The key themes for the New Zealand bond market in 2021 have been the steepening of the yield curve and relatively limited issuance, which has kept credit spreads tight. Inflation remains a risk, and demographics will be a major factor for an economy dependent on migration for growth.
Steep yield curve, tight credit spreads
The steepening of the yield curve has been one of the key themes of the New Zealand bond market in 2021. The 2-year/10-year yield spread is at its steepest in five years, and we expect the curve to remain steep and therefore keep bond investors in favour. The yield curve is likely to remain steep for two reasons. The Reserve Bank of New Zealand (RBNZ) is expected to stand pat with its policy rate through 2021 and possibly into 2022, keeping yields at the front end of the curve low. The longer end of the curve, on the other hand, will face upward pressure from global growth and inflation concerns.
Another key feature of 2021 is that new debt supply has been limited relative to demand. A significant volume of high-grade bonds will mature in the corporate space in 2021, with NZD 4.8 billion of debt maturing in Q2 2021 within the corporate space. There has been concern that new supply won’t be able to replace maturing debt as domestic banks, which have access to funding through the central bank, may not return to the capital market. In addition, corporations have shown a reluctance to spend despite the availability of cheap capital. Therefore, new issuance is highly sought after. We believe that the limited issuance will support credit spreads, keeping them tight. Strong inflow into the market from KiwiSaver (a savings scheme in New Zealand) is also expected to play a role in tightening credit spreads.
Inflation and migration trends potential risks
New Zealand’s inflation accelerated slightly to 1.5% year-on-year in Q1 2021, from 1.4% in Q4 2020. But thus far, there really is no sign of supply constraints inflation. This is surprising considering all the media stories about supply chains being broken, retail not being able to get the goods they need, the building sector not being able to secure timber and labour being restricted. This doesn’t mean we have negative inflation but rather a situation in which we haven’t seen a widely expected uptick in inflation yet. We are looking for a short-term uptick in domestic inflation, but we don’t think the RBNZ will react as they are likely to see it as transitory. Inflation, however, is still something to keep an eye on.
In addition to inflation, migration trends bear watching from an economic perspective. New Zealand, a country with a relatively low birth rate, has relied on population growth through migration for economic growth. However, migration has been halted as a result of the COVID-19 pandemic. The question is whether the country can resume attracting migrants once its borders are reopened. New Zealand will not be the only economy to eventually reopen; migrants bypassing New Zealand for other countries with strong growth potential remains a risk. We therefore believe migration is a key theme for 2021 and 2022.