Key Points
- The RBNZ’s quantitative easing (QE), Large Scale Asset Purchase (LSAP) programme has kicked off to a very promising start.
- In a tug-of-war between massive Reserve Bank purchases and NZ Treasury issuance, the Reserve Bank is winning.
- The New Zealand Local Government Authority raised $1.1billion in new bonds issued today – a record amount.
- Along with better COVID-19 news in New Zealand and a rebound in equities, we are starting to see better activity in high grade NZ credit.
- The market is hoping this will flow through to the broader credit market. Early signs are encouraging, but the jury is out on the poor cousins at the lower end of the credit spectrum.
Financial markets are not alone in loving time-honoured phrases to convey ideas. “A rising tide lifts all boats” was originally used by John F Kennedy to suggest that a stronger economy would help everyone. We have learnt over the last couple of decades that it isn’t as simple as that with many people left behind, while others thrive.
However, the Reserve Bank of New Zealand (RBNZ) is hoping that the concept will apply successfully to their quantitative easing (QE) initiative, labelled Large Scale Asset Purchase (LSAP) Programme. It has gotten off to a very promising start. The RBNZ will buy as much as $30billlion in New Zealand Government stock and $3billion in Local Government Funding Authority (LGFA) bonds over coming months. This week marks the third week of the LSAP, with $1.8billion of purchases.
Shortly before LSAP was announced, 10-year New Zealand Government stock yields surged to 1.75%, from below 1.00% only a week earlier. The move was driven by concerns about a massive increase in government stock issuance, to fund the Government’s support programme, coinciding with dreadful market liquidity conditions. The move higher in yields was the largest seen since the late 1980’s when this writer was a rather green bond trader. To their credit, the RBNZ moved quickly, announcing LSAP. Since then, government 10-year bond yields have dropped back towards 1.00%.
Chart 1. QE has brought liquidity to LGFA bonds and yields have declined
Source: Bloomberg
However, while this happened in the Government stock market, liquidity has remained challenging in the corporate bond market. Trading banks, which provide secondary market liquidity, have been faced with sell requests from investors, driven by underlying clients seeking to exit their fixed interest investments. The corporate bond market, despite its inherent seniority to share capital in a firm, was not immune to COVID-19.
While this created some intense volatility for a couple of weeks, the recent calm in equity markets has been replicated in corporate bonds. Prices have stopped falling, but liquidity hasn’t really improved significantly.
However, the RBNZ’s announcement to include LGFA bonds has enabled a stunningly successful bond issue today. Feedback from the trading banks is that liquidity has re-emerged in the high-grade end of the corporate bond market. It was difficult to find a willing seller this morning. The RBNZ, and especially the LGFA, should be delighted.
So why is the “rising tides lifts all boats” analogy pertinent? If, as we have seen since the Global Financial Crisis (GFC), an improving economy hasn’t helped everyone, might this apply for the weaker credits in the corporate bond market? Given the extent to which economies are weakening, and the pressures being faced by many firms and households, it seems probable that investors will tread carefully with the more challenged issuers. We only see a very small number of troubling issues in the New Zealand market, but offshore they are numerous. Viewed this way, we can see both the benefits and limitations of QE programmes. By bringing liquidity back to markets, many firms will find it easier to refinance debt and remove one source of stress. QE is one crucial piece of the economic and financial support framework. However, it can only do so much.
Credit investors can be well pleased with developments this week but will still need to apply strong credit research to their decisions.
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