THE YEAR OF the Goat is but a few days old and I can already tell you one of the trends that is likely to loom large in the months to come: the Australian and New Zealand bond markets.
Are you stifling a yawn at this prediction? If so, I can hardly blame you. I have struggled for years to engage any level of excitement when it comes to those two antipodean markets. But let me try, after a small digression.
My acquaintance with those markets goes back more than two decades, to when I worked in institutional sales at Nomura in London. Fresh from the graduate training course in Tokyo, we neophyte salesmen were still trying to comprehend the relationship between a bond’s price and its yield – surely they moved in lock-step? – when we were handed the unenviable task of dealing with Danish and German retail clients.
Small regional banks from those two countries would call up looking for prices in a quarter of a million dollars equivalent of Kiwi bonds and we’d broke it with the London branch of a New Zealand bank for a half-point mark-up. It was work that the big boys had assigned to us grunts with somewhat ironic encouragement while they got on with their US$100m Eurobond switches.
It was beyond me at the time (and still is) why the retail clients didn’t think to call up the Kiwis themselves. But no matter. There was no Bloomberg or Eikon in those days and the screen prices weren’t live, so you needed a phone to check where the market was.
A high proportion of the Kiwi bond market – two-thirds of which is held by offshore investors – is held by Japanese accounts
ONE THING HASN’T changed: the punters were on a quest for yield and found the returns available on paper from Down Under rather irresistible. And that state of affairs remains in place, even if Danish and German retail have been long subsumed in absolute return funds.
Ten-year New Zealand government bond yields trade on a 3% handle with around 20bp thrown in on top, which is conspicuously generous in relation to the government bond markets of the US, Germany or the UK.
And this return doesn’t mean getting involved in the messiness of eurozone finances or taking a punt on a politically dodgy regime in Latin America or Eastern Europe. It’s good old fashioned New Zealand and getting those yields isn’t “hard yakka” at all (that’s Kiwi speak for hard work).
It’s a shame that Kauri bonds – New Zealand dollar bonds issued by non-domestic entities – seldom emanate from anything other than somewhat staid state-owned or multilateral institutions or large banks. Germany’s KfW dominates issuance, with supranationals such as the World Bank regular visitors and Germany’s Rentenbank and Norway’s Kommunalbanken adding to the steady supply.
You don’t need to be a genius to spot that “high-quality issuers” and “three per cent or more coupons” are the perfect recipe for a Japanese carry trade.
A high proportion of the Kiwi bond market – two-thirds of which is held by offshore investors – is held by Japanese accounts.
With Japanese rates at ultra-low levels, the yen remaining a one-way devaluation bet and Japanese institutions looking to invest offshore as never before (an outbound M&A wave is finally under way) I would suggest that the heady start to the Kauri bond market in 2015 is just the beginning. The 10-year Kiwi government curve sits just 80bp back of the Aussie government curve, and you’d have to reckon for a compression there.
But that will probably happen in the context of declining Aussie yields, too, since the Australian bond market is also a major target of yen carry money, even though it trades some way through New Zealand.
THE AUSSIE PRIMARY bond year has got off to a flying start and even though there might be a greater potential credit concern around Australian dollar debt given that we are heading into the doldrums of the commodity super-cycle, the yields on offer and the country’s relative political stability will draw in the carry trader.
It’s not just from Japan, either, but from a pool of cash emanating from low-yield environments such as the US, the UK and the stronger countries of the eurozone. And the decline in the Australian dollar from its highs means there is a rump of potential forex gain to add spice to Kangaroo issuance (for offshore issuers that borrow in Aussie dollars).
Much like the Kauri market, the issuance pool is dominated by stolid, state-owned entities and high-rated FIG, with a twist of RMBS thrown in. But, as with New Zealand, it would be nice to see issuance emanating from the lower reaches of the credit curve.
The problem is that there have been damp-squib Kangaroo deals that have failed to capture the attention of the domestic investor base, which is deeper than the New Zealand domestic bid, and this has proved a deterrent to potential issuers.
As both the Kangaroo and Kauri markets have kicked off 2015 in fine fashion, it must surely be time for potential issuers to start making phone calls and for bankers servicing the Aussie and Kiwi investor base to become a little more imaginative in what they bring to the table.
As QE kicks off in the eurozone, as the Fed sits on its hands as far as rate tightening is concerned, and as Japan’s mammoth easy money experiment remains in full swing, there could be no more opportune moment for these two markets to undergo an existential overhaul.
