Investor interest returns to bonds

"There has been a change in the dynamics of the investment market and bonds are looking more attractive at the moment," said BNZ treasurer Tim Main. Photo / Thinkstock

Yields rise on expectation central banks will curtail measures aimed at pump-priming GFC-battered economies.

Bond markets have undergone a sea change during the last few months, heralding the start of a more normal investment climate after years of unnaturally low interest rates, say fixed interest specialists.

Since May, bond yields have risen significantly in New Zealand and the major financial markets - led by the United States - on the expectation that central banks will soon curtail measures aimed at pump-priming their GFC-battered economies.

This week's US Federal Open Market Committee meeting is an important one because expectations are that the Fed will reduce its US$85 billion ($104 billion) a month bond-buying programme, which has helped keep long-term borrowing rates low, paving the way for more normal conditions to eventually prevail.

While the Fed is a long way off raising rates, the start of its tapering of the stimulative measures will be seen as an important step in the rehabilitation of the US economy and its northern hemisphere counterparts, bond market participants said.

The Reserve Bank of New Zealand has signalled it intends to start raising its official cash rate, which sits at 2.5 per cent, next year.

"There has been a change in the dynamics of the investment market and bonds are looking more attractive at the moment," said BNZ treasurer Tim Main.

"I would not say that the risks are entirely gone, but things are improving and confidence globally is lifting," Main said.

On the home front, demand for Westpac NZ's $800 million five-year bond, which yielded 5.545 per cent, was seen as a significant indicator of investor demand - particularly for instruments yielding over the magic 5 per cent level.

"Now that yields on five-year bank debt have risen over a percentage point since May, it appears investor appetite has returned," said Christian Hawkesby, head of fixed income at Harbour Asset Management.

Renewed investor demand for bonds is a global phenomenon - US telecommunications firm Verizon last week raised US$49 billion, which is the largest corporate bond deal in history.

BNZ's Main said investors now faced the chance to get higher yields without the risks of inflation rapidly rising to erode returns.

Shifts in the bond markets will have an impact on fund managers' asset allocations after years of low interest rates.

The New Zealand sharemarket has gained about 25 per cent over the last 12 months, partly because of local dividend-yield stocks looking attractive relative to fixed-interest markets.

Philip Houghton-Brown, head of investments at Mercer New Zealand, said the interest rate markets were going through readjustment.

"Investors are now just re-pricing the likelihood of growth on a more sustainable path," Houghton-Brown said.

"Confidence - that the recovery is sustainable - is returning in the United States as well as in New Zealand," he said.

Benchmark US 10-year bond yields which were at 1.6 per cent in May are now pushing 3 per cent.

"The big worry for bond markets over 2011/12 and 2013 has been central banks keeping rates artificially low and that they should correct higher at some stage," Hawkesby said.

"The correction is happening quicker than people thought," he said.

"Our view is that the jump in yields over the last couple of months has been part of that correction and that they are likely to drift higher over time as central banks continue to step away from the amount of stimulus that they have provided."