Rates path ahead
There is a sense in global markets that the end of the lower-for-longer rates cycle may finally be in sight, if not approaching fast. The way ahead is far from clear, however.
JONES Investors generally talk to us to gain comfort with New Zealand’s economic and fiscal outlook. The government’s recent long-term commitment to sustaining the level of outstanding New Zealand government bonds (NZGBs) has also been helpful in building long-term confidence.
I believe many investors are comfortable with a strategic, rather than tactical, allocation to New Zealand even if they recognise risks in the outlook for global rates markets.
CHAO Often when we meet investors they ask us about the market outlook and we ask them about the same thing – I don’t think anyone has the answers. In general, the things being discussed today resonate with what we hear globally. There is a lot of money out there, and although tapering will happen at some point the path may be slow. The hope is that if everything is done in a transparent manner the transition should be orderly.
I think there is a general sentiment that rates will continue to rise and therefore in some ways the party will be over. The question of course, is when.
RUSCHPLER When we speak to global investors about New Zealand dollars specifically the key issue raised is that the rates differential to US dollars is fairly narrow these days. This has certainly reduced demand somewhat, especially out of US real-money accounts.
On the other hand, most accounts we speak to are broadly happy with their current exposures – they aren’t offloading positions. The sense we are getting is that a lot of investors are holding stable: they don’t seem to be adding in absolute terms but it looks like they are reinvesting redemptions.
BUTCHER We’re still seeing offshore holdings of New Zealand Local Government Funding Agency (LGFA) bonds increasing – they have increased in 36 out of the past 39 months, in fact.
But I wouldn’t want to draw too many conclusions about outright demand for New Zealand dollars based on this, because we are still benefiting from a substitution trade from investors that already hold New Zealand Debt Management Office or high-grade Kauri bonds and want to switch into higher-yielding LGFA paper.
What I would say is that I am somewhat more comfortable about demand than I was 6-9 months ago. Talking to some large international fund managers, they say New Zealand real yields are still among the highest in the developed world. Even though what we offer is tight to US Treasuries and Australian government bonds, we still look quite attractive on a risk-adjusted basis.
One thing I’d note is that a narrower front-end of the curve should actually make it easier for offshore investors to hedge the currency. In the case that New Zealand real yields are attractive but the currency outlook isn’t as appealing,
New Zealand dollars as an investment destination could still be attractive if it is less expensive to hedge the currency risk in the short term. If offshore front-end rates start to rise and the official cash rate (OCR) doesn’t, it should be cheaper for offshore investors to hold New Zealand assets.
There is a lot of money out there, and although tapering will happen at some point the path may be slow. the hope is that if everything is done in a transparent manner the transition should be orderly.
RUSCHPLER Asian Development Bank recently issued a US$4 billion, five-year transaction and it went pretty well, to say the least, judging by the record order-book size. I take the point about the US dollar being a little weaker, but the bottom line is that investors have a lot of US dollar cash to put to work. On this basis, transactions are likely to continue to be met with healthy demand.
MARSH I think it would definitely be positive for demand, but unfortunately I don’t think the preconditions exist for the Reserve Bank of New Zealand to begin increasing the OCR. The fundamental inflation view would have to change, and I can’t see this happening unless we get a 15 per cent drop in the value of the currency caused by a new, left-wing government and a whole lot of other things coming to pass. Otherwise I am very much still in the lower-for-longer camp.
JONES The relative path of the OCR compared with offshore cash rates will clearly be more important than the path of the OCR per se. The influence of relative cash rates is most keenly felt on short-end NZGB spreads, with the influence fading further out the curve.
Changes in cash-rate differentials may influence the short-term relative performance of NZGBs to offshore peers, but they do not appear to fundamentally affect demand for NZGBs. For example, we do not see a strong relationship between the New Zealand- Australia cash-rate differential and nonresident holdings of NZGBs.
DORE I believe hikes in New Zealand may be required to re-establish an appealing yield differential. As rates increase in other developed-market currencies, the appetite for global investors to take on FX risk generally declines.
Many investors have taken on the additional FX risk simply to enhance yields. But if interest rates in the US and Europe continue to rise, rates for New Zealand dollar assets will also have to increase in order for them to become or remain attractive to global investors.
