NZ no longer an 'island'

Data Flash (New Zealand)

NZ no longer an 'island'

Summary

On 7 March we recommended that investors buy NZ short bonds against Australia. Our favoured way to put this trade in place was to receive 3Y NZD swap and sell the 3Y AUD future.

The slump in NZ business confidence in the March QSBO has dramatically narrowed the "confidence gap" between NZ and Australia. A significant convergence in short bond yields seems likely and we continue to recommend the trade.

NZ no longer an "island" immune to the global slowdown

Note: For Australia, NAB business conditions are used rather than expectations. The last observation for NZ assumes the April National Bank survey is in line with the March QSBO.

The NZIER has just reported a significant fall in NZ business confidence. In the Institute's March survey overall business sentiment has fallen to -2, from a reading of +31 at the end of the December quarter.

Interestingly, the NZIER's survey comes just two weeks after the National Bank's monthly survey reported a high level of business confidence for March. This indicates that sentiment has reversed very quickly, though the more rural flavour of the NBNZ survey may affect the comparison somewhat.

The QSBO data has, not surprisingly, prompted the NZ market to fully price in a rate cut by the RBNZ on 19 April. While a poor outcome for the Q1 CPI may persuade the RBNZ to wait until the May Monetary Policy Statement, the plunge in sentiment suggests that further rate cuts by the RBNZ are almost certainly a question of when not if.

In contrast, Australian business sentiment has steadied in the last few months as RBA rate cuts provided an offset to deteriorating global conditions. In fact, the NAB survey reported a small rise in business confidence in March even as business conditions remained unchanged.

With the gap between NZ and Australian business sentiment narrowing, the interest rate gap between the two countries should also narrow. Certainly, the RBA's recent statements suggest they could pause for a period. If the RBNZ does ease in April and/or May the gap between official rates will narrow.

Indeed, spreads have begun to narrow. The gap between the 3Y NZD swap and the 3Y AUD futures has narrowed some 20 bp since we recommended the trade. We see considerable scope for a further compression in spreads.

David Plank Fixed Income Strategist

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