Downgrade Doubles Bond Risk Gap as New Zealand Loses AAA: Australia Credit
Credit-default swaps insuring Australian bonds for five years traded at 100.5 basis points on Oct. 5, 23 basis points less than the price to guard against a default by New Zealand, according to CMA. The gap was the widest since July 2009 and compares with an average of 11 basis points over the past year.
S&P and Fitch Ratings cut New Zealand’s top credit rating on local currency debt for the first time last week because government and household debt is expanding. Australia, which pledged to return to a budget surplus by 2013, still holds the highest bond rankings. That’s reflected in the debt market, where New Zealand 10-year bond yields have risen 13 basis points to 4.44 percent since Sept. 29, when Fitch announced the cuts, while rates on similar-maturity Australian notes gained 1 basis point to 4.27 percent.
“The sovereign fundamentals of New Zealand are marginally worse than Australia,” said Susan Buckley, head of global fixed-interest at Brisbane-based QIC, which manages about A$25 billion ($24 billion) in bonds and cash. “You’ll demand a bit more risk premium attached to New Zealand bonds versus Australian yields. Australia has a lower budget deficit and will return to surplus sooner.”
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S&P reduced New Zealand’s long-term local currency rating one level to AA+ with a stable outlook on Sept. 30 while the foreign-currency debt was cut to AA from AA+. Moody’s Investors Service reaffirmed New Zealand at Aaa for local and foreign- currency debt in May.
Australia’s AAA long-term sovereign ratings were affirmed with a stable outlook by S&P on Sept. 23, making it one of three Asia-Pacific nations with Hong Kong and Singapore to hold the company’s top credit grade, Bloomberg data show. Its local currency bonds have AAA grades from S&P, Fitch and Moody’s. Fitch rates the nation’s foreign currency debt at AA+, while Moody’s ranks it the highest grade.
S&P cited concern New Zealand’s “external position will deteriorate further at a time when the country’s fiscal settings have been weakened by earthquake-related spending pressures and fiscal stimulus to support growth,” according to a statement.
A magnitude-7 earthquake in Christchurch and surrounding districts in September last year wrecked homes and roads, before a temblor measuring 6.3 struck close to the city on Feb. 22, killing 181 people, slowing spending and setting back business investment.
New Zealand’s economy almost stalled in the second quarter with gross domestic product rising 0.1 percent from the previous three months. Australia’s economy grew 1.2 percent in the three months to June 30, the fastest pace in four years.
Traders have pared bets on an increase in New Zealand’s benchmark rate, which is at a record low 2.5 percent, to 19 basis points over 12 months from 51 on Sept. 1, according to a Credit Suisse Group AG index based on swaps. Australia’s 4.75 percent key rate is the highest in the developed world, with investors wagering that a global slowdown may force the central bank to reduce that by 1.44 percentage points over a year, a separate gauge shows.
Quake costs are a challenge to the New Zealand government’s target of returning to a budget surplus by 2014 to 2015, Finance Minister Bill English said in September. The deficit was about NZ$18 billion ($14.2 billion) in the year ended June 30, the government said Aug. 30. It said in August the government’s share of earthquake costs had increased to NZ$12.9 billion.
‘Swallowing the Extras’
“I don’t think we’re at the end of that process,” English said. “It’s a problem. We’ve got to keep making progress and keep swallowing the extras.”
Australia’s budget deficit was narrower than forecast in the year through June as a reduction in spending more than offset lower-than-estimated tax revenue, Treasurer Wayne Swan said Sept. 30. The shortfall was A$47.7 billion in fiscal 2010 to 2011, compared with the A$49.4 billion forecast in the May budget, Swan said.
“The government remains determined to return the budget to surplus in 2012 to 2013, despite softer-than-expected revenues and increased global instability that will inevitably make the task more difficult,” he said.
The Aussie dollar traded at 97.88 U.S. cents at 2:55 p.m. after reaching $1.1081 on July 27, the highest since it was freely traded in 1983. New Zealand’s currency fetched 77.31 cents after climbing to its post-float high of 88.43 on Aug. 1.
Australian corporate debt returned 8.4 percent year-to-date, compared with gains of 2.8 percent on global company notes, Bank of America Merrill Lynch indexes show. The extra yield investors demand over government securities to hold Australian corporate debt surged 64 basis points last quarter to 241 basis points, as global premiums jumped 101 to 264, the indexes show. The spread on the Australian index rose to 249 on Oct. 6, the highest since August 2009.
The Markit iTraxx Australia index slipped 1 basis point to 217 as of 11:35 a.m. in Sydney, according to Credit Agricole SA.
Credit-default swap indexes are benchmarks for protecting bonds against default, and traders use them to speculate on credit quality. A drop signals improving perceptions of creditworthiness, while an increase suggests the opposite.
Australian sovereign bonds returned 10.9 percent in the past 12 months, the most among 26 markets tracked by Bloomberg/EFFAS indexes. New Zealand’s debt was the second-best performer, advancing 10 percent.
The Australian Office of Financial Management said today it plans to issue a new bond with a maturity of about 15 years via syndication. The funding arm for the government named Citigroup Inc., Deutsche Bank AG and UBS AG as joint lead managers for the issue.
Australia is “a better credit and a more liquid market,” said Warren Potter, a bond portfolio manager at AMP Capital Investors in Wellington, New Zealand, who help manage NZ$2.6 billion in fixed income assets. Most investors “realize that the credit story in New Zealand, while not as good as Australia and not as good as it was previously, still stands out amongst other credits globally,” he said in a telephone interview yesterday.
Australia has $190 billion in sovereign debt outstanding and its currency is the world’s fifth most-traded, accounting for 7.6 percent of daily trades in currency markets, according the Bank of International Settlements’ triennial survey. The New Zealand dollar is the world’s 10th most-traded currency with $59.9 billion in average daily transactions. New Zealand’s government has the equivalent of $46 billion of bonds on issue, according to Bloomberg data.
Non-resident investors held 62.5 percent of New Zealand government bonds in August, up from 60.1 percent in July, according to data from the Reserve Bank. Offshore investors held 75 percent of Australian bonds as of June 30, up from 73 percent at the end of the previous quarter, according to data from the central bank and statistics bureau.
New Zealand sold NZ$200 million in bonds maturing between 2015 and 2023 yesterday. The auction drew bids worth 2.4 to 4.1 times the amount on offer.
“The auction result was solid,” Commonwealth Bank of Australia analysts wrote in a note to clients yesterday. “We suspect that eventually, New Zealand’s relatively sound fiscal position (on a global comparison) and diversification away from Europe and the U.S. will underpin solid demand for kiwi bonds.”