By Peter V O'Brien
Friday 31st October 2003
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Bank bill yields last Friday were 70 basis points lower than the December 31 figure.
Short-dated securities such as bank bills are subject to different influences from those affecting bonds, although both react to changes in the Reserve Bank's official cash rate (OCR).
The OCR was cut from 5.75% to 5.5% in April and reduced in later Reserve Bank reviews to 5%, a figure maintained in the bank's October 23 review.
Inflationary pressures from a hot housing sector and general economic growth, offset by imported delation arising from the effects of the dollar's strength on import and export prices, will be key factors affecting future OCR policy.
A rise in the OCR next year could increase fixed-interest yields and house mortgage rates, the last possibly catching out some people who enthusiastically joined the property investment boom.
The decline in bond yields in the first half of the year was generally foreseen, given the trend overseas. Investors who bought bonds in, say, December and liquidated in June/July made solid capital gains.
Conversely, those who were sufficiently out of touch to sell in December, buy in June/July and still hold the latter paper would be showing solid.
Some discussions of movements in the New Zealand bond market take a lofty global stance, relating our yields and consequent capital gains or losses to an interlocking world market comprised of individual countries' bonds.
That approach is usually based on the state of US 10-year bonds.
It has some validity but can downgrade peculiar local matters and changes to the New Zealand dollar's value.
The last is important in relation to overseas investors who trade New Zealand bonds.
Assume a US investor bought New Zealand 2013 government stock in December at a 6.07% yield, used US dollars to buy New Zealand currency for the transaction and was unhedged.
The New Zealand dollar was worth 52.55USc on December 31, which meant $US1000 would buy $NZ1902.94, say $NZ1903.
Government stock worth $NZ1903 at 6.07% in December was $NZ2155 on June 30 at 5.36%, a gain of 13.24% in six months.
The US investor, wishing to repatriate the sale proceeds in US dollars, would have sold New Zealand dollars at 58.25USc, producing $US1255, a 25.5% gain on the original $US1000, of which 12.26% related to the currency.
The example was a happy combination of capital appreciation of the bond and benefits from currency movements.
There could be unhappy combinations, including a situation where the bond's capital value fell and the New Zealand dollar depreciated against the US.
The rise in bond yields since June/July, representing a decline in capital value, coincided with a rise in share prices, in major markets and in New Zealand.
Investors were apparently selling bonds and buying shares, a standard situation according to market theory, apart from the fact that there was a buyer for every bond sold and a seller for every share bought.
A brief consideration of price changes to short and long-dated fixed-interest securities shows there can be several interacting reasons for movements, some apparently offsetting others.
It leads to the reasonable conclusion that attributing interest rate ups and downs to one or two specific forces is simplistic.
Bond holders who missed the sell signals a few months ago could see yields go higher in 2004 if the OCR rises and the long bond market stays bearish.
Investors seem to agree. The range of yields on successful bids in government bond tenders since May has risen steadily for February 2006 and April 2015 maturities.
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