Less-attractive Australian interest rates and competition from issuance of asset-backed securities have brought the Kangaroo market to a halt, in contrast to a still-thriving Kauri market supported by New Zealand’s strong fundamentals.
The Kangaroo market’s fast start to the year has petered out, due in part to the volatile global backdrop and to the fact that overseas investors are choosing to park the money in alternative areas, including Kauri offerings across the Tasman Sea.
The two Antipodean markets have diverged in recent months with Kauris holding up better, despite the Kiwi dollar’s 12% decline in the first half of 2015, double this year’s Australian currency slippage.
Offshore issuers in the Australian dollar market, where sovereigns, supranationals and agencies are dominant, sold A$8.6bn (US$6.6bn) in January and February alone, up substantially from A$5.5bn in the first two months of 2014.
“We have seen elevated offshore demand for Kauri paper with foreign investors attracted by the strong New Zealand economy and the fact that, until recently, it was the only developed country to be hiking interest rates.”
Kangaroo supply was on course to hit the highest annual level since 2011, the year when the Australian Prudential Regulation Authority left Kangaroos off its list of liquid assets for Basel III purposes, thereby reducing bank-balance-sheet demand for such bonds.
Since February, however, Kangaroo issuance has declined steadily with a lower amount raised in the ensuing four months. Indeed, the A$15.3bn of Kangaroos sold in the first half of 2015 is below 2014’s A$16.7bn-equivalent total.
This slowdown has been greater than in other Australian bond markets with Kangaroos’ share of total Aussie dollar supply declining to 20.6% this year from 23.1% in 2014.
To help explain the decline, Tom Irving, syndication manager at TD Securities, the leading bookrunner in the Kangaroo market in 2015, cites the prospect of more attractive relative yields for US dollar securities as the Federal Reserve prepares to hike rates for the first time since 2006.
“Australian yields are likely to increase to reflect the global move higher, but, with the RBA (Reserve Bank of Australia) still in easing mode, Australia’s pick-up over the US dollar and other currencies is expected to narrow,” Irving said.
Another factor weighing on Kangaroo supply has been the upturn in alternative, higher-yielding Australian dollar issuance, particularly corporate and residential mortgage-backed securities, which were few and far between at the start of the year.
“We are seeing more RMBS and corporates coming to the market now and this has crowded out some demand for SSA Kangaroos,” Irving said.
Australian Triple A rated RMBS offer 80bp–90bp over bank bills, which is much juicier than Kangaroo bond market leader KfW, the 2018s of which were trading around 10bp–15bp over swaps in June.
Lack of alternatives boost Kauris
In New Zealand, where there has been no competing ABS supply this year, the much smaller, but broadening, Kauri market has held up better.
Foreign issuance in the local Kiwi dollar market reached NZ$5.1bn (US$3.5bn) in January–June, on course to break 2014’s annual record of NZ$6.3bn comfortably, having almost reached the previous high of NZ$5.5bn in 2007.
The most notable Kauri trade was KfW’s debut on May 20, when Germany’s Triple A rated government-guaranteed agency priced a NZ$650m five-year bond just five days after an inaugural NZ$350m four-year sale from regional German agency L-Bank.
KfW is the biggest foreign issuer in the Australian dollar market, with over A$30bn of Kangaroo bonds outstanding, but it has never ventured over “The Ditch”.
“We have seen elevated offshore demand for Kauri paper with foreign investors attracted by the strong New Zealand economy and the fact that, until recently, it was the only developed country to be hiking interest rates,” said TD Securities’ Irving, who has been sole or joint lead manager on three of this year’s 15 Kauri trades.
“It remains to be seen if this demand can be maintained given the Reserve Bank of New Zealand’s recent change of course, which led to June 11’s 25bp rate cut to 3.25% with the prospect of more easing to come,” he said.
The KfW and L-Bank debuts provided a welcome diversification of the Kauri market, which had been relying on larger deals from a small pool of existing issuers for its earlier growth.
Not only does the Aaa/AA/AA rated country benefit from a strong economy, as well as a stable political and regulatory environment, New Zealand Government bond yields are also the highest in the developed world.
The yield on 10-year NZGBs was 3.64% on June 30, 66bp more than Australia’s 2.98% return, while US, UK and Canadian 10-year sovereigns were paying 2.31%, 2.05% and 1.75%, respectively. Even after their recent reversal, 10-year Bunds yielded 0.78%, while 10-year Japanese Government bonds yielded just 0.45%.
Non-residents hold 69% of outstanding New Zealand sovereign bonds (as of May 2015) and, as the central government’s borrowing needs decline, the Kauri market has helped pick up the slack.
In addition to the absence of local securitisations, Kauris benefited from negative net government supply of NZ$700m in fiscal year 2014–15 (July 1 to June 30). In contrast, net Treasury bond issuance in Australia in 2014–15 rose to around A$45bn, which would have crowded out some Kangaroo demand.
However, sovereign-supply dynamics are set to shift in Australia’s favour in the new fiscal year. Net Treasury bond issuance is expected to slow to A$38.2bn in 2015–2016, whereas net government issuance in New Zealand is predicted to turn positive to the tune of NZ$6.8bn.
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