The missing linker?
With inflation expectations back on the minds of market participants, a boost in demand for inflation-linked product might be expected to follow. So far, this has not come to pass in New Zealand.
MARTIN When we reinstated our inflation-indexed bond offering back in 2013, buyers were largely investors with long-dated liabilities. Over the last eight years, the market has matured to the extent that most domestic fund managers now participate, at times, as well as global institutional investors and hedge funds.
The demand base is definitely becoming more diverse. However, we are still in the early stages of inflation being on the radar of underlying investors. Due to where we have come from in the inflation cycle, the fear factor that drives demand for inflation product doesn’t yet seem very present.
At the moment, we are balancing what we consider to be the minimum volume of issuance to balance market presence with not wanting to oversupply the market with issuance.
We have indicated that, of our NZ$30 billion (US$22.8 billion) programme for 2021/22, there will be around NZ$1 billion of tendered linker issuance or NZ$50 million a fortnight. We have been advised that this is close to the minimum we can tender to provide a regular price point.
SPEIZER The US is the market leader in traded inflation. Its 10-year bonds are priced at 2.4 per cent breakeven, which seems fair. The biggest debate is whether inflation sticks in the years ahead. New Zealand inflation is not yet fully priced but it is getting there.
In the last six months, we have seen the most positive outlook for inflation for some time. The world grew complacent about structurally low inflation. But now we are in a new era with unprecedented fiscal and QE stimulus working together. How this pans out in the long run is subject to much debate among economists.
WAIT As yields have rallied, then bottomed and are now selling off, offshore investors with long-term real-yield positions have been trying to take profit on these trades. Over the last six months there has been a 10-to-one ratio of inflation-linked sellers to buyers.
This continues to have an impact on the market as there are still long-term real-yield investors looking to get out and a very small universe of domestic investors looking at breakeven opportunities.
Turnover in linkers has plummeted in the last three months and there is no secondary market. It has been challenging and will become even more so since linkers are no longer included in the LSAP [large-scale asset purchase] programme. Just NZ$10-20 million per week would be enough to help get the secondary market functioning.
Inflation is front and centre for markets at present, so the linker market should be thriving. But in reality one tender per month is all that’s possible at the moment. The three tenders in April, on top of steady investor selling, killed the market. We have to calibrate issuance with demand – if investor demand picks up it would be easy to ramp up issuance again.
LE QUESNE It is not the purpose of the LSAP programme to respond to illiquidity in individual markets. We talk about responding to widespread market dysfunction that is impeding monetary-policy transmission and causing lack of confidence that ultimately would lead to higher borrowing costs in New Zealand debt capital markets.
However, since we removed IIBs [inflation indexed bonds] from our auction schedule we haven’t seen conditions or bid-offer spreads move far from historic average levels. Turnover stats do not appear to have changed substantially over this period.
AUSTIN The investor community, locally and offshore, would likely have appetite for other inflation-linked product. The current dysfunction in the New Zealand government linker market doesn’t rule out other linker issuance coming to market.Thinking about KiwiSaver and its projected growth, we are already at NZ$60 billion and are predicted to exceed NZ$200 billion in the next decade. Roughly one in 10 current KiwiSavers is over 55. As more KiwiSavers near or reach retirement it is likely that we will see an increase in savings product offerings for this cohort.
Inflation-linked securities should be a natural fit for these portfolios, which in turn will improve market liquidity. The inclusion of inflation product in fixed-income benchmarks would also be a helpful development.
CARTER Notwithstanding current market dynamics, inflation will remain an important product for the New Zealand debt capital markets. Investors want diversity and a wide range of tools and products to manage their portfolios.
BUTCHER Most councils don’t have inflation-linked revenue and in fact their cost base is highly correlated to inflation. Linkers are expensive to issue relative to conventional bonds so we won’t issue them unless they cheapen from an issuer point of view.
BISHOP We have considered inflation-linked bonds, because there is a link between our revenue streams and inflation. We haven’t issued so far because of uncertain demand and complexity – but I never say never.
BLIGH The inflation-linked bond is one of the financing tools we consider and we are fielding questions around issuing more linkers. Equally, we still need to build a nominal programme to support our monthly bond tenders and we have been clear and open that this is our objective.
My view on demand for inflation is based on whether current inflation is going to transition to the forward view of inflation through breakeven rates. There is much discussion about whether inflation is transitory and whether it is going to contract or become more systemic and self-contained.
This is the question for which no-one has the answer until it happens. It is probably why different asset classes are being supported as opposed to there being defined inflation-linked bond demand.