Demand for LGFA bonds cools as Fed’s QE exit saps debt appeal

Demand for Local Government Funding Authority bonds, strongly overbid since the first tender in February last year, cooled this week as the Federal Reserve's likely exit from its quantitative easing programme sapped demand for interest rate-sensitive assets.

Investors offered to buy $547 million of the LGFA's May 15, 2021, bonds at a tender on Wednesday, about twice the $270 million on offer. They were sold at a weighted average yield of about 4.46 percent. Bids of $30 million were received for the $15 million of December 15, 2017, bonds, which sold at a weighted average yield of 3.928 percent.

That contrasts with an average bid-to-cover ratio at LGFA tenders of four times under a programme that won the INFINZ Debt Deal of the Year Award in 2012, according to fund manager Harbour Asset Management.

"As the outlook for the US economy has improved, the US Federal Reserve has changed tack," says Mark Brown, Harbour Asset's director, fixed income portfolio management. "With it, the market's search for yield has switched to an aversion for assets with interest rate sensitivity. Bonds and defensive stocks are out of favour."

He says the highest bids accepted were 0.3 percent higher than in the secondary market, "a pretty large discount for such a good quality bond issuer".

The LGFA said the Fed's meeting was a contributing factor to demand in this week's tender, as was the fact that the Debt Management Office held a tender for $120 million of April 15, 2020, bonds yesterday. The DMO received bids of $352 million.

"It's understandable that institutions were potentially a little bit more cautious than they might otherwise have been," says Andrew Michl, the LGFA's manager, credit and client relations. This week's tender was also the second largest by the LGFA and the largest of a single maturity.

Still, "historically these were very good levels and relative to swaps and government bonds for councils to borrow at", he says.

The yield on New Zealand 10-year government bonds climbed to 4.14 percent today, the highest since April last year and up almost 100 basis points since early May. The yield on 10-year US Treasuries is about 2.4 percent, the highest since August 2011.

"A lot of people are trying to run through exit doors that are not very large," Mr Brown says. With current levels of volatility, investors do tend not to want to buy assets or want a bigger price concession, "so issuers tend to step away" from the market.

The LGFA is owned by 30 local authorities and the government, and was established to provide lower-cost funding to councils, many of which are too small in their own right to make the bond market economic. The size of the tenders is dictated by the councils' funding needs.

The agency has sold $2.19 billion of bonds since it began issuing in February last year.

(BusinessDesk)