Forsyth Barr says the flattening yield curve outlook is important for fixed income investors and they should be targeting a duration of around three years

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The following is a summary of the key events impacting fixed income markets over the past week.

Wholesale interest rates continued their rise last week as the market anchors its forecasts for the tightening cycle to begin in March 2014. Offshore attention shifted to Australia where as expected the RBA cut its cash rate to its lowest level since 1959.

Swap rates continue to grind higher

As the market awaits an announcement from the Reserve Bank of New Zealand (RBNZ) regarding the proposed limits on home lending, wholesale interest rates continue to edge higher. The 10-year swap rate finished the week up +17bp with the 1-year up just +5bp. While the yield curve steepened, we still expect to see a flattening of the curve once the RBNZ begins its tightening cycle.

The flattening yield curve outlook is important for fixed income investors and our recommendation is for bond portfolios to maintain duration around three years. As the yield curve flattens, investors will not be rewarded with higher interest rates the further out on the curve they invest.

Protection from rising interest rates

Another alternative to protect against rising interest rates is to utilise the large number of price traded, resettable securities that trade on the NZDX. While some of these securities may not be suitable for some investors, there are a number of these types of securities that are worth considering.

We have also seen a number of banks offer floating rate bonds alongside a fixed rate bond offering. Even though interest rates are forecast to rise, generally speaking, the floating rates have not provided too much of an advantage over fixed rates. A sharp rise in the short-term rates would be needed to make the floating rate bonds more attractive.

Housing in the news again

Much of the commentary from the RBNZ this year has been about their concern around the strength of the housing market and its possible negative impact on the financial stability of the New Zealand economy. Addressing this issue via the Official Cash Rate has not been an option for the RBNZ due to the high NZD, but according to reports, the RBNZ is very close to imposing lending restrictions, which could have wider consequences for the New Zealand economy.

According to the Real Estate Institute of New Zealand the median house price rose +6.6% in July versus the pcp, however with all 12 regions posting an increase, the RBNZ will feel more justified in its proposed reaction. The jury remains out on whether imposing lending restrictions will have any impact at all on both the housing market and lending growth. The RBNZ seems (and rightly so) to be ignoring the political pressure and acting independently.

Credit markets wider once more

In New Zealand, the yield on the ANZ Investment Grade Bond Index rose +14bp to 4.80%, its highest level since April 2012. It was a similar story offshore with both the US and Australian credit markets wider by +3bp last week. European credit was pretty flat, widening by +1bp.

There are two closely watched data releases this week with New Zealand retail sales (always closely associated with strong house prices) due on Wednesday and US inflation data on Friday.

If the current market pricing and forecasts are correct then in a few months we may well see New Zealand leading the way on the interest rate front. Recent statements from a number of the main central banks highlight the various different parts of the cycle that central banks now find themselves on. 

RBNZ – Our own central bank risks undoing all its hard work on the lowering the NZD with its recent hawkish tone and subsequent ‘on hold’ calls by other central banks. Current market pricing has one +25bp hike priced in for March 2014 with another in April 2014. Upward bias to OCR.

RBA – The recent -25bp cut took the Australian Cash Rate to its lowest level (2.50%) since the central bank was established in 1959. While one further -25bp cut remains priced in before the end of 2013, the upcoming election clouds the timing of that possible cut. Downward bias to the cash rate.

US Federal Reserve – The Fed is obviously the most closely watched of the central banks and comments over the last few months have put the Fed under more scrutiny. The Fed hasn’t done a great job in its “taper talk”, as it is now referred too, with a number of Fed officials stating differing opinions. What we have is the possible removal of US$85bn per month from the markets which will impact both debt and equity markets. While unemployment is tracking down, there is still some way before it hits the 7% level which would initiate some removal or tapering of the Fed’s stimulus programme. No interest rate changes on the horizon.

ECB – At the most recent European Central Bank meeting, the governor stated “key ECB interest rates to remain at present or lower levels for an extended period of time. This expectation is based on the overall subdued outlook for inflation extending into the medium term, given the broad-based weakness in the real economy and subdued monetary dynamics”. No interest rate changes on the horizon. 

BoE – The new Bank Of England’s Governor. Mark Carney, has changed things around and is now offering ‘forward guidance’. In its attempt to steer expectations about future rate rises, the BoE’s forward guidance is now similar to that of the Fed’s unemployment target. Interest rates will stay low (0.5%) until unemployment falls to 7% (currently 7.8%). The BoE doesn’t expect this to occur until 3Q16. No interest rate changes on the horizon. 

BoJ – Japan’s national debt has just passed the 1,000 trillion yen mark! And is now twice the size of its economy. The Bank of Japan is hoping its pledge to double the supply of money in two years by purchasing government bonds and risky assets, this will help spur growth . No interest rate changes on the horizon. 

Corporate / Credit news

ANZ Australia closed its Additional Tier One offer, raising A$1.12bn of the Basel III compliant capital securities. ANZPD began trading on the ASX on 8 August. The issue raises the Tier One capital ratio of ANZ by 30bp to 10.1%.  

ANZ (Australia) issued a new four year senior unsecured floating rate note. ANZ raised A$1.75bn at a margin of 85bp over the three month bank bill.

Credit Agricole S.A. released its second quarter financial results. Net income for the quarter was €696m versus €56m in 2Q12. Credit Agricole’s tier 1 capital ratio is 10% with core tier 1 of 8.6%.  

Downer EDI (DOW) released its FY13 financial results which were stronger than expected. DOW’s NPAT rose +10% to A$215m with strong cashflow and lower net debt levels also present in FY13. The outlook for FY14 remains flat with a challenging environment forecast in Australia.  

Meridian Energy (MEL) announced it had reached a commercial agreement with New Zealand Aluminium Smelters owners on the renegotiated electricity contract.  The new contract sees amongst other things a reduction in the current electricity charge from 1 July 2013. Meridian Energy announced its FY13 financial results with total borrowings falling by $645.4m to NZ$1,180.2m. This lower debt figure sees MEL’s gearing ratio fall to 4.5%. NPAT rose by +296% to NZ$295m.

Quotable Value (QV) said housing values increased by +3.1% in the past three months and by +8.1% in the past year. Auckland once again lead the country with house values up +12.8% in the last 12 months.  

Telecom and Chorus welcomed the announcement of a government review of the policy framework for regulating telecommunications services in New Zealand. It is expected that this review will provide considerable clarity going forward for both companies around pricing. 

TOWER (TWR) is reviewing its previously announced capital management plans including the early redemption of its NZ$81.8m bond (TWC010) and NZ$114.5m capital return.  TWR has received the $189m sale proceeds from the Life insurance business however, the RBNZ requires TWR to hold a minimum solvency margin of NZ$80m above the minimum solvency capital “MSC” of NZ$53.3m. Total regulatory capital including the General Insurance Pacific MSC is now NZ$166.9m. Whilst TWR maintain some headroom as part of its normal risk management policies.  The minimum solvency margin is industry wide and reflects the MSC does not take account of catastrophic events such as the Christchurch earthquakes.  The minimum solvency margin will be unwound as the remaining outstanding claims related to Christchurch are settled.  It is envisaged this could take place over the next two years as residual claims are settled.  

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