RBNZ remains an outcast with one +25bp hike priced in for March 2014 meeting; already 80% chance of a +25bp hike at January 2014 meeting

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The following is a summary of the key events impacting fixed income markets over the past week.

By the end of Tuesday most of the worlds’ central banks will have disclosed their current thoughts on their respective economies. The Reserve Bank of Australia (RBA) holds its monthly meeting on Tuesday while the European Central Bank (ECB), the Fed and Bank of England (BoE) met last week.

Central bank outlooks remain mixed

There is becoming some divergence in Central Bank monetary policy with the recent round of Central Bank meetings. We saw the hawkish tone set by our own Reserve Bank of New Zealand (RBNZ), while the comments from RBA Governor, Glenn Stevens, suggest that the RBA is close to lowering its cash rate. National Australia Bank recently moved to match the rest of the market calling for at least one -25bp cut and one further cut before the end of 2013.

The story in the Northern Hemisphere is similar with the Fed buoyed by strong economic data (including a four year low unemployment rate, see below) while in Europe the ECB and BoE remain accommodative. The ECB said interest rates would remain low for an “extended period”.

BoE’s new governor Mark Carney will make his first public comments on Britain's economy since taking charge of the central bank on Wednesday which is expected to be "… a big market-moving event" according to one analyst.

The RBNZ remains the outcast with one +25bp hike priced in for the March 2014 meeting and an 80% chance of a +25bp hike at the January 2014 meeting. Overall two hikes to the current 2.50% Official Cash Rate are priced in by the end of April 2014.

Credit markets tighten across the globe

Credit markets in both the US and Australia tightened by -4bp over the course of the week, whereas European credit spreads contracted by -7bp. In New Zealand, the yield on the ANZ Investment Grade Index rose by +7bp last week to close at 4.70%.

Inflation-indexed bond overbid

The New Zealand Debt Management Office (DMO) sold NZ$300m of the September 2025 Inflation-Indexed Government Bond after receiving NZ$683m worth of bids. The bonds were sold at a weighted average yield of 2.3204%.

US unemployment falls

The widely anticipated non-farm payrolls data released at the end of last week provided a mixed bag. The market had been expecting 184,000 new jobs in June however, the 162,000 disappointed along with a -26,000 revision lower of May’s data. This disappointment was somewhat offset by the unemployment rate falling from 7.6% to 7.4%.

This key economic indicator is going to be even more heavily scrutinised in the next few months as the market looks for signs that the magical 7% is within grasp. The 7% level is where there is ‘broad support’ among the Fed for shutting down its US$85bn bond-buying programme.

The end or a wind-down of the bond buying programme will see interest rates begin to rise again and New Zealand long-term interest rates will likely follow suit.

Local Authority bonds replace bank bonds

The return on the ANZ Investment Grade Bond Index was once again negative for the month of July (see graph below). The yield on the index continues to climb higher up +20bp to 4.70% at 31 July and +61bp at 31 May 2013.The +20bp rise in July was consistent with the underlying swap rates which posted rises of +17bp at the long-end, +26bp at the five-year and +17bp at the short-end of the curve.

The market continues to firmly believe that the Official Cash Rate (OCR) will increase in the first quarter of 2014. These beliefs along with an improving economic scene in the US have put pressure on the long-end of the curve. If and when the OCR begins to rise, it is likely that the New Zealand swap curve will begin to flatten as short-term interest rates begin to rise.

The yield curve has already flattened by around -9bp over the month of July due to the expectations that the Reserve Bank of New Zealand will need to raise the OCR sooner than it had originally forecast.

The duration of the ANZ Investment Grade Bond Index continues to be quite short at 2.8 years and is consistent with our own recommendation that fixed income portfolio duration be around 3 years. The short duration call will benefit fixed income portfolios as interest rates begin to rise.

One of the features of the index is the changing of its constituents. At this time last year, 50% of the index was made up of bank issuance. As at 31 July 2013, bank issuance has fallen by -6% to 44% with issuance from the Local Government Funding Agency (LGFA) rising by +8%. Debt issuance from the Local Authorities now makes up 22% of the total index.

This is a trend which is likely to continue as the LGFA continues to expand and banks being very well funded via its retail deposit base as opposed to the retail bond market.

The 16% of total issuance contribution from the corporate sector was unchanged from a year ago but unfortunately it is not growing despite being able to issue bonds to an issuance starved retail investor base at some attractive issue yields.

The returns on New Zealand Government Bonds are likely to remain a touch volatile as their close correlation with the US means NZGB’s will also be subject to market gyrations around US economic data.

Corporate / Credit news

Auckland International Airport (AIA) received a big tick from the Commerce Commission, with the Commission confirming that AIA was not generating excessive profits. This outcome significantly reduces the regulatory risk surrounding AIA.

Fonterra continues to grab the spotlight with another profit warning. Fonterra recently warned on its FY13 profit outlook the previous week and has now warned on FY14. The higher Forecast Farmgate Milk Price announced last week, from NZ$7.00 to NZ$7.50, means higher cost of goods sold which negatively impacts earnings.

Infratil (IFT) confirmed that its convertible Infrastructure bonds maturing on 15 September 2013 will be redeemed for cash at maturity and not converted into shares in Infratil.

The Local Government Funding Agency (LGFA) held tender number 14 last week where it sold NZ$10m of April 2015’s and NZ$185m of May 2021’s. Demand once again exceeded supply with the April 2015’s sold at a yield of 3.45% and the May 2021’s sold at a yield of 5.03%.

Meridian Energy (MEL) released its operating information for the three months ended 30 June 2013. MEL’s retail customer connections fell by -15,227 versus the prior quarter comparative to 272,077.

The NZX released its monthly operating statistics for July. Over the year to 31 July the number of listed debt securities fell -25% with total trades on the NZDX falling -1.6% versus the pcp. The value of those trades also fell -22%. Year-to-date the amount of debt raised is NZ$93m versus NZ$1,596m on the primary equity market.

TOWER confirmed the unconditional sale of its Life business with a settlement date to be released soon. It is then expected that TOWER will provide TWC010 holders with the required 45 business days of early redemption.

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