How Important Are Global Market Shocks For Explaining NZGB-Swap Spreads?

We have published an Analytical Note: How important are global market shocks for explaining NZGB-swap spreads?

This Note documents historical developments in the spread between New Zealand Government Bond yields and interest rate swap (IRS) rates – the NZGB-swap spread.

Key findings

• NZGB-swap spreads tend to become more volatile during periods of global sovereign bond market illiquidity and moved persistently higher after the Global Financial Crisis. The increase in NZGB-swap spreads since mid-2023 has been correlated with higher sovereign bond-swap spreads in a range of jurisdictions.
• This Note estimates a structural vector autoregression model to understand how much of the overall variation in NZGB-swap spreads is explained by US shocks.
• Forecast error variance decomposition analysis shows that in the longer-run, around 56% of the variation in the 10-year NZGB-swap spread is explained by US shocks. Historical decomposition analysis shows both US and domestic shocks have been important drivers of the increase in the 10-year NZGB-swap spread since mid-2023.

Trends in New Zealand financial markets can often be traced back to global factors, which is why it is important to understand to what extent changes in domestic financial conditions are a response to global or local shocks.

Why we did this research

The spread between New Zealand Government Bond (NZGB) yields and interest rate swap (IRS) rates – the NZGB-swap spread – has increased since mid-2023.

NZGB-swap spreads often rise sharply during periods of illiquidity in the NZGB market, so it is important to understand whether movements in NZGB-swap spreads can be explained by macroeconomic factors (such as the domestic business cycle or global shocks) or are due to factors that may be symptomatic of a deterioration in NZGB market liquidity.

As discussed in one of our recent speeches, trends in New Zealand financial markets need to be understood in their global context. This is a key motivation for undertaking this analysis to understand how much of the variation in NZGB-swap spreads is driven by US shocks. We focus on the influence of US shocks because of the central role that the US plays in global markets.

Read the speech - Transmission currents and the flow of monetary policy to financial conditions- https://govt.us20.list-manage.com/track/click?u=bd316aa7ee4f5679c56377819&id=a55c167954&e=456d2b38b7

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