AU-NZ 10Y Differential Not Showing Concerns About NZ Current Account Deficit

In his testimony to parliament yesterday regarding the Financial Stability Report (FSR) RBNZ Deputy Governor Hawkesby said:

• “We note that the current account deficit has increased recently, and that’s partly a story around the resilience of consumption and demand in NZ. We take some comfort that for a long period now we’ve had a downward trend in our net foreign liabilities, and that’s really a key source of vulnerability typically.”
• “If markets are worried about the current account deficit, what we’re likely to see is interest rates rising and the exchange rate falling.”
• “We’re not seeing concerns about New Zealand government debt in markets. New Zealand government debt is still relatively low.”
• In early March, the AU-NZ 10-year yield differential narrowed to -100bp, its lowest level since the late 1990s on the back of a worse-than-expected deterioration in NZ’s current account deficit and the resultant S&P bond ratings comments.
• A simple regression of the AU/NZ 10-year yield differential versus the AU-NZ 1Y3M swap differential revealed that NZ's current account deficit concerns had added around 20-25bp to the 10-year differential.
• The same analysis today however reveals a model error of only -5bp, supporting Hawkesby's comments, particularly given the AU/US 10-year yield differential appears too low.

Figure 1: AU/NZ Model Error - 10-Year Yield Cash Differential Vs. 1Y3M Swap Differential

Source: MNI – Market News / Bloomberg