NZ government bond yields elevated before Budget

NZ bond yields have been elevated before this month's Budget. Photo / NZME

New Zealand government bond yields have lifted as markets anticipate a heavier-than-forecast borrowing requirement from the Government in this month’s Budget.

Benchmark 10-year bonds currently trade at 4.81 per cent from 4.69 per cent a month ago, and 4.19 per cent this time last year.

The Treasury, in its latest update, signalled it would be taking in $14 billion less in tax revenue than was previously forecast over the next four years.

ANZ strategist David Croy said in a recent commentary that the market is “staring down the barrel” of an upward revision at the May 30 Budget to planned issuance over the next four years of perhaps $10b to $12b.

Hamish Pepper, fixed income and currency strategist at Harbour Asset Management, said long bond yields had been creeping up over the past year or so in anticipation of higher bond issuance.

The expected surge in the supply has led to an unusual situation where yields are now higher than the equivalent swap rates, thereby reversing the normal relationship between the two.

More recently, the United States Federal Reserve’s “higher for longer” stance on monetary policy has pushed local yields higher still.

“If we go back to the middle of last year, there is this concession being built into government bonds, which is reflecting the upcoming supply,” Pepper said.

“That concession, relative to swaps, is still there - it’s part of the story.”

Government bond 10-year bond yields are now 10 to 15 basis points higher than the equivalent 10-year swap rate.

However, the gap has narrowed somewhat over the past month or so, which Pepper said showed there is more comfort in the market now about the prospect of more supply coming on stream.

Recent bond tenders and syndications have continued to attract very strong demand, particularly from overseas.

At this week’s tender, New Zealand Debt Management’s $250m tender of May 2030 bonds attracted 2.5 times the amount on offer in bids. Likewise, the $250 million of March 2033 bonds was almost three times covered.

“It’s been at levels that people, especially foreign investors, have been happy to be investing in New Zealand, and of course we need them to.”

Overseas investors already own about 60-65 per cent of the Government bond market.

“That’s the likely base-case number for how much we are going to need them to participate in bond issuance over the coming three or four years,” Pepper said.

At current levels, New Zealand has the highest bond yields in the developed world, which has helped to put a floor under demand.

Going forward, it’s likely that kind of yield premium compared with other countries will be required, he said.

In markets close to New Zealand, US 10-year bonds trade at 4.6 per cent, Australia 4.40 per cent and Britain 4.30 per cent.

“It’s not common to see swap rates sit below physical government bond yields as you would expect because they are a true ‘risk-free’ interest to behave.

“In most markets, sovereign debt carries the lowest risk is, and should therefore trade at the lowest yield.

“It’s a huge programme ahead in terms of how much issuance that needs to occur,” Pepper said.

New Zealand is not alone in terms of its government bonds trading at higher yields than their synthetic equivalents.

The disparity exists in the US, where there are similar concerns about the supply story.

While there are supply concerns domestically, the revealed preference of foreigners to continue to buy New Zealand bonds is something that has calmed the market to a degree, he said.

Jamie Gray is an Auckland-based journalist, covering the financial markets and the primary sector. He joined the Herald in 2011.