New Zealand’s Flat Yield Curve Signals Weaker Economic Growth

(Bloomberg) -- New Zealand’s yield curve has flattened markedly, signaling that the central bank’s tightening cycle is expected to significantly slow economic growth.

The spread between 5-year and 10-year swap rates fell to 1 basis point Monday in Wellington, from 11 points immediately after the Reserve Bank’s rate decision on Nov. 24. The gap was nearly 40 basis points in early October.

“It’s quite unusual for the New Zealand curve to be this flat, this early in the cycle,” said Nick Smyth, interest rate strategist at Bank of New Zealand in Wellington. “The fundamental interpretation is the Reserve Bank is going to cause a major growth slowdown.”

The RBNZ raised its official cash rate to 0.75% and signaled it will need to raise the benchmark more quickly than previously expected to contain inflation, taking it to 2.5% over the next two years. It projected annual growth will slow to 1.3% in 2023 from 4% in 2022.

Smyth said some technical effects may also be at play. A record volume of mortgage fixing in recent months requires hedging, which is keeping the 5-year swap rate elevated, while the 10-year rate is being depressed by low global yields.

He said in New Zealand the yield curve is not a perfect predictor of what’s going to happen, compared to bigger economies such as the U.S.

Still, “the market is telling us it expects the RBNZ to hike reasonably aggressively, it expects a material growth slowdown down the line, and it expects post this rate-hike cycle the likely direction of the RBNZ after that is more likely to be downwards,” he said.

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