Capacity and cuts top the talking points in New Zealand

SPEIZER One of the major explanations for New Zealand’s sticky inflation is the magnitude of fiscal and monetary stimulus used in response to the pandemic, relative to other countries. One measure of the fiscal response is government spending as a percentage of GDP, and IMF [International Monetary Fund] estimates have New Zealand’s figure at around 15 per cent – second-highest among the world’s advanced economies, after the US.

Monetary policy was another contributor. According to estimates from the Bank for International Settlements [BIS], our change in central bank assets as a percentage of GDP was the fifth-largest among advanced economies. Large structural fiscal imbalances cause higher core inflation, relative to average, while large shifts in fiscal and monetary policy combined give a much stickier inflation profile.

CRAIGIE I still believe the big-picture story of inflation in advanced economies over the pandemic period has been more similar than it has been different. Demand drivers through monetary and fiscal stimulus have played a role, and there have been various supply shocks – goods inflation followed by services inflation. The latter has been the more sticky.

In jurisdictions where policy easing has begun or may soon begin, central banks are still expressing caution about the stickiness of core inflation measures. The Reserve Bank of Australia (RBA) is not ruling out anything and the US Federal Reserve has said it needs to see more evidence that inflation is returning to target before it starts to ease.

RBNZ research discussed by our chief economist in a recent speech shows tightness in the labour market, brought about by border closure and strong domestic demand, has had a big impact on inflation in New Zealand. Food prices have been a more persistent contributor to inflation over the past year, which partly reflects domestic weather events. On the other side, energy prices have been less affected than in other regions – including Europe.

The RBNZ has been saying for some time that aggregate demand needs to fall to be more in line with the capacity to supply goods and services. We are seeing this happening; monetary policy is working. Headline inflation has fallen but it still has a little way to go. It’s important we continue to see a reduction in core measures of inflation.

MARTIN Investors were aware the economy is facing a softer growth outlook and that inflation remains sticky. They generally appeared very engaged in the New Zealand story and seemed to be looking for opportunities to add to positions in fixed income. They feel we are at the top of the cycle and, while the RBNZ is perceived as being patient, the expectation seems to be that when the reserve bank cuts it might do so quite sharply.

Also, although in New Zealand we have good reason to focus on our debt levels, foreign investors view them as quite positive compared with many other countries. For NZDM [New Zealand Debt Management], having a bigger issuance programme has actually had some benefits – we receive feedback that it has improved liquidity and global participation in our market.

RADICH Investors are seeking opportunities to allocate to fixed income in New Zealand, but some have been burned quite a few times by the RBNZ. As much as the market tries to pre-empt central bank moves, the RBNZ – particularly with its focus on the nontradable side of inflation – continues to frustrate offshore investors.

Investors are anticipating rate cuts but continue to get stopped out when the RBNZ refreshes market expectations. They then get enticed in again, particularly as the US talks about cutting. As a result, investors are probably a little frustrated with the price action. Consequently, they have pulled back and are now content to wait until we get the first cut. We can already see this in some parts of the bond curve.

While the RBNZ continues to sound hawkish, we need the Fed to start talking about cutting rates. As soon as it does, we will start seeing downward pressure on the US dollar and potential for the New Zealand dollar to appreciate. This should mean offshore accounts starting to invest – if they do, it will likely be on a soft US dollar story.

MARTIN There was some sense that investors were in position for an RBNZ cut and may have been burned a couple of times. But they seem willing to play the long game based on the risk-reward equation. It is unlikely that there will be another hike whereas rates will be cut at some point and, based on past experience, cutting might be quite sharp when it happens.

BUTCHER The RBNZ got accolades back in 2021 for being the first central bank to raise rates, and it went hard and fast. But sentiment may now be that the bank is too patient and is prolonging the transition to easing. Market participants are impatiently waiting for the RBNZ to come through. It means we are going to remain on investors’ radars for the next year or two, but maybe for the wrong reasons.

On the other hand, New Zealand having higher interest rates has led to a very strong retail bid into our bonds. There is also an extra pick-up in yield for patient investors that can hang on to easing positions for longer.

FUJIMOTO Central banks are all fundamentally going in a similar direction – except for the BOJ [Bank of Japan]. The ECB [European Central Bank] has already started cutting rates and the Fed is also on track to cut. Considering this, we don’t foresee global investors changing their appetite toward New Zealand dollar products. Rather, there is a continuation of demand from global investors.

One key reason for this ongoing interest is the need for investment diversification. Despite global geopolitical tensions, we have not heard that investment will be moving away from diversified investment strategies. On the contrary, New Zealand’s geopolitical stability presents an attractive future and supports investment in the jurisdiction. In short, New Zealand remains a key diversification market for some investors and provides a stable and reliable option for those looking to mitigate risk.

As has been mentioned, the New Zealand economy remains robust. While other countries all over the world are preparing for slower growth, the New Zealand economy and labour market is still growing. New Zealand also has a strong agricultural sector, which supports its economy in the long run. We expect New Zealand dollar products will continue to have interest from global investors and don’t expect this to change anytime soon.

HELLERUP Our orderbooks over the last two years have largely been driven by the domestic investor base, in particular bank treasuries. Regardless of where rates are, these investors need to buy for their liquidity portfolios so I expect there will continue to be demand domestically.

By contrast, there has been very little international demand. But it has not been the main driver of our deal flow for the last couple of years anyway. In global markets, central banks and official institutions are the main buyers of supranational issuers – and they need to buy, wherever rates are. I’m not sure how dependent demand is on where rates are; I think it is much more of a relative value play.

BILL I am probably somewhere in between the views of Jens and Chihiro. From our conversations with offshore investors, some are staying on the sidelines because of the hawkish tilt of the RBNZ.

But, at the same time, the hawkishness of the bank, the fact that it was quite proactive and that the transmission mechanisms in New Zealand are arguably faster than in many other economies would suggest that, at some point, its forward-looking reaction to fight off inflation succeeds.

This would clearly be a very conducive backdrop for fixed-income investors. It feels like we’re waiting for this tilt to take place. Absent other idiosyncratic trends such as issuers being crowded out and an adverse cross-currency basis swap spread, this should be quite supportive of the Kauri market.

BILL Yes, this is one way to look at it. Several things have been at play, like the higher inflation rates lately in Australia and Canada – these have been somewhat of a surprise to markets.

Commodities-reliant economies are more dependent on what is happening in global markets. And with New Zealand being relatively smaller than Australia, its economy’s ability to make up offshore commodities demand with internal demand is more limited. It is arguably much more difficult to manage monetary policy in New Zealand because of this. The RBNZ has indeed been very proactive.

When it comes to the SSA Kauri capital market, we have historically witnessed high volatility of domestic versus offshore demand, including periods of time in which offshore capital came in at scale.

The fact that incremental Asian demand has developed and is looking for a home in an Asian time zone can be beneficial for New Zealand. There aren’t many alternatives to Australia for offshore investors at present and I am quite confident the New Zealand capital market could play a complementary role to a well-developing Australian capital market.

MARTIN At budget, Treasury’s economic and fiscal forecasts were based on at least 100 basis points of rate cuts by around this time next year, while the RBNZ’s own trajectory is a bit more patient. If the rates profile plays out as you say, it could mean slightly higher interest costs than we are expecting, at least in the near term.

If there were to be any impact on the bond programme it would be highly dependent on how the government chooses to respond. It has choices and can change expenditure plans to accommodate conditions. Meanwhile, we are comfortable that we have the flexibility and the tools to be able to deal with an increase or decrease in our programme from where it currently is.

RADICH There might be a question mark about what term premium investors need to buy bonds, given the backdrop. For example, if we get a change in how fiscal policy, the tax environment and a growing budget deficit are evolving, investors will potentially be on the sidelines while it plays out.

MARTIN It is interesting in the context of what is going on in the global scene that investors have not seemed very curious about the details of our recent government change. They view our political spectrum as having a small range compared with many other jurisdictions and are not expecting significant changes for the borrowing programme.

FUJIMOTO Luckily, we haven’t seen much change in demand for our bonds during recent instances of market stress. Our demand comes from official institutions and bank balance sheets, which makes it stable, and our needs are also stable. Overall, we are a safe-haven asset.

Of course, we must align where demand is with currency and duration. But we have the luxury of being able to print even in this landscape of event risk. This said, the available windows can be a bit limited and we are monitoring them closely – far more than we used to.

MARTIN About five years ago, annual programmes were about NZ$6-8 billion (US$3.7-4.9 billion). If you told me then that NZ$38 billion was going to be business as usual I would have been sceptical – but this is what we delivered last year and are intending for this year.

We can expect a similar issuance run rate, with tenders of around NZ$500 million per week. We have announced we will do three syndications this fiscal year – once again, identical to what we completed last year. Syndications in recent times have been NZ$2.5-5 billion.

MARTIN Domestic capacity is finite: all the bank balance sheets need to buy our bonds to a certain level. There is also the regular inflow into KiwiSaver – some of which makes its way to NZGBs [New Zealand government bonds] – and there are fund managers making choices every day. But our growth really is offshore.

We are pretty comfortable with demand: our proportion of offshore ownership is more than 60 per cent and we see some new names every time we run a syndication. The bigger programme has made NZGBs more attractive to global investors that previously thought the credit story was fantastic but the market was just too small to invest time into looking at NZDM as an issuer.

RADICH There is finite appetite from local banks. Tender bid coverage ratios are decreasing and it’s clear that natural demand from bank balance sheets is starting to reduce. Without the offshore component I suspect there will be further underperformance in NZGBs, versus swap and versus Australia.

There has been some impact on secondary-market liquidity. Two-way flow has lessened in the last six months as most domestic banks continue to fill up on government bond holdings and offshore continues to stay away. However, the local market is remaining supportive as it continues to find a way to recycle flow without moving the market to a disadvantageous extent.

In my mind, offshore will stay away until the US election is out of the way or until it becomes more likely that the Fed will cut. We will need to carry the load in absorbing government tenders – which, in the short term, will mean underperformance.

AUSTIN To take a longer-term perspective, tender statistics have generally been consistently strong for NZGBs. The moving average of where they clear is about 1.5-2 basis points through mid. Overall coverage ratios have dropped off in recent months, but only to 2-3 times covered – which objectively is a good result.

The concern is the occasional tender that struggles during periods of supply overhang. This has happened in recent times in the ultra-long end, where it has proved difficult to consistently issue volume.
Broadly, the market is absorbing issuance – but supply is not going away. This is a global issue, though, with debt programmes seeming to be constantly revised upward.

MARTIN It is important to note the changes in our tender approach. It is more flexible now. We used to announce what we planned to do a quarter in advance. Now, because we have a bigger programme, we are more sensitive to market and demand dynamics. We survey our primary dealers for market feedback just a few days out from each tender, and we may tweak our bond offering accordingly.

RADICH I can remember the bad old days – equally, it could be that certain bonds were massively in demand but they weren’t on the schedule so couldn’t be issued. It is much better to have the ability to cater to market demand.

BISHOP If you had asked me this question a month or two ago, I might have given a different answer. However, we have recently printed a moderately sized, long-dated wholesale deal via reverse enquiry and this showed us there is certainly demand out there.

I think it’s fair to say that it fluctuates. Sometimes, trying to issue larger deals can be problematic – it depends on having the support of our key wholesale investors, while shorter dates depend on the retail bid. It is a consistent market for us as long as our so annual requirements aren’t too large.

BISHOP There are two reasons we went to the Australian dollar market. One was attractive pricing when swapped back to New Zealand dollars. The other was that the LGFA [New Zealand Local Government Funding Agency] has cleared a path. In the past, it has been very hard to place Auckland Council in the minds of Australian investors because we are not a state government but we are a lot larger than Australian councils. LGFA’s efforts to establish its credit profile has helped us to be pitched at the right level. Australia’s A$500 million (US$336.4 million) benchmark size also suits us.

It is likely that our issuance task will fall in the coming years but we don’t want to be a one-time issuer in the Australian dollar market and we would also like to keep a presence in the euro market as we do a lot of investor work over there. We will need to be careful about how we balance these requirements with our domestic market and the fact that we can access funding through the LGFA.

BUTCHER The answer is simple: in the past year we achieved a NZ$6.5 billion funding task versus NZ$3.5 billion in the previous three years. We had got to a point where we had to diversify; we couldn’t continue to pump out bonds into the domestic market. The Australian market was the one for us – pricing was attractive and we were able to build a curve. Going forward, we have about NZ$5.5 billion to do for each of the next three years. Taking the view that we have about NZ$2.8 billion of maturities each year domestically, we think we can do NZ$3-4 billion a year in the domestic market – which means the extra NZ$1.5-2 billion will come from offshore.

We have established an ECP programme that is going really well for us – we have built outstandings to US$600 million of ECP. We will consider establishing an EMTN programme to provide additional flexibility if needed.

DODDRELL The Australian dollar transactions executed by LGFA were positively received. The participation of institutions such as LGFA in the Australian market not only enhances their own presence but also paves the way for other New Zealand issuers. In particular, LGFA’s strong investor engagement facilitates smoother entry for corporate entities from New Zealand into the Australian market.

BILL There certainly has been crowding out, which is evident in the spreads of SSA [supranational, sovereign and agency] issuers versus NZGBs. We used to oscillate in the 50s basis points over NZGB while we currently are in the 20s.

On the other hand, more prominent NZGB supply should improve the accessibility and overall weight of the market. Also, the fact that NZDM is pursuing ESG [environmental, social and governance] goals and targets with its green framework increases visibility and provides the needed demonstrative leadership.

Absolute debt levels in New Zealand are very low so outstanding debt isn’t an issue. In fact, increased supply improves overall market liquidity. However, it feels like there was just too drastic of a pick-up in supply from the NZDM. Combined with liquidity policy review considerations – which put a lot of offshore issuers on hold in the interim as investor uncertainty grew – this created a bit of a void with only a couple of SSA issuers coming through within the last 10 months.

BISHOP It is probably a matter of taking it as we find it since we are not a direct competitor. We haven’t experienced any crowding out and while our investors are probably not different, it is a different portfolio to them. We have not been concerned at all about the changing scale of government issuance.

CARTER I would suggest it is probably a net benefit because we may unearth more buy-side accounts for ‘NZ inc’. But, to John’s point, while the breadth of offshore accounts participating in NZGBs continues to grow, we don’t necessarily witness these investors immediately turning around to chase LGFA and Auckland Council domestic issuance. This is because the deal sizes and the portfolio sets these issuers attract are quite different.

The biggest challenge is probably the impact on swap spreads. LGFA bore the brunt of some of this over the last few months whereas the rest of the credit spectrum, including Auckland Council, was less affected.

AUSTIN There has been a lot of recent consolidation in the New Zealand fund management industry. There has also been some movement of domestic funds to offshore managers, as well as a drift toward passive funds management.

As overall funds under management increase, investors are looking further afield to access product. This likely means Australian fixed income, including high-grade, comes more into play for domestic funds.

CARTER In the year to date, we’ve had reasonably robust supply from high-grade issuers excluding the SSA sector. But in the here and now there is absolutely an imbalance. Asset managers are screaming out for supply.

There are notable reasons why supply is not coming. The strength of offshore markets this year has been unprecedented – as reflected by the strong execution outcomes for LGFA and Auckland Council in the Australian dollar and euro markets this year. Likewise, the Kauri market has not been attractive for SSAs this year compared with other issuance options available to them.

For bank balance sheets, there has been a focus on the higher capital requirements coming in 2028. They are concerned about whether issuance in senior format could cannibalise their future capital programmes, including the continued refinancing of these programmes.

There has only been a small number of senior New Zealand bank deals this year and they have been in the US dollar and euro markets. But it is the prudent approach to take. It has been so strong offshore. It is therefore not surprising that issuers have taken the money off the table while it’s there and kept the home market free.

Lack of supply in the Kiwi market is leading investors to look at Australian dollars, outright and on a swapped basis. Five years ago, New Zealanders’ thoughts on the Australian market would likely have been that it was fickle. But more recently it has proved to be very robust, and this is giving a lot of confidence to New Zealand’s issuers and investors – which has an impact on supply here.

SILVER Regulatory developments and sustainable finance taxonomies are evolving – including in Australia but also in New Zealand, where we are a couple months behind but very much in tandem. At the same time, strong issuance volumes have continued in sustainable bonds globally. The first quarter of 2024 was the most prolific on record. There is a lot of confidence – which is important.

There has also been more sovereign participation. The Australian Office of Financial Management’s debut green bond was A$7 billion and three times covered by investor demand. Meanwhile, France issued a €8 billion (US$8.9 billion) green bond off a massive €98 billion of investor orders. Demand is strong for sustainable debt opportunities globally.

In New Zealand, one aspect of regulation slowing issuance continues to be a challenge for issuers and investors alike.

But the Financial Markets Authority (FMA) recently closed a consultation on how to make it more efficient to issue in sustainable format, which is very positive. We have several customers waiting for the outcome of this consultation to guide their sustainable finance strategy, and our expectation is that we will see more sustainability-linked bonds (SLBs) in New Zealand in the next 12 months.

New Zealand has a very different transition from many jurisdictions because such a large proportion of our emissions come from the agriculture sector. We also need to scale up massively in renewable energy.

It has been good to see the continued evolution of standards. For instance, the International Capital Market Association released new guidance in June that included material relating to “green enabling technology”. This guidance recognises that every green project has an upstream value chain that helps get it into existence, without which there would be no transition. This includes steel for turbines or chemicals for solar and batteries. We now have guidance for this part of the value chain, and we are committed to supporting our customers with these new green funding areas.

A theme that is growing globally and is very relevant locally, too, is the increasing focus on natural capital. In New Zealand, 70 per cent of our exports rely on natural capital and many of our customers are starting to realise they need to understand their business’ dependencies on nature – for example, clean and freely available water, soil stability and productivity, and wetlands to play a role in flood abatement, water quality improvement and climate regulation.

With the leadership of the Aotearoa Circle, many companies are upskilling on nature risks. We are confident there will be an increased focus on nature and sustainable financing. We have one customer that has set a target that aligns with the Kunming-Montreal Global Biodiversity Framework, for example. Likewise, Westpac itself includes a raft of biodiversity funding options in its sustainable lending programme, which underpins all of our sustainable loans.

Staying with the risk lens, greenwashing continues to be a theme for investors and issuers. Globally, greenwashing regulation and litigation continues to focus on the use of labels.

The Australian Securities and Investments Commission has said it has greenwashing “firmly in its sights”– and local investors and issuers will be focused on minimising risk. However, we are confident issuers and investors alike can maintain their ambition while also managing greenwashing risks. Focusing on accuracy and transparency is the key here.

Another consideration for New Zealand is that, while we are on the leading edge of the climate disclosure trend, other jurisdictions are fast catching up. For instance, a report by Chapman Tripp for the Aotearoa Circle showed that the majority of global GDP – which represents destination markets for more than 80 per cent of New Zealand’s exports – is now covered by mandatory climate disclosure regimes.

What we are also seeing is that climate and sustainability is increasingly the subject of border levies and international trade negotiations. This makes local politics much less relevant and means we need to keep focused on global market drivers, doing everything we can at home to support New Zealand businesses to meet global requirements.

Access to global markets for capital, talent and exports is key for our economy and prioritising sustainability is an important prerequisite.

SILVER It is important to keep in mind that climate-related disclosures are not like financial statements – they are nuanced and include governance, risk, and strategic response. There are not going to be apple-for-apple data points any time soon. At best, over the next couple of years we should start to see trends at a sector level. Our continued focus is accuracy, verification and transparency. We are telling clients: tell the whole story, nothing but the whole story, and make sure it’s true.

We are a little way away from ‘let’s not worry about greenhushing’ but my sense is that the developing taxonomy will definitely help. I also believe banks and advisers are playing a key role in helping businesses know what to do, how to do it and how to communicate it.

SILVER I believe it will, because many of the challenges with SLBs are regional. When we speak to European investors, we are hearing that classifying funds with SLBs in them is difficult. The regulatory framework does not lend itself to this. Additionally, as with any new market we know there is a ‘storming’ stage before we get to ‘norming’ and ultimately ‘performing’.

There has been continuous innovation but also flexibility in how structures are designed, and a few issuers in the early stages chose targets that were not as ambitious as they needed to be. The continued achievement of these targets has led some to question the integrity of the structure in the past.

The third consideration is reputational risk. A high proportion of SLBs have an early call component, which implies that if the issuer doesn’t think it will meet the target it can just call the bond early. None of this helps market confidence, participation or trust.

New Zealand has not had these challenges but we have had regulatory hurdles that have made SLB issuance difficult. We anticipate these will be removed with the FMA’s consultation.

There are a lot of sustainability-linked loan (SLL) structures in New Zealand and there is strong uptake of the Science Based Targets Initiative validated targets. Companies here have been well advised and understand their sustainability risks. We have front-footed climate legislation and climate disclosure regimes.

New Zealand companies are well placed and are already maximising the opportunities of sustainability-linked structures.

CRAIGIE Earlier this year, we published a report on the use of credit risk weights for climate-related purposes. The most important thing to keep in mind is why prudential capital policy exists – which is to ensure banks are accurately measuring and managing risks so we can have resilient financial system with a low instance of failure. It is not intended to drive investment into particular segments of the market.

This is not to say that climate is not relevant to prudential policy and that it can’t play a role in the space, but it has to be based on data. This is an emerging area.

I think there is more scope in haircuts and the central bank’s collateral framework. I do not have anything to announce today, but it is an area we are interested in investigating because it is talking about what risk we are willing to take onto our own balance sheet via the collateral we take. There are some instances internationally of central banks that have looked at this, and it is something we are open to.

Meanwhile, the RBNZ is building up its foreign reserves after having remained static for a long time. As part of this, we will be exploring how we increase our exposure to labelled products. We already have some small investments in this space, which have been done via the BIS investment pools and one of its other instruments.

The BIS can package up funds of funds for central banks to invest in. This has been an interesting innovation because it takes away some of the liquidity risk central banks worry about in foreign reserves portfolios.

It is possible that, in future, we will seek to make more direct investment in green and other labelled assets. Greater supply of sovereign green bonds is helpful for us, and for other central banks and reserve managers, because this is the level of credit quality we are most focused on.

MARTIN We went to the US in February and Europe more recently. There was a clear contrast between the two regions. In the US, institutions that were very interested in the sustainable finance area told us they were surprised by the lack of momentum in the US and lack of underlying demand from their investor set. Whereas the topic came up in most meetings in Europe.

Investors were sometimes interested in green bonds, but often they had their own internal or third-party models to assess ESG credentials on a whole-of-issuer basis.

The green-bond eligible expenditure pool has grown since we initiated the framework. As of 1 July 2024, the pool sits at NZ$11.8 billion and we expect it will continue to grow with each budget cycle. We have about NZ$6 billion of green bonds on issue, so there is headroom for further issuance.

The market can expect us to use it in the next 12 months while our green bond is the generic 10-year point on the curve. Our sense is that the bond is largely owned by investors that buy it as a point on the curve while only a small minority have it tucked away in green-specific mandates.

Regarding social assets, at present we have no intention to go any further than our green-bond framework. The framework allows us to comment on social co-benefits.