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The following is a summary of the key events impacting fixed income markets over the past week.
Since our last report [on 16 December] there has been plenty of headlines, in particular from the US, which may make 2014 a very interesting year for fixed income investors. On the local front, all indicators point to 2014 as being a boomer for the economy, how will the RBNZ respond?
Can the NZ economy deliver? And will the RBNZ respond accordingly?
By all accounts everyone is picking 2014 to a cracker for the New Zealand economy which has already resulted in the Debt Management Office (DMO) lowering its New Zealand Government Bonds (NZGB) offerings for Q1. A healthier budget and economic outlook will see the DMO offer just NZ$400m of NZGB’s and NZ$400m of inflation-linked bonds in the first quarter of 2014.
The other more pressing issue of the improved economic backdrop is how the Reserve Bank of New Zealand (RBNZ) will respond via not only Monetary Policy but also its macro-prudential tool-kit. It is pretty hard to argue against the current market forecasts of a hike in the Official Cash Rate (OCR) at the March meeting.
The OCR only tells half of the story though
Despite the OCR remaining unchanged in 2013, underlying interest rates moved higher with the five-year swap rate rising +154bp over the twelve months. The yield on the ANZ Investment Grade Bond Index also increased over the year by +107bp. After falling to a low in May 2013 of 3.91% the yield on the index steadily rose to finish the year at its highest level of 5.14%.
2014 looks set to be an interesting one with a definite change in the shape of the yield curve expected as the RBNZ looks set to enter the fray. The long-end of the curve will once again largely be directed by offshore events which may also prove interesting due to the ‘taper timetable’.
US is mostly positive
The US Federal Reserve Chairman, Ben Bernanke, reiterated his upbeat assessment of the US economy. On December 18, Bernanke announced that the Fed would begin reducing its monthly bond purchases by US$10bn per month in January, noting signs of an improving economy, this message was affirmed on 6 January, the day before the new Fed boss was formally announced, Janet Yellen.
Yellen will become the first woman to run the Fed and will begin (or continue) on from Bernanke on 1 February. Yellen is and has been a big supporter of the Fed’s strategy so little directional change is expected.
The rest from around the globe
Once again the US jobs figure was closely watched and while the US unemployment rate fell from 7.0% to 6.7% (inching closer to the magical 6.5% level), the 74,000 jobs created in December was well below the expected 200,000.
The Bank of England (BoE) who are also targeting an unemployment rate of 6.5%, left interest rates on hold at 0.5%. The BoE will release the minutes of that meeting on 22 January.
The European Central Bank (ECB) was far more cautious than both the Fed and the BoE when it left its interest rate at 0.25%. The ECB hinted there maybe downside risks to its current view on inflation and uncertainty around the economic outlook in Europe remains.
New Year, Same Questions
Despite another new year rolling around, the same questions remain in the market. On the local front New Zealand’s ‘rock star’ economy remains at the forefront and the implications this may have on monetary policy. Offshore there are many questions that linger; what will happen in Australia and Europe?
Will the US continue on its recovery path?
While New Zealand retail fixed income investors have no control over these macro issues, the start of a new year provides a good time to review fixed interest portfolios and if possible, position portfolios for the upcoming year. The Reserve Bank has indicated that it expects the Official Cash Rate (OCR) will rise in 2014 with most now expecting this to occur at the RBNZ’s first Monetary Policy Statement set to be delivered on 13 March 2014.
As the chart below highlights, the current expectation is for the short-end of the curve to rise ~1.00% over the coming year. In comparison, the long-end of the curve is only expected to rise by ~0.30%, culminating in a flattening of the yield curve. For this reason we have been recommending fixed income investors maintain shorter duration (~3 years) in order to reduce the impact of rising interest rates.
By adjusting the OCR the RBNZ moves short-term interest rates and due to the expectation that the OCR will rise in 2014, shorter-term interest rates are forecast to rise more sharply than longer-term interest rates. In order to take advantage of a rising OCR, investors can invest in fixed interest securities such as cash, reset securities or floating rate notes (FRN). By investing in these types of securities investors can reduce/eliminate interest rate risk.
Obviously the majority of fixed interest securities are longer-dated and most fixed interest portfolios will contain a number of these longer-dated securities, therefore some prudent selection is required. Many investors benefited from the use of annual reset securities in 2013 as prices increased by >20% in most cases as investors looked to the future to take advantage of resetting coupons/dividends.
However outside of cash, FRN’s and reset securities investors should invest in quality corporate bonds with coupons that are paying in excess of the implied neutral cash rate of 4.50%. Corporate bond yields have not increased to the same extent due to corporate credit spreads tightening. By way of example the credit spread on the Auckland Council September 2017’s halved to just 46bp over the course of 2013. Similar movements were observed at the other end of the credit spectrum, with the credit spread on BBB+ Genesis Energy March 2016’s tightening by -41bp.
We therefore have the base rate (swaps) rising and the corporate credit margin (credit spread) contracting which is limiting the rise in a corporate bonds headline yield. How much tighter can corporate credit spreads contract is however another topic altogether.
Corporate / Credit News
At the end of 2013, AMP completed its tier two retail issue by upsizing the deal once again. The transaction was completed with A$325m of subordinated notes issued at a margin of 265bp over the Australian 90 day bank bill rate.
North Queensland Airport Group successfully refinanced A$587m of maturing bank facilities. The company which is 25% owned by Auckland International Airport (AIA) now has “the certainty it needs to progress its capital expenditure programme and invest for future growth”, AIA’s CFO stated.
Contact Energy (CEN) announced it is considering an offer of NZ$225m of senior bonds in which it may exchange as part of its refinancing of its maturing bond (CEN010) in May 2014. The offer is expected to be open in late February.
Fitch Ratings provided a generous appraisal of Fonterra’ decision to withhold payments to farmers and slash its dividend. Fitch said the company’s decision is “characteristic of the fiscal discipline that underscores its credit rating”. Fitch currently rates Fonterra as AA.
Goodman Fielder (GFF) completed the divestment of three of its businesses. GFF sold its Meats and Pizza businesses in New Zealand with proceeds expected to be in the range of NZ$15 to NZ$17m. The sale will result in a non-cash impairment charge of between NZ$32m to NZ$36m. At the end of 2013, GFF announced it had divested its biscuit business for ~A$17m which will again result in a non-cash impairment charge of between A$50m to A$55m in the FY14 interim accounts.
According to a report by Ernst & Young, Kiwibank now comprises 79% of its parent equity value. EY determined an equity valuation of NZ Post of NZ$1.252 billion with Kiwibank comprising NZ$992m of this. With the Reserve Bank of New Zealand’s transitional timetable now in force, Kiwibank’s capital position has decreased due to its non-Basel III compliant tier one security, KCSHA, now only contributing 80% of its original capital contribution.
Medical Securities (A-) raised NZ$30m via the wholesale bond market at a margin 70bp over the 90 day bank bill rate. The floating rate note will mature in December 2016.
Nufarm (NUF) had its BBB- long-term issue rating confirmed on its senior secured A$530m bank facility.
Telecom (TEL) announced it was considering the sale of its 60% interest in Telecom Cook Islands Limited.
TOWER (TWR) advised that after speaking to several interested parties it would remain the owner of TOWER Life. TWR has sold three businesses over the financial year for NZ$370m and has released significant amounts of capital to shareholders.
Vector (VCT) confirmed that the change in international rating methodology from S&P resulted in a credit rating downgrade from BBB+ to BBB.
Wellington City Council issued a NZ$12.5m floating rate note to wholesale investors which will mature in September 2021. The margin was 66bp.
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