A big gap has opened up between the market and the Reserve Bank of New Zealand’s views of where interest rates are heading.
The two-year swap rate - which can have a bearing on home mortgage rates - has continued to decline over the last few months, aside from it spiking higher in the aftermath of last week’s Monetary Policy Statement (MPS) being issued by the Reserve Bank.
Two-year swaps now trade at 5.21 per cent - down substantially from 5.783 per cent two months ago.
Moves in the wholesale markets suggest that home mortgage rates may be on their way down, while last Wednesday’s MPS was unmistakably hawkish, or supportive of higher rates.
As expected, the central bank left its official cash rate (OCR) unchanged at 5.50 per cent, but its forecasts showed the rate hitting 5.69 per cent by the end of next year.
“The gap is massive,” Hamish Pepper, fixed income and currency strategist at Harbour Asset Management said.
“Really, the market is not on board with the Reserve Bank’s view of the economy, or the outlook as well,” he said.
“On the day of the MPS, the market only briefly entertained the ideas that were put forward in the document - the idea that an additional hike in the OCR was being implied, for example.
“The market has now clearly got a different view of how things are in New Zealand and how they might play out,” he said.
“In terms of just how disconnected the market is, you have essentially got a situation where the market is somewhere between 50 to 75 basis points - by the end of next year - below where the Reserve Bank’s forecasts are at,” he said.
Market pricing has the OCR dropping to 4.9 per cent by November next year, against the Reserve Bank’s forecast for the final quarter of 5.69 per cent.
On the global front, New Zealand’s central bank is being seen as an outlier while other central banks are looking to either hold or cut their rates.
Pepper said there is a degree to which the cutting “playbook” employed overseas is being applied to New Zealand.
New Zealand was among the first of the central banks to start tightening (October 2021), and the transmission of those higher official rates into lending rates is seen as quick in comparison with countries like the US, where 30 years is the average term for a mortgage.
Then there is the high level of foreign participation in New Zealand’s interest rate markets, which makes them more inclined to follow foreign trends of lower rates.
“This summer will be a good test as to who is right, because obviously, there is a high degree of tension between what the Reserve Bank is saying and what the markets are saying,” Pepper said.
Over the coming months, market attention is likely to focus on growth, fiscal, CPI and labour data as investors look for evidence inflation may be on the decline.
The Reserve Bank’s next MPS is due on February 28.
“By then, I think we will have a good case as to who has the right view of the world here,” Pepper said.
“I think mortgage rates are quite likely to come down if markets continue to disagree with the Reserve Bank’s view of the world.”
ANZ strategist David Croy said overseas inflation-friendly data was helping to drive local rates down.
“The Reserve Bank is on its own in threatening to raise rates again - at least, that is the perception in the markets,” Croy said.
“There is a very large gap now, and that gap is likely to persist until the market is given evidence that it should not exist,” he said.
“For the moment, it’s a standoff.”
Jamie Gray is an Auckland-based journalist, covering the financial markets and the primary sector. He joined the Herald in 2011.