Confidence returning to bond markets

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

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

On that score, this week's US Federal Open Market Committee meeting is shaping up to be an important one for the markets because expectations are that the Fed will reduce its US$85 billion a month bond-buying programme, paving the way for more normal conditions to eventually prevail.

While the Fed is still a long way off actually raising rates, the start of its so called "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.

Domestically, the Reserve Bank has signalled that next year it intends to start raising its official cash rate, which sits at 2.5 per cent.

"There has been a change in the dynamics of the investment market and bonds are looking more attractive at the moment," Bank of New Zealand treasurer Tim Main said. "I would not say that the risks are entirely gone, but things are improving and confidence globally is lifting," he told APNZ.

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

Renewed investor demand for bonds is also a global phenomenon - US telecommunications firm Verizon this week raised US$49b - the largest corporate bond deal in history.

BNZ's Main said investors now faced the opportunity of accessing 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 unnaturally low interest rates.

The New Zealand share market has gained about 25 per cent over the last 12 months, due in part to 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 a period of readjustment. "Investors are now just re-pricing the likelihood of growth on a more sustainable path," he 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 were at 1.6 per cent in May and are now pushing 3 per cent, which is a big jump in bond market terms.

"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.

"Now it's becoming more interesting for investors to consider weighing up the pros and cons of locking in for a longer investment horizon, particularly when you consider the official cash rate is still at 2.5 per cent, and with some of these corporate bond issues coming out at 5.5 to 6 per cent.

"Our house 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 stimulus that they have provided," he said.


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