Your Quarterly E-Zine
Edition 11 • December 2019

This website contains the latest edition of Forsyth Barr Focus, a quarterly on-line magazine written by senior members of Forsyth Barr's investment team.

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Bionic bonds

In New Zealand, and globally, interest rates hit historic lows in 2019. For investors, this has meant some fantastic returns out of bonds. In this article, you’ll see a chart entitled “Bionic Bonds” that indicates the yield received on bonds and the capital gain or loss over 10 years.

As the chart shows, the capital gain has been the significant component of the overall return in 2019, compared to past years when the coupon/income has been the major contributor to the overall return.

Looking back, post-Global Financial Crisis, the Federal Reserve in America slashed the Fed Funds rate to 0.0%. The Fed Funds rate is the equivalent of our Reserve Bank Official Cash rate.

Since the middle of 2014, the Federal Reserve had been slowly raising rates, as much to reflect markets recovering from the mayhem of the GFC. This move was to return markets to what the Federal Reserve considered more normal levels (which they called “normalisation”).

The Federal Reserve’s last hike was in December 2018. It was in the December quarter of 2018 that markets were roiled by an equity meltdown that emanated out of China, as the commencement of a tariff war between the US and China really hit home.

The uncertainty resulted in the Federal Reserve pausing the rates rises and then actually cutting rates this year in what they called “insurance cuts”. They were scared that the economy was going to slow, too quickly, as a result of the tariff war.

When equity markets experience a sharp “pull-back”, money is typically transferred out of equity funds and into bond funds. This is called “safe haven” investing. The market often says that when the Federal Reserve sneezes, the world catches a cold. This proved to be the case.

Interest rates rallied globally. At this point, it is important to remember that a rally in interest rates means that yields go lower while the value/price of the fixed interest security rises.

Globally, over $17 trillion of bonds now have negative yields. Europe, with Germany staring a recession in the eye (currently 0% GDP), saw its 10-year Government bond yields go as low as -0.7%.  

“Money never sleeps” is a famous quote from the film “Wall Street”, and there is certainly an element of truth in the line. Investors globally, whether wholesale or retail, are always looking for a decent return, which is why higher yielding countries like New Zealand are always on the radar.

Offshore investors can invest in any country, so once the US bonds rates rally (lower in yield) they will look at investing in other markets whose economies comparatively look better value after the US move. This was the case with New Zealand - an economy which was performing pretty well (compared to other OECD countries), with relatively high bond yields (compared to the rest of the world).

The world is experiencing the longest equity bull market rally of all time, and certainly low interest rates are partly fuelling the fire. At some point a recession will occur and typically rates go lower in a recession. This is, of course, a concern for us as savers/investors.

How will Central Banks around the world extricate economies from this super-low interest rate environment? It will be fascinating to watch.


Brent Stephen AFA
Director, Fixed Interest

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