Fear of the Fed drives NZ bond yields sharply higher

Financial markets expect the US Federal Reserve to take a big stick to inflation with a series of interest rate hikes. Photo / File

New Zealand Government bond yields spiked higher in line with overseas trends as markets awaited the outcome of this week's Federal Reserve meeting, when the US central bank is widely expected to start raising rates for the first time since 2018.

The yield on the US benchmark 10-year Treasury bond leaped to 2.15 per cent - its highest point since mid-2019 - as concerns continued to mount over sharply higher inflation and the possibility of a recession arising from the current oil shock.

New Zealand Government bonds traded up at 3.08 per cent - their highest point since September 2017, having already firmed on Friday to 3 per cent.

Harbour Asset Management portfolio manager Shane Solly said financial markets were pricing in seven hikes of 25 basis points apiece from the Fed this year.

"We have seen US bonds in particular being sold off," Solly said.

"It's just fear of the Fed.

"We have been observing this 'bondcano' that has been building up and now the pressure is being released."

In bonds, yields rise when prices fall.

While much of the narrative in the financial markets had been about inflation, Solly said the risk of recession was now entering the fray.

"There is no doubt that the medicine you have to have to get the heat out of an economy is a recession," he said.

David McLeish, Fisher Funds senior portfolio manager, said central banks, including the Reserve Bank of NZ, were facing a dilemma.

"On one side they have to look like they are doing something about trying to get inflation down and therefore raising interest rates, while on the other hand they don't want to raise them too quickly and essentially cause a recession," he said.

"There is going to be a very difficult balancing act and different pundits have different views on how they can balance that.

"It will undeniably be a huge challenge, not only for our own central bank but for most around the world," he said.

McLeish said last year's concerns about supply chain logistics had lessened a little.

Now, the problem was what was looking like energy crisis thanks to the Russia-Ukraine conflict.

However, for the moment, the pressure has gone off oil prices, with West Texas Intermediate falling to US$103 a barrel from its US$123/barrel peak.