“The outlook revision reflects our view that a substantial debt reduction is becoming more difficult to envisage, as fiscal consolidation has been delayed in the past few years,” Fitch wrote at the time.
New Zealand Government bond yields have been rising – key 10-year bonds now trade at around 4.7%, from just over 4% last October.
Government bond yields are lower than their corporate equivalent, and lower still than home mortgage rates.
Matt Logan, portfolio manager, credit, at Fisher Funds, said New Zealand was not alone with its stretched bond market.
“Every Government is trying to spend more on infrastructure, so that’s one impulse.
“As a result, basically every G7 country is running a fiscal deficit,” he said.
New Zealand’s fiscal deficit runs at about 3% of GDP – lower than in France (5.1%), Britain (4.3%), and the US (6%).
Logan said fiscal deficits here and around the world were creating a “tidal wave” of government bond issuance.
“If you’re spending more than you earn, then you’re going to have to borrow some money to make up for it.
“And, and that’s what basically every major Government is doing, which in and of itself isn’t a bad thing.
“But if we’re all doing it at the same time, then that’s tricky.”
Then there is the demand side.
“If the demand to buy those bonds outpaces supply, then it’s fine.
“But I think there’s a natural limit on just how much bond purchasing can happen.”
That was particularly the case for long-end bonds – 10-, 20- and 30-year paper.
The natural home for those longer bonds would be an insurer or an asset manager, but particularly insurance and pension funds.
That’s when the demographics come in.
“The baby boomer generation is getting older, and so their natural appetite [for bonds] is still there, but their demand to buy bonds is not increasing at the same rate as Governments’ appetite to borrow,” Logan said.
“So you’re just seeing that cost of borrowing is going up, which is a pretty difficult medium- to long-term trend to get away from.”
New Zealand government borrowing, like most countries’, exploded higher in the Covid period.
The Covid era involved quantitative easing – the issuing of vast amounts of government bonds, bought by market participants and sold to the Reserve Bank.
Now the reverse – quantitative tightening – is happening.
The Reserve Bank is selling the bonds back to Treasury, which is having to issue new bonds to fund the purchases, further adding to the supply-demand dynamic and putting upward pressure on yields.
Logan noted Fitch’s action did not mean New Zealand was out of step with the rest of the world.
“The budget has to balance sooner or later, and so we kind of … at the more fiscally responsible end of the party, but we’re all in the same party.”
The majority (60%) of NZ government bonds are owned offshore, so the local market was at the whims of global bond dynamics.
“So when the US rate goes up in the morning, it doesn’t really matter what’s happening in New Zealand, our yields are going to go up as well.”
Logan said that with the New Zealand economy being so weak, the country was stuck in “a bit of a negative feedback loop”.
Added to the interest rate outlook was the likelihood that the Reserve Bank will have to start raising its Official Cash Rate (OCR) to stave off inflation.
Economists expect the rate, currently at 2.25%, to hit 3% by the year’s end.
The Reserve Bank’s next OCR review is due on May 27 – a day before the Government’s Budget.
“I think there are … signs of stress in the market, which is healthy because that’s how financial markets should work,” Logan said.
“There should be stress on both sides, for the buyer and seller.”
But if the stress continues?
“It’s a little bit like having a bad heart. If you’re stressed one day, that’s okay. But if you’re stressed for the next 10 years, it’s not good for your heart.
“And I think that’s the concern for bond markets.”
Jamie Gray is an Auckland-based journalist, covering the financial markets, the primary sector and energy. He joined the Herald in 2011.
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