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The following is a summary of the key events impacting fixed income markets over the past week.
US Federal Reserve Chairman Ben Bernanke surprised the market last week by declaring that the Fed would not be reducing its monthly bond purchases. It appears the toner cartridge in the US printing press has plenty of ink left in it with no guidance as to when the US$85bn per month quantitative easing programme may be altered.
The Fed will do whatever it takes
Despite making a meal out of recent communications with the market, the Fed made it very clear that it will do whatever it takes to get the world’s largest economy back on track. Bernanke stated that there is no fixed schedule, signalling that it remains dependant on growth and the labour market.
The Fed’s US$3.66 trillion balance sheet (US$869bn in August 2007) looks set to expand with Bernanke stating that “conditions in the job market today are still far from what all of us would like to see”. The Fed also eased back its growth projections, however the “soft” economic data was present back in July and August so it seems strange that it chooses now to backtrack on comments made in recent months. We expect no action from the Fed until the new Fed Chairman gets his/her feet under the desk in early 2014.
Impact on markets
The impact on financial markets was severe with US treasuries posting a -15bp drop, it was the biggest rally in almost two years. Equity markets continued their recent gains with the Dow Jones Index and the S&P500 both closing at all-time record highs.
In New Zealand, the yield curve flattened as long bonds rallied to close the day -12bp lower with the short-end just -3bp lower. Currently the steepness (10-year less 2-year) of the yield curve remains around the 154bp level.
What does this mean for NZ
The month of September has seen both the Fed and the Reserve Bank of New Zealand (RBNZ) release its policy thinking, which was pivotal for building a forward interest rate curve. With the RBNZ being more hawkish and the Fed ‘not delivering’ on its expected action, the yield curve a year from now is much flatter than the current curve.
On current pricing the one year swap rate is expected to be about 120bp higher in a year’s time and the 10-year swap rate only 36bp higher. Obviously a lot can change on the way to this ‘new curve’, however it does cement our view that fixed income investors continue with a portfolio duration of three to four years. As the curve flattens, investors will not be paid for the additional duration and hence risk.
NZD remains an issue for the RBNZ
The recent decision by the Fed will likely see continued capital inflows into emerging markets and ‘high interest rate’ economies like New Zealand. Whilst New Zealand’s Official Cash Rate remains at record low levels, we are one of the few countries that has a reasonably solid economic footing and therefore the future direction of the OCR is up (the ‘when’ is the hard part!).
This poses a significant problem for the RBNZ as the NZD continues to strengthen. The NZD is now ~+7% higher versus the greenback this month and +12% versus the Australian dollar year-to-date and signalling future rate rises could well see the NZD appreciate further, a result the RBNZ is keen to avoid.
Corporate / Credit news
Christchurch International Airport (CIA) launched an 8-year senior bond issue. CIA is seeking NZ$50m (plus the ability to accept oversubscriptions of NZ$25m). The BBB+ rated issue has a minimum interest rate of 6.25% with the coupon being set on 27 September at the higher of the minimum interest rate or 1.45% plus the prevailing 8-year swap rate.
Statistics New Zealand released the second quarter Gross Domestic Product data showing the economy grew 0.2% or 2.7% on an annualised basis. Both figures were ahead of forecasts and given the expected impacts from the drought, not a bad result. The result highlighted the impact the construction sector is having in the Christchurch rebuild with 2.3% growth. Statistics New Zealand also revised up the March quarter to 0.4%.
The New Zealand Debt Management Office (DMO) drew strong demand for its tender of NZ$300m of April 2020 NZGB’s. The tender saw NZ$602m worth of bids placed with the 24 successful bids receiving a weighted average yield of 4.55%.
Rabobank raised A$500m via floating rate note at 113bp over the Australian 90 day bank bill rate. The issue matures in 25 September 2018.
The Reserve Bank of Australia released the minutes of its 3 September meeting. The RBA is still very much open to further rate cuts, however no moves are imminent. Like New Zealand, the RBA remain hopeful of a decline in the exchange rate, however, the decision by the Fed to delay tapering may see that hope extinguished for the time-being.
The RBNZ released a consultation paper that is proposing to include personal loans and credit cards when assessing its criteria in granting a home loan. The RBNZ is concerned that prospective buyers may use credit cards or personal loans to top up their deposits in wake of the RBNZ’s loan-to-value restrictions. Most banks have now re-priced their high LVR loans to make them more expensive than lower LVR loans.
TOWER Limited advised that it intends to return NZ$70m of capital to shareholders as soon as practical from the sale of the majority of its life insurance business. Due to capital requirements enforced by the Reserve Bank of New Zealand, it is unlikely that TOWER will redeem its bonds (TWC010) early as first indicated.
The US published data saying the world’s largest country is within US$0.025bn of its US$16.699 trillion debt ceiling. US President, Barack Obama said he will not negotiate over an extension in the upcoming budget debates.
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