Local fixed income managers are looking to add duration as the spectre of a negative official cash rate (OCR) looms into view.
David McLeish, Fisher Funds head of fixed income, said the manager had added longer-dated government bonds post the OCR call.
McLeish said while the RBNZ held the OCR steady at 0.25 per cent, there was “a sense that it wanted to take rates negative” last Wednesday, thwarted only by technical bottlenecks at some financial institutions.
“The Reserve Bank is ramping up pressure on the laggards to resolve the [negative rate] operational issues,” he said. “There’s a new urgency.”
Officially, the RBNZ set a course of no change for the OCR until early next year, only hinting in its monetary policy statement (MPS) that negative rates remain “an option in future, although at present financial institutions are not yet operationally ready”.
“It was noted that discussions with financial institutions about preparing for a negative OCR are ongoing,” the MPS says.
Instead, the RBNZ doubled its quantitative easing (QE) program to $60 billion last week, adding inflation-linked government bonds to the mix, to further cushion the blow of a coronavirus recession.
But there’s a fine line between cushioning the economy and suffocating it with a pillow.
According to McLeish, negative rates might suck the remaining oxygen out of markets.
“The fact a negative OCR is being presented as a natural policy progression is quite alarming,” he said. “When you introduce negative rates you’re crossing the Rubicon; there are lots of unintended consequences.”
Regardless, McLeish said fixed income managers can continue to add value in a negative rate environment.
“Even if the NZ 10-year rate is zero or negative, bonds can still generate a positive return,” he said. Assuming the OCR dips below the zero bound, fixed income portfolios weighted to longer duration bonds could see capital appreciation of between 8 to 9 per cent, McLeish said.
He said high-quality credit was increasingly attractive, too.
Like Fisher Funds, AMP Capital also boosted holdings of longer-term bonds post the OCR call, portfolio manager, Carrick Lucas, told investors last week. Lucas said the manager in addition took the opportunity to top up on inflation-linked bonds, now included in the RBNZ QE pool.
As the RBNZ notes, however, monetary policy must mesh with government fiscal action to be effective in crisis-fighting. And last week’s budget delivered on that side of the equation with a $50 billion spending boost this financial year along with a super-charged multi-year bond issue program set for the Debt Management Office (DMO).
In a note published last Friday, Harbour Asset Management says the DMO borrowing plan “implies outstanding nominal government bonds of $65bn could increase to around $120bn by end June 2021”.
“Having already bought around $10bn of New Zealand Government bonds (NZGB), if the RBNZ continues to purchase bonds at its recent pace ($1.35bn/week), it may not be able to absorb the $48.9bn of net NZGB issuance in 2020/21, leaving the DMO increasingly dependent on demand from other investors, including those offshore,” Harbour says. “Given the relative expensiveness of NZGBs to Australian and US government bonds, however, the clearing price of our bonds going forward may be at cheaper levels and the increase in NZGB yields following the Budget announcement reflects that.”
Following the OCR announcement the NZ 10-year bond yield dropped 0.15 per cent only to bounce back 0.2 per cent higher post budget.
“So while the 10-year yield was mostly unchanged over the two days, this disguised some very big daily moves,” McLeish said.
The RBNZ, though, has shored up its ability to support the bond market further. In a subtle change of emphasis, on May 10 the Finance Minister Grant Robertson approved an earlier RBNZ request to restate the terms of the government indemnity for losses on the central bank’s QE program.
Rather than backing the RBNZ against “interest rate and credit losses” on a fixed level of bond purchases (set at $30 billion for vanilla government bonds and $3 billion of inflation-indexed and local council securities, governor Adrian Orr requested – and received – a government indemnity based on a proportionate model.
Under the revised agreement, the RBNZ will be off the hook for losses accrued on 50 per cent of NZ government “nominal bonds on issue” as well as a similar guarantee on 30 per cent of in-play inflation-indexed and local government bonds.
“The indemnity will be needed until the MPC is confident that it can sustainably achieve its inflation and employment objectives in the medium term without conducting [large-scale asset purchases] LSAPs,” Orr says in the letter. “Without the indemnity, the Bank would not have sufficient capital to conduct the bond purchases necessary for the MPC to achieve its economic objectives. Given the uncertainty about the scale and duration of the economic shock, I propose that the indemnity remain in place initially for at least 18 months.”
Despite retaining the option to take the OCR below zero, for now at least the RBNZ has ruled out the precedent of the US central bank, which last week began buying corporate credit exchange-traded funds (ETFs) as part of its liquidity-pumping efforts.
As the COVID-19 brand of ‘unconventional’ monetary policies out-weird earlier versions, though, traditional fixed income managers face a tough assignment.
Even the world’s largest bond manager, PIMCO, is feeling the pinch, reporting net outflows of almost US$50 billion in the March quarter: BlackRock, the world’s biggest fund manager, also booked net outflows of US$19 billion over the period, likewise led by bleeding fixed income products. A Bloomberg report attributed the PIMCO outflows to flighty “retail investors” looking to park funds elsewhere for the duration.
