bonds, New Zealand remains attractive to foreign investors given how low yields are in Europe and Japan, he said.

"Investors are looking for yield and are willing to take the risk to get a bit more yield," he said at a press conference in Wellington after keeping the official cash rate at a record low 1.75 percent. The Federal Reserve's federal funds rate's target range of 1.25 percent to 1.5 percent.

Spencer said he would be surprised if the spread turned in favour of US Treasuries, despite a growing view the Federal Reserve may raise rates more times than previously expected while the Reserve Bank reiterated its view that local rates won't rise until the latter half of next year at the earliest due to the lack of inflationary pressure.

Ructions in financial markets this week - triggered when strong US wage growth stoked inflation expectations in the US - were "a bit of a warning sign" as the volatility shows how nervous markets are about the normalization of interest rates and inflation, Spencer said. Markets are currently expecting a gradual process and a sharper move would lead to more volatility, he said.

"I think the greater risk is that the spread moves out again," given how jittery markets are, Spencer said. "If there is a move in markets to risk-off, or if there is a negative surprise then those spreads may go back to more normal levels."

RBNZ deputy governor and head of financial stability Geoff Bascand said in an interview if the rate differential turns negative, the New Zealand dollar would face downward pressure, although "there is more risk that we will see spreads widen, rather than narrow" as the local market typically benefits from a "risk-on environment."

Bascand said that's consistent with the US dollar being weak as "money has said we don't need to fly home to the US, so it has flowed in here."

Spencer noted the kiwi was higher than the bank's November projections on a trade-weighted index basis "due in large part to a weak US dollar," although he didn't expect a sharp decline.

"I don't think we are concerned about the currency. It hasn't moved that much since November. We are comfortable where the currency is," Spencer said, While the central bank is expected it to drift down slightly "we will stay in this vicinity," he said.

The kiwi dollar dropped about a quarter of a US cent after the release of today's policy review, recently trading at 72.27 US cents.

(BusinessDesk)

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