Rising tension: Bond yields puts market at odds with RBNZ

Reserve Bank is keen to keep mortgage interest rates low in the face of rising bond yields. Photo / NZ Herald

Rising bond yields have continued to put the market at odds with the Reserve Bank's efforts to keep funding costs low.

The Reserve Bank last week advised that its week bond buying programme would increase this week to $630 million, from the previous rate of $570m, but market analysts said the increase was more likely to be technical rather than signalling any change of stance.

A summary of the bank's monetary policy committee meeting last month said that weekly changes in the central bank's large scale asset purchase programme (LSAP) did not represent a change in monetary policy stance.

Regardless, analysts said there was a tension between market forces putting upward pressure on bond yields here and around the world, while central banks in Covid-recovery mode remain steadfast in keeping them low.

But they said the Reserve Bank would tolerate higher bond yields so long as they don't translate into mortgage rate increases.

The two-year swap rate is at 0.55 per cent, up from close to zero in November and 0.3 per cent in February, while key 10-year bond yields have surpassed 2.0 per cent.

Bond yields have largely been mirroring the sharp gain in US 10 year Treasury yields, which last traded at 1.56 per cent, based on America's improving economic prospects.

Market strategist Imre Speizer said there was tension between the Reserve Bank's goal of keeping rates low and what is happening in the bond market.

"But unless they feed into mortgage rates, it really doesn't matter too much," he said.

"They know that it's a reflection of global interest rate markets," he said.

"If mortgage rates start rising here - and they haven't yet - that represents a significant tightening of conditions which would require them to loosen somewhere else, so at the very least it would mean keeping the official cash rate at 0.25 per cent for longer than they would have done otherwise," he said.

Markets are factoring in the view that inflation will rise and will remain high while the common central bank view is that inflation will rise, then subside.

"The traders are betting that inflation will remain high and will not fall back, while forcing the banks into tightening earlier," Speizer said.

Hamish Pepper, fixed income and currency strategist at Harbour Asset Management, said rising bond yields here, in the United States, Australia and some other countries, were a reflection of upward revision in growth expectations.

"They (the Reserve Bank) are happy for longer dated yields to price in that better economic outlook but when it comes to short dated yields, where there is a strong relationship with household lending rates and business lending rates - that's where there is a stronger relationship with household lending.

"That's where the sensitivity is. They don't want to see those go materially higher."
Pepper said the funding for lending programme - aimed at providing lending to banks at the official cash rate 0.25 per cent had only reached just over a billion dollars since its inception.

But he said the existence of the programme was helping to anchor lending rates at low levels.

ANZ senior strategist David Croy said the Reserve Bank was unlikely to be overly concerned by the rise in yields.

"They have joined the view of other central banks - such as the US Federal Reserve - that the rise in yields is simply a reflection of an improving economic backdrop," Croy said.

"If we were seeing a rise in yields without a commensurate improvement in the economic outlook, then that would prove alarming."