Apart from term swap interest rates continuing to turn upwards last week in response to generally stronger than expected local economic data (housing, retail sales and farm incomes), the highlight of the week was the inaugural issue of Local Government New Zealand (“LGFA”) bonds to the market. Our advisory firm kicked off this initiative to consolidate and aggregate local government debt some four year ago. It was very satisfying to see the project come to fruition with the establishment of the LGFA and a successful first bond issue.
The issuance margins at 80 basis points over NZ Govt Bonds for the 3-year maturity and 118 over for the almost 6-year term were generally below pre-tender expectations from bank dealers and fixed interest brokers. Whilst the demand from investors was strong with 4.4 time coverage in the tender (the NZDMO average 2.9 times coverage in NZ Govt Bond tenders), the margins were a little higher than what I thought may have been obtainable for the first issue.
There was certainly a fair amount of uncertainty around the price discovery process with this being the first ever tender. Equivalent benchmarks of Australian “semi-Government” State Treasury Corp trade between 110 to 130 basis points over Commonwealth of Australia Government Bonds. The LGFA December 2017 bonds were issued at a yield some 25 to 30 basis points below what equivalent term Auckland Council bonds trade at.
What was encouraging for the LGFA for future issues is that the 2017 bond traded down five basis points in yield in the secondary market after the primary issue tender. Another tender of the 2017 bonds within a few weeks should see some of the unfulfilled investor demand produce even lower issuance spreads to NZ Government bonds.
There was a fair amount of market opposition to consolidating local government debt into a single issuer in the early days. Not only did the individual council borrowers need to be convinced that the change was going to be worthwhile; a number of the fixed interest fund managers, bankers and brokers who invested into and arranged individual council debt issues were wary about the status-quo changing.
However, it was always our belief that local government debt was mis-priced (i.e. spreads to swap and NZ Government bonds too high) in the New Zealand debt market as there was no proper competitive tension in the pricing as Councils could not issue debt outside New Zealand. The big advantage the LGFA now has is that if investors in New Zealand start pricing the spreads up, LGFA can issue its debt offshore. Thus much greater power as a borrower to control credit spreads through supply and demand of its bonds into the domestic market.
For Mum and Dad investors there is now a high quality, high rated, highly liquid non-Government fixed interest security available that delivers a yield return well above short-term bank deposits. For institutional funds managers there is another high quality fixed interest asset class to invest into that is not Government and not bank risk. For Council borrowers there is now both term and pricing advantages. For ratepayers there is the benefit of lower cost debt, which would have to be the only local government cost that has reduced in a very long time. Winners all round really.
Is this as good as it gets for the Kiwi Dollar?
The NZ dollar has butted its head up against the resistance ceiling at 0.8400 on several occasions over recent weeks, without attracting the conviction from new buyers to send it convincingly higher. International equity and currency markets have settled somewhat in February after the strong gains at the start of the year due to positive Chinese and US economic data during January.
Volatility measures (i.e. VIX Index) have reduced and this has aided the continuation of the NZD strength. The daily movements of the NZD/USD exchange rate are not presently being influenced by local NZ economic data. However, the year has commenced with further evidence that the NZ economy is tracking along at a more robust pace than what most economic forecasters have been expecting.
Last week there was confirmation of farmer incomes being up 17% on the previous year to average $134,000; residential property sales activity and prices were up, as were retail sales for the December quarter. GDP growth for the December quarter could well be another positive 0.60%, on top of the 0.80% increase in the September quarter, when it is released on 22 March.
On a relative basis compared to other countries the NZ economy is currently expanding at an annual GDP growth clip of +3.00% - and that is before GDP measurement differences that understate our GDP compared to Australia – according to the Reserve Bank of NZ gurus. It is little wonder that the NZD is at a strong point when GDP growth performances are compared. We are doing very well with the strong underlying economic fundamentals of still historically high agricultural commodity prices. The last time our farmers earned over $134,000 in a year was in 2001/2003 when the Kiwi dollar was 0.4500 to the USD.
Despite all the positives for the Kiwi dollar, the feeling is that they are all priced-in to the exchange rate already and the following negative factors that could push the NZD down are lurking in the markets:-
§ Whilst official Chinese economic growth data has been strong to date, the anecdotal evidence mounts that activity has slowed in recent months. The PBOC has again relaxed bank reserve ratio requirements, indicating that maybe the officials are preparing for a more rapid slowdown than previously anticipated. Market analysts see annual Chinese GDP growth slowing from 8.9% to 8.2% this quarter. The NZD was shoved up in January on the back of stronger Chinese data being positive for the AUD and commodity prices. That market consequence would reverse abruptly if Chinese economic data comes out weaker than expected over coming weeks.
§ The USD itself has started to make gains of its own on the back of the more positive US economic figures. The USD currency Index has climbed back to 79.25 and should add to those gains as the US economy out-performs both Japan and Europe this year. Japan eased monetary policy considerably last week; further Yen weakness to well above 80.00 to the USD has to be expected.
§ The NZD gains to 0.8400 are over-extended when compared to the close historical correlations to the EUR/USD exchange rate, the Dow Jones Index and Wholemilk Powder prices (see chart below). The thin and less liquid FX markets over the New Year period exaggerating the gains well in excess of these major drivers.
§ Whilst the Greeks and the EU edge towards agreement on the second bail-out and the risk of a Lehman-type financial melt-down in Europe has abated, any new setbacks on resolving the European sovereign debt crisis will be met with sell-offs in global equity markets and thus a weaker NZ as a consequence. Risk appetite from investors remains fickle and frenzied, thus “risk-off” periods will continue to see NZD selling.
Holding the Kiwi dollar up near 0.8400 has been a stronger Australian dollar, buoyed by stronger employment growth numbers and the decision by the RBA not to cut their official interest rates two weeks ago. The AUD/USD rate has encountered strong resistance previously at the 1.0800 level, with their manufacturing (export as well as import substitution) and retail sectors really suffering from such a high currency value. Whilst the mining/resources states of Queensland and WA complain about labour shortages, manufacturing plants in NSW and Victoria are announcing redundancies and lay-offs. One wonders for just how much longer their currency can reflect only part of their economy.