RBNZ & RBA talk down their respective dollars; ECB surprises with rate cut; how to insulate your portfolio against rising interest rates

By Craig Simpson

Much of the focus for November was on the impact Loan-to-value (LVR) restrictions are having and whether the housing market is cooling. For most of the month the NZ dollar remained elevated against both the US$ and A$ and remains a concern for the RBNZ.

RBNZ and RBA trying to jawbone their dollars lower

In a speech to Federated Farmers Meat and Fibre Council in Wellington, Assistant Governor and Head of Economics Dr John McDermott said “The nominal exchange rate is currently at historically high levels against nearly all of our trading partners. The real exchange rate – which takes into account relative inflation rates, and so is a better measure of overall competitiveness – is also at historically high levels.”

“However, the Reserve Bank believes that, from a long-term perspective, the exchange rate is overvalued. The high exchange rate is contributing to economic imbalances and the Reserve Bank would like to see it lower in order to promote more sustainable economic growth.

The RBA said they were “open minded” about currency intervention in response to a report from the  International Monetary Fund (IMF) report that said the Australian Dollar was 10% overvalued. The Australian economy is not performing as well as our own and therefore the RBA is not under the same pressure as the RBNZ.

Signs the LVR restrictions are starting to bite

Early indications that high LVR lending (excluding exemptions) is falling with data released by the RBNZ showing 11.7% of total new mortgage lending was high LVR loans compared to the 25.5% in September.

It may still be too soon to say the restrictions are working effectively however anaecdotal evidence suggests some prospective first home buyers are withdrawing from the market and house sales are easing. It will take several months of data to, in my opinion, be able to declare the restrictions a resounding success.

Another factor impacting home buyers is short term interest rates are on the increase. Swap rates have been rising across the curve and the 2-year rate is back at August 2011 levels. This indicates we can expect mortgage rates to increase in the not too distant future as banks move to protect their healthy margins.

There is a dispersion of opinions as to when the RBNZ will start to hike rates with the wider market and main bank economists forecasting anywhere between March and June 2014.

If the RBNZ does raise rates we will be the first of the worlds major developed economies to do so.

One of the important considerations for our central bank will continue to be the high NZ$ and the inflationary pressures which are starting to gather momentum. The RBNZ will be conscious that if they do hike rates the NZ$ may strengthen and could pose further problems for our central bankers.

ECB surprises market while other central banks retain status quo for now

Apart from the 0.25% cut from the ECB there were no real surprises from the major central banks during the month.

Speculation was begining to mount that the RBA may look to cut rates during the month however the status quo remained. European central banks are battling to stave off deflationary pressures with some form of quantitative easing likely.

In the UK the market is starting to think hikes could be likely although the new BoE Governor is trying his hardest to temper expections. Below is a summary of the main central bank action from brokers Forsyth Barr.

RBA - kept its official cash rate on hold at 2.50% on Melbourne Cup day citing a couple of positives, mainly: “further ahead, private demand outside the mining sector is expected to increase at a faster pace, though considerable uncertainty surrounds this outlook.” The RBA also threw some caution with: “Public spending is forecast to be quite weak and the Australian dollar, while below its level earlier in the year, is still uncomfortably high. A lower level of the exchange rate is likely to be needed to achieve balanced growth in the economy.” As evidenced by the confusing commentary, two of the ‘big four’ banks are still forecasting the next move from the RBA will be a cut.

ECB surprised many by reducing its benchmark interest rate to a new record low of just 0.25% The ECB kept its deposit rate at 0% and trimmed its marginal lending rate to 0.75%. ECB President, Mario Draghi and the ECB only have one rate cut left in its bazooka. However with inflation running at just 0.7% - the lowest level since November 2009, it is clear that the ECB is concerned about deflation.The ECB chief once again pledged to keep interest rates low for an “extended period” but with only one shot left before interest rates reach 0%, other tools such as quantitative easing may have to be introduced.

BOE - refrained from joining the ECB and left its interest rate on hold at 0.5%. Whilst this was widely anticipated, the focus will turn to the release of the economic projections due for release from the BoE this week. Recent economic data from the UK has been positive and this is seen in the +27bp rise in the 10 year gilt since 1 July 2013.

The BoE appears to be the only other central bank which could be considering rate hikes as the UK economy recovers from many years in recession

Floating rate notes versus fixed rate bonds

During the month Forsyth Barr in their fixed income commentary picked up on the topic of floating rate notes versus fixed rate bonds. As noted in the chart below based on interest rate forecasts there is an inflection point where floating rate notes will be preferred over a fixed rate bond.  Their analysis focussed on the recent issues from  Port of Tauranga’s (POT) - fixed rate issue and Auckland Council’s floating rate note issue which was issued at a margin of BKBM +47bp. By contrast the POT was 1.33% over the comparable swap rate of 4.535% which resulted in an annual interest rate equivalent to 5.865%.

Alternatively POT could have issued a 6-year FRN at a 1.33% margin over the BKBM (90-day bank bill rate) to result in a first coupon of 4.00%, meaning POT would have secured six year funding at a variable (unknown) cost that is then reset every 3 months.

The difference between the 90-day bank bill rate and the 6-year swap rate at the time the analysis was conduct was 1.865% (4.535% minus 2.67%). Once the 90-day bank bill rate rises above 4.535% then the investor would be better off in a POT floating rate note compared to the fixed rate note that was actually issued.

Given the Reserve Bank of New Zealand (RBNZ) is expected to hike the Official Cash Rate (OCR) by approximately 2.00% to 4.50% by March 2016 (implying a 90-day bank bill rate of 4.70%), investors are currently better rewarded to accept POT’s fixed rate bonds benefitting from the term premium.

Forsyth Barr concluded that an investor is indifferent when analysing the offer for Auckland Council’s FRN or fixed rate bond. 

The base rate for a fixed tranche was 4.0% versus the floating rate base of 2.67%, so investors are initially receiving higher income from the fixed rate tranche.

They concluded that at present there is a compelling argument for investing in longer dated fixed rate bonds however when the expected outcome is similar to the Auckland Council example, the floating rate note would be the preferred option.

Market performance indicators

The NZ Government Stock index was the only benchmark to record a negative result last month

Strong quarterly returns were seen from offshore bonds hedged back to NZ$. Unhedged global bonds were the poorest performers over the past twelve months recording a negative 3.5% return to investors.

Government bond indices have under-performed corporate bonds over most time frames this year which would be concerning those clients mandated to hold a portion of their fixed income portfolios government securities.

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 (again). 

Bond issues, tenders and offers

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

• Transpower (TRP) issued a further NZ$200 mln to its NZDX listed (TRP010) bond with the issue yield of 5.337%, higher than the 5.14% coupon.

• The Debt Management Office (DMO) received NZ$663 mln of bids for NZ$200 mln of April 2020 New Zealand Government Bonds. The bonds were sold at an average yield of 4.55%.

• Mighty River Power (MRP) announced that S&P’s revised global ratings criteria and methodology will have no impact on its current BBB+/stable credit rating.

• ASB issued a three-year floating rate note at +65bp over the 90 day bank bill rate. The NZ$320 mln issue will mature in December 2016.

• Latest bond tender of NZ$200 mln received bids for NZ$663 mln with an average weighted yield of 4.5469% (previously 4.4509%)

• Rabobank had its credit rating downgraded from AA to AA- by Fitch Ratings. Fitch also maintained its negative outlook. Fitch stated the downgrade was largely due to the improving credit profile of its peers.

• The Debt Management Office (DMO) received tepid demand from its auction of NZ$200 mln of September 2025 inflation-indexed NZGB’s. The DMO received 32 bids totaling NZ$268 mln for the inflation protected bonds resulting in a 1.34x coverage ratio.

• Latest bond tender of NZ$200 mln received bids for $268 mln with weighted average accepted yield of 2.7552% (versus 2.6339% previously)

• Transpower (TRP) announced it is seeking to raise up to NZ$200 mln through its already listed bond, TRP010. The new tranche will be fungible with TRP’s existing NZDX listed bond TRP010 which matures in 30 November 2018. The coupon is 5.14% for the AA- credit rated unsecured, unsubordinated bond. The issue yield will be set on 27 November 2013.

• Vector (VCT) announced it had successfully established NZ$230 mln of new bank facilities that will expire in December 2016. The facilities replace the existing NZ$125 mln working capital facilities that were due to expire in December.

• Wellington International Airport (WIA) redeemed its existing senior bond, WIA010 on 15 November 2013. WIA020, its replacement, is now trading on the NZDX.

• NAB launched an offer of NAB Convertible Preference Shares. These securities will contribute to NAB’s tier one capital. The loss absorbing (by way of conversion to NAB shares) preference shares are expected to be priced around 3.25% to 3.40% over the 90 day bank bill rate. Dividends are fully franked.

• Moody’s Investor Services released its credit opinion on Auckland Council stating its credit rating of Aa2 along with a stable outlook was focused around strong governance and stable and predictable sources of revenues.

• Contact Energy (CEN) redeemed its NZ$200 mln capital bond, CENFA, on 15 November.

• Dunedin City Council raised NZ$50 mln via a fixed rate bond that will mature in November 2020. The coupon was set at 5.56% or 75bp over swap.

• ANZ New Zealand has borrowed NZ$350 mln through a three-year issue of floating rate notes priced at 65 basis points over the 90-day bank bill rate. The issue matures in three years time on November 18, 2016 and carries an initial interest rate 65 basis points over the 90-day bank bill rate

• NZDMO bond tender of NZ$200 mln received bids for NZ$557 mln with an average weighted yield of 4.4509% (previously 4.3645%)

• Infratil reset the coupon on its perpetual infrastructure bond, IFTHA, on 15 November at 1.50% over the prevailing one-year swap rate. The new rate is 4.53% p.a.

• GMT Bond Issuer Limited (Goodman Property Trust) announced it is considering making an offer of up to NZ$75 mln (plus up to NZ$25m in oversubscriptions) of secured, unsubordinated bonds to retail investors. The bonds will mature on 4 December 2020 and will be guaranteed by GMT.

• Auckland Council (AKC) successfully raised NZ$250 mln via a wholesale floating rate note. The FRN was priced at a margin of 47bp over the 90 day bank bill rate and will mature in March 2017.

• ASB Capital will reset the dividend on its perpetual preference share, ASBPA, on 15 November at 1.30% over the prevailing one-year swap rate. The new rate is 4.31% p.a.

• AMP announced an offer of unsecured, subordinated tier two capital notes. AMP is looking to raise at least A$300 mln through the issue of the floating rate note that will have a maturity of 18 December 2023, however AMP does have the ability to call at the five year mark. The margin is expected to be in the range of 2.65% to 2.85% and holders of the existing AQNHA.ASX have an opportunity to reinvest. The notes are loss absorbing via a conversion to shares mechanism now required under Basel III. AMP stated that it would redeem the New Zealand version of the notes on its first call date being 15 May 2014.

• NZDMO raises interest rates on its KiwiBond and Earthquake Bonds as domestic wholesale rates rise - the one-year Kiwi Bonds will increase by 0.25% to 2.25%, the two-year Kiwi Bonds will increase by 0.50% to 2.75% and the interest rate for the four-year Earthquake Kiwi Bonds will increase by 0.50% to 3.25%, effective immediately.

• NZDMO Inflation Indexed bond tender of NZ$200 mln received bids for $603 mln with weighted average accepted yield of 2.6339% (versus 2.6314% previously)

• LGFA tender of NZ$115 mln received bids for NZ$755 mln with 8 year bond yielding an average 5.3810% (previously 5.6352%)

• ASB has borrowed €500 mln (about NZ$814 mln) through an issue of five-year covered bonds secured by New Zealand residential mortgages. According to Reuters, the bonds are paying a coupon of 1.5%. They were reportedly priced at 25 basis points over the swap rate, or around BKBM plus 89 basis points.

• Toyota Finance New Zealand raised NZ$75mln across a NZ$50mln fixed rate line and NZ$25mln floating rate note priced at 85bp over the 90 day bank bill rate. The coupon on the fixed rate bond is 5.25% with both bonds  maturing in April 2019.

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