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Yields Are High Down Under

The commentary below is for the benefit of our readers from opinion makers and writers not associated with Euro Pacific. We do not guarantee the accuracy and completeness of third-party authored content. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific, or its CEO, Peter Schiff.
By: 
Stephen Kleckner, CAIA
October 23, 2012

Currently, many American investors may be finding themselves in the midst of a largely frustrating quest: the search for a decent yield on fixed income investments. With the Federal Reserve holding rates near zero for the foreseeable future, there is nothing even resembling a mirage on the horizon.  But those who refuse to give up the hunt may need to look “no further” than the other side of the globe. Down under and across the ditch (otherwise known as the Tasman Sea) you’ll find the island country of New Zealand. Apart from the highest sheep to human ratio of any developed country, it also offers the highest bond yields for any developed country with a strong bond rating.

Due to their relatively strong fiscal positions, both New Zealand and its blood brother down under, Australia, have been given Aaa ratings from Moody’s rating agency.  According to the CIA World Fact Book, New Zealand’s national debt as a percentage of its Gross Domestic Product is just 34% (2011 estimate). This compares to 82% in 2011 for Germany, 84% for Canada (2011 estimate) and 102% for the United States.  Furthermore, the 3.4% 10-year local Government bond yield offered by New Zealand is the highest in the world for any Aaa-rated country.  In fact, besides Australia, whose government bond yields have been oscillating around 3%, no other nation really comes close.

Over the past two yearsboth the Australian and New Zealand dollars have seen a near-10% appreciation against the US dollar. This strength has come despite severe natural and manmade obstacles, most notably the devastating earthquake that struck Christchurch, New Zealand, in February 2011.  The New Zealand economy has remained strong despite reconstruction obstacles and the diversion of resources to infrastructure projects.

The strong currency has translated into low inflation. The New Zealand CPI is now just 0.8% for Q3 (annualized), marking 2 consecutive quarters of 10-Yr low inflation. Despite the low inflation, interest rates in Australia and New Zealand have remained above the developed world average. But the performance of New Zealand sovereign bonds has lagged Australia’s this year. This is partially a result of the relative lack of liquidity in the New Zealand sovereign debt market – an issue that the New Zealand authorities are trying to address by bringing in more of those international investors who typically target Australia.

A New Zealand 10-year bond that yields 3.4%, with a CPI of 0.8% offers a real yield (after inflation) of 2.6%.  In today’s yield deprived world, those numbers are actually quite attractive. However, due to the relatively low liquidity associated with the New Zealand dollar, the currency can be more volatile than the typical benchmark currency. This tendency can make many fixed income investors understandably shy. Hence the discount in price. But for those who can stomach the extra choppiness, a 2.6% real return for a Aaa-rated security may be worth considering. 

Australia has seen its 10-year rates fall 53 bps this year, while New Zealand has lagged behind, only falling 17 bps. Given New Zealand’s dependence on its larger trading partners, the country’s central bankers will likelymake policy adjustments to keep pace with overseas developments, i.e. lowering rates.  If rates continue to drift lower in Australia, the United States, Europe and Japan, New Zealand will have to follow suit.  Australia recently came through with a surprise 25 basis point cut to its cash rate.  It is wise to assume that New Zealand has some catching up to do.  If the yields on the New Zealand 10-year bond falls to more “normal” developed world levels, investors in those bonds could see capital appreciation in their currently held positions. 

Stephen Kleckner is Co-Portfolio Manager, Senior Analyst, of Euro Pacific Asset Management, LLC. 

Neither Stephen Kleckner nor Euro Pacific Asset Management LLC (EPAM) is affiliated with Euro Pacific Capital, however, EPAM is sub-advisor to the firm’s Registered Investment Advisor (RIA). Additionally, Peter Schiff is a member, and chair of the Investment Committee of EPAM.