NZ bond yields push higher after inflation although panorama uncertain

The yield on New Zealand's longer dated bonds rose a few more basis points than their US counterparts.

The spread between New Zealand's longer-dated bonds and their US equivalent increased as higher-than-expected domestic inflation helped solidify market expectations the central bank will be lifting rates sooner that it's forecasting.

Statistics New Zealand today said the consumers price index rose 1 percent in the three months to March 31 for an annual pace of 2.2 percent. That was the highest annual increase since the September 2011 quarter and also marked the first time inflation has hit the mid-point of the central bank's 1 percent-to-3 percent target range since that period.

Economists had tipped the CPI to lift 0.8 percent in the first three months of the year, for an annual rate of 2 percent, according to the median in a BusinessDesk poll. The Reserve Bank, meanwhile, had forecast inflation of 0.3 percent in the first quarter for an annual rise of 1.5 percent. It wasn't expecting inflation to be 2 percent until 2019.

The higher-than-expected inflation added to the view that the central bank may move to lift interest rates sooner than it is forecasting. The bank held the rate at record low 1.75 percent in March and its latest forecasts point to a rate hike in mid-2019. However, given signs of inflationary pressures and a still-hot housing market, most economists are expecting rate hikes sometime in 2018.

Ross Weston, a senior trader at Kiwibank, said the yield on New Zealand's longer dated bonds rose a few more basis points than their US counterparts today in the wake of the inflation data but noted that any moves will be capped by buyers coming in if kiwi bonds look more attractive on a yield basis. New Zealand's 10-year government bonds were up around 3.5 basis points in afternoon trading while US 10-year yields were largely flat overnight.

Weston said market pricing is still pointing a rate increase in the first quarter of 2018 but what shifted after the data was that now there is some expectation the central bank will have to hike more than anticipated: "They might end up behind the curve a little bit and when they go, they might have to go harder than they originally thought."

Still, he underscored the central bank will likely take a wait-and-see position before changing its forecasts. "They have been fooled before and I don't think they want to be fooled again by inflation climbing and then unravelling," he said.

Vicky Hyde-Smith, head of NZ fixed income for AMP Capital Investors, said uncertainty continues to reign regarding rate hike timing after the data. She said the market is clearly prepared to price in hikes sooner than the central bank is forecasting "but we are still being a bit uncertain as to when that timing kicks in." She said the data add to the view the next move will be higher but "doesn't really give us any more certainty with regards to the when."

She said the main driver of New Zealand rates remains the global backdrop and rates have moved significantly lower on on the back of geopolitical concerns: "If you see some stability in that geopolitical risk and the Fed continuing to hike in response to their own inflation numbers, then you should expect that NZ rates will follow suit."

However, given the uncertainty, many players may opt to sit on the sidelines while it plays out and "risk manage their portfolios but look for opportunities to be positioned for higher rates."