Demand dynamics and tenor

In 2020, a number of issuers from the New Zealand government sector took advantage of market conditions to test demand for extended tenor in their bond issuance – most notably Auckland Council, which printed a 30-year green bond. This part of the market is still evolving in scale and liquidity, however.

DAVISON Did Auckland Council sound the market for a 30-year green bond on its own initiative or was it investors that demanded the longer tenor?

BISHOP We knew there was some investor demand for long tenor from reverse enquiry. But we were going largely into the unknown and we were pleasantly surprised at the outcome. We initially sought NZ$300 million (US$228.1 million) and we could have printed NZ$700 million. We eventually priced NZ$500 million with strong support from domestic as well as offshore institutions.

DAVISON What is the status of liquidity in the New Zealand government-bond market when going further out along the maturity curve? What are the likely future trends?

WAIT Liquidity has fluctuated over the last 12 months. From the moment the LSAP programme was announced it improved dramatically relative to the peak of the COVID-19 crisis. Over the last six months it has begun to deteriorate.

There is a difference between liquidity for customers – which remains strong, with banks continuing to make tight bid-offer spreads – and interbank liquidity, which has begun to fall away for a number of reasons.

The first issue is that it is inherently more difficult to run risk in a trading book in a rising interest-rate environment. We can run much larger risk positions in a bull market where yields tend to grind lower. Bear markets are usually more volatile and associated with negative carry when running short positions.

Second is correlation. For larger trades we invariably have to go to the Australian, US or swap market to find a hedge, and then unwind over time. However, short-term correlations have completely broken down, causing large short-term P&L volatility that encourages a reduction in traders’ risk appetite.

We have seen a steady decline in risk appetite across the street over the last 3-4 months.This means there is little interest in providing liquidity outside of clearing customer flow.

The market has also become overly dependent on bond tenders and LSAP programme purchases to clear risk, further reducing secondary-market turnover.

If this continues, bid-offer spreads to customers will likely widen. We have just experienced a few wild days with bid-offer spreads widening out to 4-5 basis points from the usual 1-2 basis points.

This has a negative impact, particularly for offshore customers. New Zealand is a small market and international investors have other choices.

There needs to be greater communication between the market, reserve bank and New Zealand Debt Management, and more flexibility around tender issuance and LSAP composition to help the street clear risk and facilitate customer flow. All too often, trader positioning becomes one-sided and the secondary market breaks down.

BUTCHER Between pre-pandemic and now we have seen a 35 per cent increase in secondary-market turnover in our bonds across the yield curve. We recently had a record amount of Treasury stock on-lent to interbank price-making traders as they provide much needed liquidity.

We are careful to include the maturities the market has demand for in our tender composition. However, I too can see us being on the cusp of problems from greater demand from investors but an inability by dealers to continue to provide offers, in an environment in which QE has led to bonds being highly sought after.

MARTIN Investors have not been telling us liquidity is worsening. The exception is inflation-linked bonds, where feedback is that liquidity has deteriorated in recent weeks. Generally, in the last 12 months or so, we have heard investors saying New Zealand dollar turnover has been greater and liquidity better than before COVID-19.

DAVISON What other debt capital market developments, if any, might come through from the ongoing evolution of the New Zealand savings industry?

AUSTIN It is all about KiwiSaver, which has been the major growth driver in funds under management and will continue to be. The challenge will be whether the New Zealand issuance community can provide sufficient volume and diversity of product. We are already seeing local investors increasingly looking offshore for product.


I can see us being on the cusp of problems from greater demand from investors but an inability of dealers to continue to provide offers, in an environment in which QE has led to bonds being highly sought after.