Swap rates are the pricing base for all corporate bond issuance and mortgage rates; as rates rise the value of a bond portfolio decreases

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It was certainly a big week.

As global markets digested Bernanke’s tapering schedule, this apparent bitter pill resulted in interest rates and the NZD all recording significant moves last week.

Global markets (both equity and debt markets) are now coming to the realisation that the end of the Fed’s bond buying programme will actually occur - the key question is when?

Central bank rates versus swap rates

For New Zealand bond investors the last two weeks has seen both the Reserve Bank of New Zealand (RBNZ) and the Fed state that their respective benchmark rates (the Official Cash Rate and The Fed Funds Rate) are unlikely to be raised anytime soon.

One must remember that an important distinction must be made when reading commentary around interest rates.

While the OCR may be flat, the key for bond investors is the impact on swap rates. Swap rates are the pricing base for all corporate bond issuance and mortgage rates.

As swap rates rise the value of a bond portfolio decreases. So while the message of ‘interest rates remain unchanged’ is common place, the actual rates which impact bond investors - swap rates - are moving higher, particularly at the longer end of the curve.

Traders in NZD bonds have a different time line to the RBNZ on when the OCR will move.

In our view, bond investors should maintain a bond portfolio duration of around three years in order to reduce the risk to rising interest rates.

RBNZ the winner?

The prospect of higher mortgage rates has also increased over the last week with a couple of major banks having already warned that record low mortgage rates are about to end. As swap rates rise, banks will be forced to raise mortgage rates to cover their cost of funding, this may effectively deliver a tightening for the RBNZ without the Central Bank doing anything.

A dream result for the RBNZ given their view on the New Zealand housing market.

Mixed GDP and current account data

The RBNZ had (less than a week earlier) forecast that the New Zealand economy expanded by +0.5% in the March quarter, however, an actual reading of +0.3% was less than both the RBNZ and the market had been expecting. Given the previous quarter’s +1.5% growth, the reaction from the market to this backward looking figure was minimal.

The current account deficit to GDP improved to -4.8% (from -5.0%) with New Zealand’s net external debt to GDP now at 65.6%. This improvement was not a surprise given that according to Statistics New Zealand, almost a third of New Zealand’s international assets are held in overseas sharemarkets. Strong performance from these markets boosted New Zealand’s asset values by NZ$2.4bn.

Credit markets

Credit markets were wider across the board last week as one would expect given the movement in bond markets. Both Europe and Australian credit were +17bp wider with the US performing a touch better at +14bp.

In New Zealand, the yield on the ANZ Investment Grade Bond Index rose +24bp over the week to start the week at 4.48%, the yield on the index is now +57bp higher than its record low of 3.91% on 8 May 2013.

Any tapering will be data driven

The market had spent considerable time (since May 22 to be precise!) getting itself prepared for the Fed announcement, and when it came the market wasted no time in digesting the comments and unleashing its feelings on the bond and equity markets.

So what did the Fed say? (and why do we care in NZ?)
Firstly, it started back with statements made to Congress by Fed Chairman Ben Bernanke on 22 May regarding a ‘possible’ slowdown of its US$85bn/month bond buying programme, which the market dubbed ‘tapering’.

Since those statements, the market/experts/commentators have all been obsessing over when or if the Fed will ease back on its current stimulus programme.

Lets be clear that the Fed announcement last week made no changes to any of its existing monetary policies, it just outlaid a more positive view on the US economy. The Fed did not announce it will do less but rather how and when it will do less going forward, However, by describing the beginning of the end of its unconventional policies, this was treated no differently than actually implementing this course of action.

At the end of the day, any tapering will be dependant on the economic data that supports the withdraw of stimulus. While interest rates may head higher (which they already have done) there may well be some consolidation until certainty about a US economic recovery is witnessed.

Consequences for NZ

As we have done and continue to do, we highlight the close correlation between New Zealand bonds and US treasuries (at the long end of the curve), the impact of a bond sell-off in the US has consequences for the New Zealand bond market. The reaction in our local market to the Fed’s comments have been swift to say the least:

• On the Thursday immediately after the Fed’s comments, New Zealand swap rates were +14bp to +19bp higher across the 5-year to 10-year part of the curve.
• The steepness (10yr less 2yr) of the New Zealand swap curve is now +45bp steeper than it was on 3 May 2013.
• The April 2023 New Zealand Government Bond was sold off +33bp (or 10%) on Thursday. At the time of going to print the yield on the 2023 NZGB was 4.25%.
• The yield on the ANZ Investment Grade Bond Index rose +24bp over the week. The yield on the index is now +57bp higher than its record low of 3.91% on 8 May 2013.

Corporate / Credit news

The New Zealand Debt Management Office (DMO) announced it intends to offer a new inflation-indexed bond in or around September. The inflation linker will have maturity of 2030 and will be sold through a syndication process. The DMO sold NZ$120m of New Zealand Government Bonds (NZGB’s) at auction last week. The auction of April 2020’s received NZ$352m of bids and were sold at an average yield of 3.7805%, +46bp on its previous auction.

Downer EDI (DOW) had its credit rating upgraded by Fitch Ratings from BBB- to BBB. Its outlook remains Stable. The reasons for the upgrade related to an improved financial risk profile, earnings diversification and more discipline around the vetting of project bids.

Fonterra (FCG) had its A+ credit rating affirmed by S&P. Its outlook was also affirmed as Stable.

Heartland Bank (HNZ) confirmed it will repay its outstanding bonds (MAR010) when they mature on 15 July 2013. The record date is 5 July 2013.

The Local Government Funding Agency (LGFA) held tender number 13, offering NZ$15m of December 2017’s which received NZ$30m of bids from 8 bidders and were sold at an average yield of 3.9283%. The NZ$270m of May 2021 LGFA bonds received NZ$547m worth of bids from 56 different bidders (successful bidding range 26bp!). The bonds were sold at an average yield of 4.4648%.

NZ Post (NZP) announced it plans to cut up to 100 jobs. The job cuts will be in management with the restructure only affecting 6% of its 1300 corporate staff.

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