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Will NZ government bonds extend their rally ?

Thursday 5th January 2012

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New Zealand government bonds may struggle to extend their rally this year after the nation’s remoteness from Europe’s debt woes helped drive yields to record lows in 2011.

The yield on 10-year government bonds was recently at 3.84 percent. It reached an all-time low of 3.76 percent last month, rounding out a year in which the benchmark bond shed about 2 percentage points.

“It’s very hard to see bonds making big gains in 2012,” said Mark Brown, director, fixed income portfolio management at Harbour Asset Management.”With yields already very low, it’s mathematically very hard to generate strong returns.”

New Zealand has no government bonds coming due this year. By contrast, the Group of Seven largest nations plus Brazil, Russia, India and China will be looking to refinance US$7.6 trillion bonds in 2012, up from $7.4 trillion a year ago, according to Bloomberg data.

Borrowing costs are likely to rise in the face of actual and threatened credit rating downgrades in the US and Europe. Still, many central banks will be keeping interest rates low for the foreseeable future.

“Global monetary policy is going to stay easy,” Brown said. Low central bank rates will have the effect of “anchoring yield curves” and reducing the scope for a large rise in long-term bond yields.

US 10-year Treasuries bottomed out at a yield of 1.67 percent in late September and were recently at about 1.9 percent, having declined almost 190 basis points in 2011.

America’s government bonds have benefitted from their ‘safe haven’ appeal, with the greenback still regarded as the world’s reserve currency. That’s trumped concerns about economic challenges within the US, including ballooning fiscal deficits, low growth, high unemployment and growing government debt, Brown says.

In 2012 “we will continue to see weak global growth, stress in Europe and the geopolitical pressures in the Middle East and Europe continuing,” he said. “That may mean that bond yields stay low in places like the US, despite the supply of bonds coming to market.”

Even in Italy, where government bonds have sold at yields around 7 percent, a level seen as unsustainable by some investors, there is scope for yields to decline, even in the face of more supply, if Europe makes progress containing its debt crisis, he said.

In New Zealand, the overnight index swap curve, which shows bets traders are making on central bank interest rate moves over the coming 12 months, is sitting near zero. Some investors say there’s potential for the Reserve Bank to start hiking the official cash rate from a record low 2.5 percent in the second half.

New Zealand 10-year bonds are yielding about 190 basis points more than comparable US Treasuries, helped by demand for higher yields, especially from sovereign investors in Asia.

“The balance of risks lies with New Zealand government bonds underperforming the US,” Brown said.

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