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Bond Focus: NZ yield curve stretched by bond sales, low rates

The steepest yield curve in 13 years is set to continue in New Zealand, mirroring the US and other major economies, as governments worldwide ramp up bond sales while central banks hold short rates near record lows.

Sunday, 14 June 2009

by Paul McBeth

The gap between yields on two and 10-year New Zealand bonds widened to as much as 250 basis points this month, the largest since 1996, according to Bloomberg data. Opposing forces are acting on each end of the curve, part of the reason why longer-term fixed-rate mortgages have risen while rates for shorter loans have declined.

The yield curve is "very, very steep" and with monetary policy set to stay loose, "it's got the potential to be here for a long while," said Grant Hassell, head of fixed interest at AMP Capital Investors. "There's a continual supply of government bonds every week" and that's driving up yields on longer bonds.

Record sales of government debt risk are saturating global bond markets, driving yields higher. The Obama administration expects to sell US$1.3 trillion of Treasuries in the first three quarters of this year, to help plug a record US$1.75 trillion budget deficit. The yield on 10-year Treasuries rose to 3.99% this week, an eight-month high, before dipping back to 3.86%.

The Federal Reserve has kept its interest rate target close to zero to revive an economy is its worst recession since WWII.

In New Zealand, the Debt Management Office is lifting bond sales by 55% to $8.5 billion this year, or 4.9% of gross domestic product, the highest relative to GDP in 16 years. The government's residual cash deficit is forecast to widen in the next few years, reaching $12.5 billion in 2011.

New Zealand's yield curve has turned sharply positive in the past five months having been negative in the days before Lehman Brothers collapsed in September. The yield on two-year bonds has fallen to 3.77% from 5.78% on September 12. Ten-year yields are at a six-month high 6.03%, little changed from their September levels. The 90-day bank bill rate has tumbled to 2.89% from 7.83%.

Andrew Michl, who helps manage $4 billion worth of fixed interest and cash for ING New Zealand, said the long end looks attractive as yields continue to rise on greater supply.

"Government bonds have started to get to good levels," Michl said. ING sees the long end as "very good value," he said.

In the US, strong demand at yesterday's auction for 30-year Treasuries pushed yields lower on optimism there's still a hunger for Treasuries, even as nations such as Russia, Brazil and China ponder shifting some of their funds into other types of securities, including IMF bonds.

Fixed-interest mortgage rates in the U.S. rose to the highest since November, said Frank Nothaft, vice president at Freddie Mac. The 30-year rates rose to an average 5.59% from 5.29% last week, according to Freddie Mac's Primary Mortgage Market survey.

"Mortgage rates followed the increase in bond yields this week," Nothaft said. "Higher mortgage rates are slowing refinancing activity, but not demand for home purchases."

David Plank, fixed income researcher at Deutsche Bank in Sydney, said New Zealand's government yield curve probably won't flatten until next year when short-end rates are likely to climb in anticipation of a return to tighter monetary policy.

Until then the gap between two and 10-year yields will probably just drift between 25 and 50 basis points from current levels, he said.

"The risk is that the Reserve Bank will commit the same policy mistake it always has" and let the housing market get away on it before tightening the official cash rate again, he said.

 New Zealand home owners rushed to refinance fixed-rate mortgages in February, when market rates were at the bottom of the trough. Five-year fixed rate mortgages, which were around 9.2% in mid-2008, had tumbled to 6.5% by March.

Since then, five-year rates have increased to a median 7.9% across the major lending banks, and two-year lending costs 6.25%, according to the www.depositrates.co.nz website.

Already, housing indicators suggest lower borrowing costs are breathing life back into the property market. Reserve Bank Governor Alan Bollard said the potential rebound in the property market was one factor that prompted him to keep the official cash rate steady at 2.5% yesterday, as rising net migration and fewer building consents issued stoked demand to exceed supply.

There was an acute shortage of houses as sellers were reluctant to sell in what's perceived to be a "buyer's market," as residential property prices slipped in May, after three consecutive monthly gains, according to the Real Estate Institute.

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