Reserve Bank Governor Adrian Orr. Photo / NZME
New Zealand’s yield curve - an important yardstick for the interest rate markets - has continued to steepen in the wake of this week’s half-point rate cut by the Reserve Bank.
After spending two years in negative territory, the curve started going positive in early August, due mostly to falls in the short end.
Those falls were later reinforced by a 25-basis-point cut in the Reserve Bank’s official cash rate to 5.25% on August 14.
A downwardly sloping curve - when short-term rates exceed long-term rates - is seen as being a negative signal for the economy.
An upwardly sloping curve - when investors are rewarded for locking in their money over the longer term - is seen as being more normal.
On Friday, the two year swap rate was at 3.71% while the 10-year swap was at 4.07%, making for a 35 basis point gap - the steepest since the first quarter of 2022.
“This is the market saying lower rates are going to have an impact on future economic outcomes,” Hamish Pepper, fixed income and currency stategist at Harbour Asset Management, said.
“From where we were prior to this easing cycle, things are looking much better,” he said.
“This is not what people had expected even six months ago and I think the market has responded to that.”
The Reserve Bank - along with most other central banks around the world - is on an easing path now inflation appears to be on the back foot.
Domestically, the proof will be in the pudding when Stats NZ releases its Consumers Price Index for the third quarter on Wednesday.
ANZ expects quarterly CPI inflation to come in at 0.8%, which would see annual inflation slow to 2.3% - closer to the Reserve Bank’s desired rate of 2%.
It’s a similar story in many other Western countries.
This week, data showed US inflation fell to 2.4% in September, cementing expectations the Federal Reserve would cut interest rates by a quarter of a point in November.
Kiwibank chief economist Jarrod Kerr pays close attention to the yield curve, which has proved an accurate harbinger of things to come.
“I think the yield curve will continue to steepen - that’s been the big trade of this year,” Kerr said.
“Yield curves steepen when central banks cut rates, so we are getting a full steepening at the moment, which is consistent with the moves that have been priced in.”
“The short end continues to glide lower, but the long end will start to price in a little bit more growth, inflation and risk premium over the next year as rate cuts are expected to work, creating better economic outcomes.
“Our yield curve is beginning to look a lot more normal because we had very restrictive short-term rates.”
The Reserve Bank and Governor Adrian Orr had drawn flak for keeping rates high - 5.5% - longer than was required in the eyes of some.
“The cash rate has been very high and it’s been put back to a more neutral level - that’s where most of the movement has happened and that long end of the curve going into next year will grind higher with better growth expectations.
“It will normalise and steepen a bit further from here,” Kerr said.
“Normal” could mean 50 to 100 basis point positive difference between the two-year and 10-year swap rates.
The Reserve Bank, in cutting the official cash rate to 4.75%, said annual consumer price inflation was within its 1% to 3% inflation target range and was converging on the 2% midpoint.
The bank acknowledged economic activity in New Zealand is subdued, in part because of restrictive monetary policy.
“Business investment and consumer spending have been weak, and employment conditions continue to soften. Low productivity growth is also constraining activity,” it said in this week’s statement.
Market expectations are for another 50 basis point cut on November 27, but views are less clear about what will happen at its first OCR announcement for 2025 in February.
Regardless, market pricing has the rate falling to around 3% in the second half of that year.
“So from 5.5% to 3% - that’s going to be a big story for homeowners and businesses,” Kiwibank’s Kerr said.
He said the Reserve Bank’s half-point cut recognised the dire state of the economy, and the view inflation was in retreat.
Kerr said it was a matter of better late than never.
Some economists said the weaker signs were evident in May, yet the bank opted to keep the OCR at 5.5% - waiting until August to start cutting.
“Where they were in May was clearly wrong compared to where they were in August, which was right,” Kerr said.
“They have been willing to adapt to make such a strong and sharp call, so I commend them for that - but it took them a long time to get there.
“There is realisation that the data is bad, that the economy is in a two-year recession, but with all of that, there is growing confidence that inflation is pretty close to 2% now and it’s going to say at 2% if we are to believe the inflation surveys.
“Confidence about inflation has clearly lifted across the board - from economists and the Reserve Bank - but from the RB’s perspective, there has been a clear recognition that the data has been much worse than they thought back in May.
“In all fairness, they swallowed that bitter pill and turned on a dime.
“You have got to commend them for that - they were not stuck in their ivory towers or anything silly like that,” Kerr said.
“They got down and did what needed to be done.”
Jamie Gray is an Auckland-based journalist, covering the financial markets and the primary sector. He joined the Herald in 2011.
ANZ stopped accepting deposits into others' accounts last year.