Roger J Kerr says NZ bonds are at risk of being sold off by foreign investors - and next week's Budget may be a trigger point

By Roger J Kerr

Whilst the risk of increasing short-term interest rates in New Zealand does still appear to be a long way off with current inflation at 1.1% - the bottom of the RBNZ’s target band - interest rate risk for corporate borrowers is still very real with increasing long-term interest rates.

Wholesale market fixed swap rates from four years onwards do track NZ and US Government bond yields, and they are heading only one way over coming months/years.

If interest rates need to be fixed to reduce volatility of annual interest cost from year to year, it is still preferable to fix sooner rather than later.

The term fixed rates (four to 10 years) could be up to 1.00% higher in 12 months’ time when most would consider the risk of short-term rates increasing starts to ramp up.

The “double-whammy” risk over coming months of both the underlying NZ Government Bond yields increasing (following US Treasury bond yields) and the NZ:US bond spread suddenly reversing upwards remains in place.

Currently, NZ 10-year Government Bonds at 2.80% are 15 basis points below US 10-year Treasury bond yields at 2.95%.

Why would global bond investors continue to hold NZ bonds credit rated AA+ when they could invest in AAA-rated US bonds at a higher yield?

Offshore holders of NZ bonds have already reduced their proportion of the total outstanding bonds on issue to below 60% from above 70% six months ago.

Further reductions are very likely as the yield enhancement incentive to be invested in NZ bonds is no longer there.

It will only take one large Asian sovereign wealth fund to wake up and realise that it makes no sense to be in New Zealand bonds vis-à-vis US bonds to cause a sharp sell-off in the NZ bond market.

The double-whammy impact comes when the NZ bond yields rise faster and further than rising US yields and the NZ:US bond spread widens out again.

Local fixed interest investment managers are also reducing the duration of their portfolios to reduce their risk to a rising interest rate environment.

It will require a special event or catalyst to spark the forecast NZ bond market sell-off outlined above.

That catalyst could well be next weeks’ Budget statement from the Labour Coalition Government.

The spending demands from Cabinet colleagues seem to be mounting on Finance Minister Grant Robertson and he may struggle to remain within his own budgetary constraint limits.

Another risk is that higher budget deficits and increased Government borrowing (more supply of new bonds into the market) will come about if the economy’s GDP growth in 2018 and 2019 is substantially less than what the Robertson budget is based upon.

Should The NZ Government Treasury forecast GDP growth above 3.00% over the next two years, bond yields will be set to increase in the market as most private sector economic forecasters have lowered their growth outlook to 2.00%.

The lower than forecast GDP growth makes a big difference to Government tax revenue and thus their debt/borrowing requirements.

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Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets.

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26 Comments

Behold The Sudden Stop. Risk of Emerging Markets Collapse
http://www.dlacalle.com/en/behold-the-sudden-stop-risk-of-emerging-marke...

So Argentina goes broke again

Some questions - Apart from the relative size of the economies, why are US bonds rated higher than ours, with their level of debt? And if there is a sell off, what flow on effect could we expect to see?

I'll save you and the ratings agencies some time. The risk of a sovereign currency issuing government defaulting on its sovereign debt in its own currency is zero (Japan, US, NZ, UK.....) unless you get a complete idiot in charge of the Treasury who can't operate a keyboard.

The ratings serve an ideological function to discipline democratic governments from engaging in deficit spending that might increase the size of government and the public sector. "No we can't pay teachers more, because, you know, the ratings agencies might downgrade us....."

The ratings agencies with their history of accurately rating of Enron, Greek debt in euros, mortgage backed securities.......

.

Oh yes and they are pretty good at telling us why it happened, after it happened.

The ratings serve an ideological function to discipline democratic governments from engaging in deficit spending that might increase the size of government and the public sector. "No we can't pay teachers more, because, you know, the ratings agencies might downgrade us....."

Yes, but don't expect things to change. The govt and media will continue to hoodwink the public who completely ignore private debt but are terrified of public debt. The sheeple have been captured.

You are right. Much of our society cannot distinguish between money earned and money borrowed. Just as long as they can spend. That’s what counts. Sheepies say “bah humbug” all together now.

Well, investors in JGBs took no notice of the downgrading of Japan's pubic debt ratings a few years ago. The sheeple may have been captured, but the people looking for risk free returns on their cash aren't.

http://bilbo.economicoutlook.net/blog/?p=33365

The MMT framework is somewhat complicated. The Japan scenario needs to be considered in the context of their industrial output and surpluses, which is somewhat different to the NZ / Australia scenarios, which are mired in h'hold-driven bubble economics. So while I agree with your notions, regardless of public spending and deficits, our situation is possibly more dire given that we're tethered to the Anglo-Saxon "lend money into existence' paradigm.

CS, edit pls. You have got Japan’s debt ratings down in the nether regions!

They were down a few years ago...not sure where they are now...but is irrelevant because boj controls yields at whatever it closes.

They were down a few years ago...not sure where they are now...but is irrelevant because boj controls yields at whatever it closes.

Tks but ref your post 13th word along - you will get my drift

CS,

Not quite zero.

Recall Russia 1998, where the sovereign defaulted on local currency denominated GKO's.

https://files.stlouisfed.org/files/htdocs/publications/review/02/11/Chio...

There have been other instances of defaults on local currency sovereign debt

Venezuela (1998),
Russia (1998),
Ukraine (1998),
Ecuador (1999),
Argentina (2001)
Jamaica (2010 and 2013)

Pretty sure most of those Latin ones involve foreign currency and pegged currency issues which aren't the same as true sovereign currencies with floating exchange rates. Russia is the exception and people I respect have put that down to a silly decision. I will investigate these further cheers.
.

The fact that markets haven't sold off NZ bonds already reminds me of the irrationality of markets in the "sentiment game". It doesn't make sense on the numbers alone. However, in trying to make sense of it, I wonder if it's to do with a mistrust of the inflation/growth/hikes narrative actually returning to the US? Are the markets wary and mistrustful after all the false starts from the FED and US economy since the GFC, maybe fear of stagflation even? Comparatively NZ has seemed calmer and more predictable?

Presumably you yourself are a multi-squillionaire, since you are so much better at judging when and what to sell than markets are ?

Wow, that's a strangely extreme reaction to a perfectly reasonable continuation of the thought experiment started within the article. Are you suggesting that markets are always 100% rational, objective and logical and that psychological factors and sentiment play no role?

Agree, it seems a strange overreaction on MdM's part.

Anyway, the Efficient Market Hypothesis is debatable in terms of being able to fully explain market behaviour: https://www.nasdaq.com/article/investing-basics-what-is-the-efficient-ma....

Now that USD bills are above 3% there will a rotation from stocks to bonds and from other currencies into USD
WP may well be correct in seeing the next downturn soon

It's not hard to predict something when you have a hand in the Government that is making it so. Hold on to your cash.

Now that USD bills are above 3% there will a rotation from stocks to bonds and from other currencies into USD
WP may well be correct in seeing the next downturn soon

Heaven help us with the petrol price if the NZD gets worse. The fuel companies will love it though. Somhow they manage to rip everyone off whatever the season.

On the plus side, it will help solve Auckland traffic issues, but they might have to invest in more buses.. (and make them electric, not stinky diesels!)