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Wave of economic gloom offers only temporary reprieve from rise in bond yields

Friday 23rd March 2012

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Weaker economic news at home and abroad may offer only a temporary reprieve from rising government bond yields, with US Treasuries seen resuming their sell-off amid perceptions that interest rates won’t return to historical lows.

US Treasuries have gained for three days in a row, pushing the yield on the benchmark 10-year bond down to 2.28 percent, after testing a five-month high of 2.40 percent this week, as reports showed manufacturing in China, the fastest-growing major economy, is continuing to contract, while in Europe both services and manufacturing are weaker.

New Zealand government bond yields have declined from a four-month high, with the 10-year bond falling about 8 basis points to 4.26 percent yesterday, and held at that level today, after figures showed the economy grew just 0.3 percent in the fourth quarter, half the pace expected by the Reserve Bank.

“Bond yields have taken a breather from the sharp rise they experienced over the past couple of weeks,” said Christian Hawkesby, head of fixed income at Harbour Asset Management. “In the short-term we can see the US 10-year yield potentially retreating to around 2.15 percent, and there continue to be risks from China and Europe. But over the medium term we still believe that the trend in global interest rates is higher led by the US Treasuries market.”

The US Federal Reserve is seen raising its key interest rate by 13.2 basis points over the next 12 months, based on the Overnight Index Swap curve. That’s up from just 6 basis points at the start of the month.

Fed chairman Ben Bernanke said it is “challenging” to determine the right time to raise interest rates though with inflation low in the world’s largest economy, there’s no pressure to tighten, Bloomberg reported him saying at a lecture at George Washington University in Washington yesterday.

New Zealand government bonds tend to take their lead from US Treasuries, a benchmark for global yields, and yields in both markets have been rising this month following signs of recovery in the US economy and the first comments from the Fed that America’s outlook is improving.

Overnight, a report from the New York-based Conference Board showed its leading economic index rose 0.7 percent during February, the fifth straight monthly gain, and Labor Department figures showed initial claims for state unemployment benefits slid 5,000 to a seasonally adjusted 348,000 last week, the lowest since February 2008.

JBWere strategist Bernard Doyle said in a note this month that the “aging bull” market in US government bonds, which stretches back three decades, is coming to an end and investors are more likely to face capital losses as yields rise in the next few years.

“While bonds will remain an important part of portfolios, JBWere is recommending clients hold less bonds than normal,” Doyle said.

Traders have sliced about 10 basis points off their bets on a Reserve Bank of New Zealand hike to the official cash rate over the next 12 months since the fourth-quarter GDP report yesterday. The central bank is now seen lifting the OCR by 26 basis points in that time, based on the Overnight Index Swap curve.

Still, given that the nation’s long-term interest rates are more driven by global markets, it is likely that fixed rates for mortgages and corporate borrowing in New Zealand will increase this year, Harbour Asset’s Hawkesby said.


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