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Models & Technicals1 July 2010Yield Curve Value AnalysisIt’s been rally, rally, rallyOn renewed global fearsLeaving NZGS 17s cheap to the curveValue RecommendationsNew Zealand Interest rates have broken their recentranges, rallying hard on very little flow and thin liquidity.Kiwi rates essentially followed the global rally, breakingcurrent ranges on the back of continued concern in globalmarkets as to the strength of the global recovery.The bond market has been trading heavily in yield, withthese falling approximately 20 bps across the curve .There was a notable pick up in offshore demand lastweek, as global prospects begin to come into question.The front end of the curve rallied strongly as the 13straded from 4.38% to as low as 4.165%. The 15s continueto perform well, rallying 20bps from 4.85% to close4.65%. The longer dated 21s closed at 5.335% as theycontinue to make new lows in yield.The swaps market has also rallied hard over the lastfew days, as it feels that market participants have beenstopped out of positions on thin liquidity resulting in a22bps rally across the curve, with a small flattening bias.The 2-year swap has broken below its 4.20% low, totrade as low as 4.07%. The mid part of the curve hasagain been hit hard, outperforming the rest of the curve,with the 5-year swap rallying almost 29 bps, to close at5.7525%. And the 10-year swap closed at 5.345% havingdecreased approximately 26bps. All of this has meant thatthe 2s5s10s butterfly has come in significantly.Our parametric model is now indicating 17s appear cheapwhile other maturities appear neutral.Parametric Yield Curve AnalysisParametric Yield Curve AnalysisParametric yield curve analysis essentially looks foropportunities between overpriced and underpricedbonds by examining their yields in comparison to a fittedyield curve.Parametric models can differ in the form of equation thatis fitted and its number of terms. We have selected threemodels which work particularly well in fitting a continuouscurve to the NZGS yield curve, namely Bradley-Crane,Elliot-Echols and Haugen. All three models use the leastsquares method to fit the curve.A feature of the parametric yield curve analysis that wehave observed is that certain NZGSs may remain cheapor expensive against a fitted curve for an extended periodof time (as much as a few months). For this reason wepresent the results of our analysis in the form of a chartwhich includes the ranges of the spread to the fittedcurve for each NZGS on a two-month rolling basis.In particular, we include, in addition to the current spread,the maximum and minimum spread, and the one standarddeviation points either side of the average spread.Yield5.50%5.30%5.10%4.90%4.70%4.50%4.30%4.10%3.90%3.70%3.50%Parametric Yield Curve AnalysisHaugen Model0.00 2.00 4.00 6.00 8.00 10.00 12.00Maturity (Years)Current Yield CurveFitted Curve\Maturity Yield Bradley - Crane Elliot - Echols Haugen11/11 3.67% Neutral Neutral Neutral04/13 4.17% Expensive Neutral Neutral04/15 4.65% Neutral Neutral Expensive12/17 5.12% Cheap Cheap Cheap05/21 5.34% Neutral Expensive NeutralAvg Abs Deviation 4.04 bps 5.48 bps 1.34 bpsParametric Yield Curve Analysis - One month forwardModel RecommendationsMaturity Yield Bradley - Crane Elliot - Echols Haugen11/11 4.09% Neutral Neutral Neutral04/13 4.77% Cheap Neutral Cheap04/15 5.25% Expensive Neutral Neutral12/17 5.66% Cheap Cheap Neutral05/21 5.95% Neutral Expensive NeutralAvg Abs Deviation 0.76 bps 2.57 bps 3.08 bpsBasisPoints86420-2-4-6Two month history of spread to fitted Haugen curve11/1104/13vincent_tan@bnz.co.nz04/1512/1705/21Max1 Stdev1 StdevMinCurrentwww.research.bnz.co.nzPage 4
Models & Technicals1 July 2010Bill Portfolio ModelQ1 GDP meets market expectations68bps priced in for the next four meetingsThe biggest announcement in the last few weeks,although nothing too exciting, was the GDP figure thatwas released by Statistics New Zealand. Q1 GDP wasright on market expectations of 0.6%. Year on year GDPcame in at 1.9%. This news reaffirms our view that thehiking cycle will continue over the year with regularincrements even though the market seems to reflect a bitof uncertainty. It was also noted that the monthly exporttotal of $4.21b was only the third occasion in the country’shistory that monthly exports have crossed the $4b mark:the major drivers were milk powder sales and NZ’s underratednewest export – crude oil.The RBNZ announced last week another way of improvingthe prudential framework in NZ’s banking system. The aimis to help ill-informed retail investors gain better protectionfrom finance companies who pay higher deposit ratesthan those of the well-rated large banks. The requirementis for non-banks “to maintain a minimum capital ratio,and to limit the amount of credit they can provide torelated parties”.In other news, the Balance of Payments showed animprovement in the Q1 current account. This result fared%3.503.403.303.203.103.002.902.802.702.602.50NZ Bank Bill Curve17-Jun-101-Jul-10Cash 1mth 2mth 3mth 4mth 5mth 6mthValueF/N ReturnAnnualisedReturnNewDurationIndex 113.3159 0.1190% 3.3398% 45Portfolio 114.2892 0.0965% 2.7085% 76better than market expectations. The current accountcame in with a small surplus of $176m, which decreasedthe annual deficit to $4.46b.The market is currently pricing a 25bp hike at the nextmeeting on 29 July at 78%. With the offshore volatilityat the moment, there is uncertainty over whether therewill be a series of 25bp increments over the next fourmeetings. The market is priced now at 68bps over thenext four meetings. The portfolio has underperformed inthe last few weeks compared to the index, as uncertaintyhas crept into markets. We have decided to keep theweightings for the portfolio as they currently stand.Weighting(%)100908070605040302010-Portfolio Index Weightings17Jun30JunCash 1M 2M 3M 4M 5M 6Mwarwick_foy@bnz.co.nzBNZ Interest Rate IndexThe BNZ Interest Rate index operates within the followingparameters;1. The index purchases bills every day out to 90 days.On maturity proceeds are used to purchase another90 day bill.2. As a result the index duration will approximate at45 days.3. Both the index and the portfolio will be revalued dailyat closing mid prices.4. The portfolio position will be held over the fortnightand updated each Models & Technicals edition.5. Any position changes within the period must be statedie. stop entry or loss levels in the current edition andthe portfolio position will then be taken back to index.www.research.bnz.co.nzPage 5
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