As European leaders burn the midnight oil to keep Greece afloat and the US economy failed to inspire more robust growth, Asian central bankers have increasingly been pouring part of their monster foreign currency reserves into New Zealand sovereign debt. This tactic looks set to tighten the country’s bond yields to record lows, at least until a solid solution calms the turmoil surrounding Europe’s debt markets.
On June 15 the Wall Street Journal reported that China and Hong Kong’s central banks are buying New Zealand debt, citing an interview with Finance Minister Bill English. In fact central banks across Asia have been buying New Zealand debt for around 12 months, and strategists believe the institutions will continue to do so.
“We will continue to see this demand as long as the crisis remains,” said Imre Speizer, Auckland-based chief market strategist at Westpac. “As long as we have slightly nervous or very nervous global sentiment, New Zealand bonds will remain attractive.”
Asian central banks are not the only ones buying New Zealand and Australian sovereign debt. Central banks from greater Europe, the Middle East and South America have been doing so as well.
These fund flows have pushed down the yield of New Zealand’s 10-year bonds, considered a benchmark for long-term debt, to a record 3.472% on May 18, a level near which they still trade.
Even though this is a historically tight yield it still appeals compared to the 1.62% yield of 10-year US Treasuries and a 1.53% yield on German Bunds with similar maturities. Speizer says he expects more sovereign inflows to lead New Zealand bond yields to drop still further in the next several months.
New Zealand’s bond yield returns are higher than the developed world, including neighbouring Australia. The reason for the disparity in the debt of the two countries is partly due to their respective credit ratings—Australia is rated ‘AAA’ by all three ratings agencies versus New Zealand’s lower ‘AA’/’AA+’ and ‘AAA’ ratings.
But investors are also pricing in a Reserve Bank of Australia (RBA) rate cut, which would make existing bonds immediately more appealing. That has led to a positive spread between Australian and New Zealand bonds, according to David Croy, head of market strategy at ANZ in Wellington.
“The biggest attraction in New Zealand is the yield,” he said. “New Zealand stands out because it is a low beta, high-return market and is becoming a new safe haven due to its remoteness from Europe.”
“Australia stands out by far, with the best return in the market of 10-year bonds. But they have high volatility. In New Zealand, you get the yield and return without the volatility.”
Croy says that it was helpful for Asia’s central banks were able to familiarise themselves with Australia’s economy, central bank and currency moves before moving into New Zealand, because the two countries have similar characteristics that make it easier for investors.
But New Zealand’s popularity with the rest of the world has posed a burden to exporters, because more capital flows have boosted the value of the New Zealand dollar against the US dollar from NZD 1 dollar at the beginning of the year to NZD 79.7 cents on June 20.
The rise in valuation makes its exported goods more expensive overseas. Exports account for a third of New Zealand’s economy.
Finance Minister English told the Wall Street Journal that the New Zealand dollar, otherwise known as the kiwi, was overvalued. Westpac’s Speizer agreed, saying it was overvalued by three cents against the dollar.
“English was right to point out that the currency is overvalued because of government bond flows. The kiwi will remain overvalued as long as we see government bond inflows.”
One New Zealand dollar may become worth 80.5 US cents in the next two weeks, but a Chinese economic slowdown may trigger a selloff of the New Zealand dollar, meaning it weakens to be worth somewhere in the mid 70 US cents over the next three months, he said.
ANZ’s Croy also noted caution on investing in New Zealand.
“New Zealand is not particularly isolated from the rest of the world. The turmoil will have an impact on economic prospects here,” he said. “Things can get nasty as the European economy slows. Investors need to be aware that New Zealand is attractive right now but we wouldn’t regard it as a pure safe haven. It doesn’t have the same credit rating as Australia.”
That does not mean central banks will start pulling their money out of New Zealand.
“Sovereign flows tend to be long-term in nature. It’s unlike hedge fund flows that tend to go in and out along with market dynamics,” Speizer said. Sovereign flows tend to be very careful and take some time in studying their target markets.”