Download Buoyant economy, buoyant bond issuance

Harbour Investment Compass
Buoyant economy, buoyant bond issuance
Fixed Interest Monthly Commentary
February 2014 | [email protected]

+64 4 460 8313
Against a backdrop of emerging market unease and patchy economic data
globally, New Zealand’s buoyant economy was underlined by even
stronger news and data releases.

Long-term interest rates fell marginally, as global influences were the
dominant influence.

We retain the view that we are on a path towards stronger global and
domestic economies, where there is the possibility of inflation rising above
the very well contained levels experienced since the GFC.

While market pricing is anticipating higher yields globally, we believe the
risk is greater that yields rise further, rather than less than, yield curves
imply.

In March we will see the Reserve Bank’s interpretation of the economic
outlook and the projected OCR path that aims to deliver 2% inflation.
Governor Wheeler can be expected to take exceptional care to craft a
message that gives rate guidance, retains flexibility and aims to reaffirm
the Bank’s inflation managing credibility.

It was a busy month for new issuance of corporate debt, with a total of
$2,545m sold by 24 different issuers. We think this shows the NZ capital
market to be in excellent shape and certainly stronger than was frequently
suggested through 2013, when corporate bond issuance levels were
lower.

We think it is unlikely that the wave of new corporate bond issuance will
force credit spreads significantly wider, but we do expect the sense of
unsatiated demand to diminish. A mild re-pricing of credit to wider
spreads would not surprise us.

While emerging markets are grabbing the headlines, equity and credit
markets are showing few signs of stress yet. An increase in risk aversion
is a real possibility.
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Domestic economic data just keeps getting stronger
Late in February another round of strong economic data were released. The ANZ
Business Outlook reached the highest level since 1994, Fonterra announced a further
increase in their projected payout for 2013/14 to a new record level and monthly net
migration numbers continued their strong trend, underpinning demand for housing. In
the ANZ survey, expected profitability also rose to the highest level since 1994, and is
most probably behind a rise in investment and employment intentions to levels also not
seen for 20 years.
Chart 1. Consumer and Business Confidence
Index
Index
150
100
Consumer confidence - ANZ/Roy Morgan
140
80
Business own activity - NBNZ (RHS)
130
60
120
40
110
20
100
0
90
-20
80
-40
05
06
07
08
09
10
11
12
13
14
An additional and perhaps overlooked aspect of the better data is the rise in our Terms
of Trade to a level not seen since the 1970s. BNZ economists suggest we may be
experiencing the best Terms of Trade since any sort of records are available, in 1861.
The income and ‘feelgood’ impact of this should not be underestimated.
The stronger activity signals are accompanied by higher inflation signals, with pricing
intentions and inflation expectations rising.
The data are consistent with a broad range of evidence that validates the ‘Rock Star’
label New Zealand has picked up lately, despite our persistent structural issues. However
the market reaction to the strong data has become almost blasé, as there is a common
view that the return to a neutral Official Cash Rate (around 4.0 – 4.5%), which is priced
into market interest rates, is all that we will see from the Reserve Bank. In isolation,
with growth forecast to rise towards 4% and inflation signals creeping higher, one might
contemplate a prospect of monetary conditions moving through a neutral level to a tight
level. This idea is reinforced by the Reserve Bank’s ‘alternative scenario’ in the
December MPS, which argues that if the Terms of Trade stayed at current very elevated
levels (rather than easing back as projected), tighter monetary conditions would be
warranted.
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The ongoing patchy path to global economic recovery is one reason to be a little more
sanguine about New Zealand’s prospects. While there are signs the global economy is
getting on better footing, notably in Europe, there are other, less upbeat signals.
Chinese data are still slightly disappointing. The cold winter has affected activity in the
US, and most Australian data is still subdued. However, for every weak sign, there are
offsetting positive ones, making the overall picture one of gradual but erratic
improvement. The IMF forecasts GDP growth in the Advanced Economies rising from
1.3% in 2013 to 2.2% in 2014. New Zealand looks streets ahead at 2.7% and 3.9%
respectively, using BNZ forecasts.
Chart 2. GDP Growth Forecasts: New Zealand compared to other Advanced
Economies
GDP Growth (YOY)
Percent
5.0
4.0
3.0
2.0
1.0
0.0
2012
2013 Est.
Advanced Economies
2014 Est.
New Zealand
Source: BNZ, IMF.
The Reserve Bank’s March Monetary Policy Statement will be a defining
moment
In January, Graeme Wheeler delivered a speech the day following the OCR review,
explaining why OCR hikes will be required to ensure a sustainable economic recovery.1
The market is pricing a 25 basis point hike in March, and further increases lifting the
OCR to 3.75% in 12 months. At present, this looks a plausible scenario. However,
ongoing decisions will be made through the course of the year, based on developments
in economic data and other influences. With economic momentum so strong at present,
and with inflation expectations starting to increase, there is a chance the Reserve Bank
accelerates the tightening path that is projected at present.
Communication will also be crucial. Governor Wheeler can be expected to take
exceptional care to craft a message that gives rate guidance, retains flexibility and aims
to reaffirm the Bank’s inflation managing credibility.
1
http://www.rbnz.govt.nz/research_and_publications/speeches/2014/5617432.html
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The influence of offshore markets
Despite all the strong data in February, market interest rates actually fell slightly as we
followed global rate movements. Patchy data was a key influence, as were geopolitical
concerns across a range of emerging economies. The progressive escalation of events in
Ukraine, the North Korean missile launches, plus uncertainty in China about growth and
the state of local government finances all highlight risks that might destabilise the path
to a fuller recovery from the GFC.
The rise in the S&P500 to record levels suggests investors are far from unnerved about
these developments to date. However we cannot discount a further deterioration that
might prompt a change in risk appetite.
Corporate bond issuance surges
While issuance of corporate bonds is typically strong in the first quarter, 2014 has seen a
particularly strong start. Through much of 2013 we frequently heard comments
regarding the dearth of issuance in the corporate bond market. Issuance was quiet, for
several reasons:
The maturity profile was low, partly as the average term of bonds issued has
been lengthening over recent years, meaning refinancing needs appear less
quickly.

As a follow up to the GFC, corporate balance sheets and funding positions had
been managed quite conservatively, so the requirement for funding was
lessened.

For retail investors, issuance has possibly also been reduced as ‘wholesale-only’
deals have become a little more frequent.
In February new issuance totalled $2,545m, with a total of 10 deals marketed to
domestic investors. Of these, $1,100m over 5 deals were sold under an Investment
Statement and available to retail investors.
Table 1: NZD Non-government debt issuance February
Issuer
ANZ Bank
Christchurch City Council
Amount
$400m
$45m
Type
Tenor
Domestic, retail
5 Years
FRN
6 years
Contact Energy
$200m
Domestic, retail
5 years
Fonterra
$250m
Domestic, non-retail
6 & 8 years
LGFA
$175m
Domestic, retail
1, 3, 5 & 7 Years
Sky TV
$100m
Domestic, retail
7 Years
4
Westpac Bank
$325m
Domestic, retail
4.5 Years
World Bank,
Kommunalbanken, Asian
Development Bank
$850m
Kauri
5 – 10 year
Eurokiwi (14 Issues)
$200m
Euro Medium Term
Notes
2 – 10 years
Total
$2,545m
All of the issuers have existing NZD securities in the market, so no new names were
launched. The term of the bonds ranged predominantly from 5 – 7 years, continuing a
trend towards longer maturities that has existed over the last few years.
The motivation behind longer-dated issuance is two-fold. Firstly, issuers prefer to lock in
long-term funding and banks are typically less willing to extend funding beyond 5 years,
historically preferring 2-3 year timeframes. Secondly, longer maturities offer investors
higher coupons, due to the positive shape of the yield curve and the extra credit spread
available for committing for a longer period. These higher coupons find favour with retail
investors who look to achieve a higher running yield than bank deposit rates.
Institutional investors have also become more willing to buy longer maturity corporate
bonds. We believe this displays a greater depth to the NZ capital market.
Seasonal factors are likely to be one cause of the increased issuance, as corporate
treasurers enter the New Year with funding markets in good heart, giving them the
opportunity to lock in funding that would need to be arranged at some stage through the
year. Pricing for hedging deals into desired currency and term e.g. floating US Dollars,
has also been advantageous.
Looking ahead, we expect issuance to remain reasonably strong, especially as retail
investors are likely to see higher coupons on deals as time progresses. Institutional
investors also will have ongoing cashflow to invest, although the recent flow of deals
may satiate current demand, meaning new deals need to be priced more generously to
find strong support.
We have a fairly neutral view on credit at present. While the stronger economy creates a
supportive credit environment, the margins available from corporate bonds have
narrowed considerably over the last 18 months, making valuation less compelling.
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Chart 3. Corporate bond spreads to NZ Government Stock
250
225
200
175
150
125
100
75
50
Financials
Locals
25
Utilities
Supra
2-Jan-14
2-Oct-13
2-Jul-13
2-Apr-13
2-Jan-13
2-Jul-12
2-Apr-12
2-Jan-12
2-Oct-11
2-Jul-11
2-Apr-11
2-Jan-11
2-Oct-10
2-Jul-10
2-Apr-10
2-Jan-10
2-Oct-09
2-Oct-12
Other
0
Source: NZFMA, Harbour Asset Management
Mark Brown,
Director,
Harbour Asset Management
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The New Zealand Fixed Income Commentary is given in good faith and has been prepared from published information and other sources
believed to be reliable, accurate and complete at the time of preparation but its accuracy and completeness is not guaranteed. Information
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