US government shuts its doors; US$1 tln of 'free money'; Market ignoring Governor Wheeler; buzz cut for Solid Energy bondholders

By Craig Simpson

The main talking point of the month was the US government's decision to shut the doors for a total of 16 days as policy makers debated on whether or not to raise the debt ceiling so the US could avert defaulting on their debt.

As part of the QE3 program the US has now pumped more than US$1 trillion of 'free money' into their banking system, maybe some of these funds should have been held back to pay the bills.

Put the cat out, turn the lights off and close the door

What happened in the US during October is officially referred to as a "spending gap" rather than a full blown shutdown, well at least that is the rhetoric coming out of the US. Spending gaps have occured on 17 previous occassions since 1976, the year Congress began its revised budgeting process.

The bickering and debating between US senators continued for a full 16 days when finally the Republicans caved in and agreed on a deal to raise the debt ceiling until 7 February 2014.

It appears the Republicans failed to hold the Democrats' Obamacare to ransom and relinquished their hardline stance for the time being.  Republicans had tried unsuccessfully on 40 previous occassions to get Obamacare repealed so maybe it is time for them to give up and find a new crusade.

Once the deal was ratified US treasury yields fell to their lowest in over two months. The deal came as a relief to investors who were nervously awating for a default event to occur.

US$1 trillion of 'free money'

The most recent Federal Open Markets Committee (FOMC) meeting highlighted that the US housing recovery had lost momentum and there had been a reversal in the recent spike in borrowing costs.

The US fiscal policy appears to be constraining economic growth and although the labour market had shown some improvement it was not enough for the US Federal Reserve (Fed) to commit to tapering back their massive US$85 bln per month bond buying program.

The US Federal Reserve has now bought more than US$1 trillion of bonds as part of its current program of 'financial crisis support' - or open-ended quantitative easing.

Starting in September 2012, the part of the Fed system that carries out these activities, the Federal Open Market Committee (FOMC) decided to increase policy accommodation by purchasing agency-guaranteed mortgage-backed securities (MBS) at a pace of US$40 billion per month "in order to support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate".

In addition, starting in January 2013, the Federal Reserve began purchasing longer-term Treasury securities at a pace of $45 billion per month.

According to our calculations that means that they have now pumped more than US$1 trillion of 'free money' into their banking system. There is no end in sight.

The Fed left its guidance on when it may raise interest rates unchanged, saying current rates of near zero would be appropriate as long as the jobless rate remained above 6.5 per cent and annual inflation remained under 2.5 per cent.

Markets ignoring Wheeler's comments

It was notable that rates markets did not show a significant response to Governor Wheeler’s warning last week that the OCR could be 200bps higher by 2016. Swap market pricing was already consistent with around 180bps of rate hikes over the next two years, starting from early next year.

Predictably the OCR was held at 2.5% at the RBNZ meeting on October 31, however the tone of Governor Wheeler's speech was regarded as neutral to marginally dovish and certainly less hawish than previous statements.

The Loan to value restrictions which came into effect at the beginning of the month and the subsequent high profile pulling of pre-approved loans by two banks has assisted in starting to cool the housing market although there was still strong growth around Auckland in particular.

Head in the oven, feet in the freezer

With annual inflation rising to 1.4% in the September quarter it is now back inside the RBNZ's medium-term target band of between 1%-3%

Some economists still see OCR hikes from March, while others such as Westpac and BNZ are pushing their forecasts out to April and June respectively..

RBNZ Deputy Governor, Grant Spencer delivered another shot at the housing market and risks to both financial and price stability. The RBNZ appear to be saying (to anyone who will listen) that the supply (lack of houses) and demand (for credit) are issues that cannot be fixed by themselves.

The RBNZ’s macro-prudential tools are designed to target the demand for credit side of the equation, however the RBNZ cannot do much around the supply of housing. The RBNZ must also realise the consequences that if New Zealand (i.e. Auckland) built the amount of houses needed, combined with the Christchurch rebuild, inflation is likely to head much higher. This would in turn see the OCR rise, implying that there is no easy fix to this issue.

One of the best summary comments I saw from the OCR reviews was this gem from JP Morgan Economist Ben Jarman. The result provided some "helpful optics" for the Reserve Bank and "at least now RBNZ officials will no longer be facing such a dramatic head in the oven, feet in the freezer problem with respect to the activity and housing data vs inflation" Jarman said.

No.1 buzz cut for major Solid Energy lenders

BNZ, Bank of Tokyo-Mitsubishi and TSB Bank are the Solid Energy lenders who will face the biggest "haircut" on monies owed by crippled state coal miner Solid Energy. TSB have previously said on record they do not consider this asset as being impared.

Bank of Tokyo-Mitsubishi is reported to be taking legal action to try to veto a debt restructuring deal. At this stage if it came to a straight vote (which requires a 'yes' from lenders holding 75% of the outstanding debt) it appears likely that it would be outvoted by other lenders. In the days immediately following this announcement Bank of Tokyo-Mitsubishi were offered preference shares which is a thank you for taking a $16.3 million haircut on the bank's debt.

Latest bond tender of NZ$200 mln received bids for NZ$1,304 mln with an average weighted yield of 4.3645% (previously 4.5557%)

The catalysts for the pull-back in NZ yields over the past few weeks appear to be both global and domestic.

First, since September, as the market has pushed back its expectations for US QE ‘tapering’ into next year, US Treasuries have led a global pull-back in yields. Second, domestically, recent implementation of LVR restriction on banks and subsequent discussion of their impact has caused the market to question the RBNZ’s need to urgently raise the OCR.

Both issues could cause the pullback in yield to extend a little further in the near-term. However, we do not expect a prolonged or deep decline in yields. We see sufficient latent payside demand in the ‘real economy’ to preclude that.

Perfect score achieved on first attempt

The syndicate running the government's new 2030 inflation indexed bonds hits a home run off its first pitch.  Initially the NZDMO indicated between $1 billion and $2 billion worth of bonds would be up for tender, however they received over $3.6 billion in offers based off an indicative pricing range of between 27 and 33 basis points over the September 2025 bonds.

Westpac in their tender preview expected strong demand for the new bonds and cited the following as factors which would attract investors: real yields are well above comparable issues in Australia, US and UK; a recent Australian syndicated issues attracted demand above expectations; the inflation linked NZ govt bonds will be included in the Barclays World Government Inflation-Linked Index following a December rejig of the constituents; and since July's offering of 2025's tender performance has improved.

The bonds, which carry an interest rate (coupon) of 3.0%, were issued at a spread of 27 basis points over the existing 20 September 2025 inflation-indexed bonds and carry a current yield to maturity of 2.97%.

The success of this issue means the New Zealand Government inflation-indexed bond tender scheduled for 17 October 2013 will not be held.

The latest tender of $200 million worth of 2025 inflation indexed bonds issued on November 7 was modestly over-subscribed.

Market performance indicators

Global government and corporate bonds hedged back to NZ$ rose approximately 1.1% for the month amd are showing 12 months returns (to end of October) of between 3% and 3.5%.

Cash and New Zealand bonds were marginally positive for the month and returning between 2.7% and 3% for the year (to end of October).

NZ Government stock has been the biggest loser this year with a year-to-date return of -2%.

The table below outlines the returns over the past one, three and twelve months. Investment into global bonds which are fully hedged back to NZ$ have provided investors with the best returns. 

Bond issues, tenders and offers

During October the following issues,tenders and offers were made:

• Wellington International Airport Limited accepted the full NZ$75m on its 6.25% May 2021 fixed rate retail offer.

• Toyota Finance raised $75m of debt due Apr 2019. The issue had a $50m fixed component and $25m FRN tranche, pricing at swap+85bps and BKBM+85bps.

• Port of Tauranga (BBB+/stable) issued a NZ$50m six year fixed rate bond issue at swap+133bps area, the first senior unsecured bond for the issuer.  BNZ was sole lead manager.

• Contact Energy announced it will redeem NZD200m of its capital notes (CENFA) on 15 November following S&P’s changes around the criteria for “high” equity content.

• NZDMO tender of Infaltion Indexed bonds worth NZ$200 mln received bids for $251 mln with weighted average accepted yield of 2.6314% (versus 2.8293% previously).

• NZDMO Govt bond tender of NZ$200 mln received bids for NZ$640 mln with an average weighted yield of 4.5557% (previously 4.5503%)

• NZDMO sells $3.6 billion worth of inflation indexed bonds maturing in 2030.

• NZDMO Govt bond bond tender of NZ$200 mln received bids for NZ$1,304 mln with an average weighted yield of 4.3645% (previously 4.5557%)

• Motor Trade Finances (MTFHC) Ltd reset the dividend rate its perpetual preference shares. The rate applicable from 1 October 2013 to 30 September 2014 is 5.32% per annum.

• Origin Energy will reset the dividend on its perpetual preference shares, OCFHA on 17 October at 1.50% over the prevailing one-year swap rate. The dividend through to 17 October 2014 would be around 4.48% if set on 15 October.

• Rabobank Nederland reset the coupon on its perpetual capital security, RBOHA. The coupon through to 8 October 2014 is 3.7075%.

• SKY Network Television reset the coupon on its annual resetting senior bond, SKTFA. The new coupon through to 16 October 2014 is 3.62%.

• Nufarm (NUF.ASX) reset the coupon on its perpetual preference share. The coupon was reset at 3.9% over the Australian six month bank bill rate. The new distribution rate until April 2014 is 6.5167%.

Upcoming maturities through to the End of November 2013 are shown below:

• 15/11/2013 - Dunedin City Treasury $40 mln with 7.07% coupon
• 15/11/2013 - Wellington Int'l Airport $100 mln with 7.50% coupon

• 18/11/2013 - ASB $170 mln with 5.52% coupon

• 28/11/2013 - Westpac $265 mln with 7.05% coupon

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