State of rates: Australia's high-grade market in depth
On 22 October, KangaNews hosted the latest in the KangaNews Debt Capital Markets Summit 2020 webinar series. The session had a rates-market flavour, including a discussion between some of Australia’s leading market participants about how massively increased sovereign issuance, central-bank intervention and a raft of new dynamics will shape their sector.
Davison A couple of years ago, when the AOFM was last heading towards a peak in annual issuance, there was a feeling that capacity was being stretched. Issuance has gone up by a step change from those levels but there do not seem to be any capacity issues. Has this been a surprise?
NICHOLL Back in 2016/17 we had an issuance task of just less than A$110 billion (US$79 billion), which was by far the largest programme we had undertaken to that point. Our weekly issuance rate at that stage was A$2-2.25 billion. There were some weeks when the market felt tight and the feedback we received from banks was that there was some congestion in the market for a few short periods.
On the basis of that experience, in April this year I wondered how our new funding programme would be received, given we had been out of the market for a couple of weeks due to the volatility and our financing task had risen to A$130 billion from A$60 billion.
However, we have been able to get the required issuance programme away smoothly – and it is still going very smoothly. There are a number of contributing factors.
For one thing, the world is a different place now to what it was in 2016/17. There has been a flight to quality, for all the reasons that make the world look a much riskier place than it did back then. All sovereigns have materially increased issuance, too, so there has been a structural change in the global asset pool.
There is good liquidity in the market. Our spread to US Treasuries went positive again after being negative for quite a while, which has made a big difference for our offshore investor base.
We have also engaged heavily with syndication as a means of issuance. This can be a more effective way for us to raise this quantity of funding quickly, rather than straining the capacity of intermediaries in tenders.
Davison It has been theorised that the semi-government borrowers may confront capacity issues before the sovereign. What is New South Wales Treasury Corporation (TCorp)’s experience through this crisis?
TRIGONA We were faced with capacity constraints in March and April as the crisis unfolded. It really took the RBA [Reserve Bank of Australia] stepping in and providing liquidity to the market for investors to become comfortable. We were then able to issue again via syndication, with two transactions totalling A$3.2 billion.
Our funding tasks were and are a lot less than the AOFM’s – in the last financial year it was A$13.3 billion, which then increased to A$17 billion. This was the largest task we have ever had to complete. By the end of the financial year we had raised around A$29 billion.
We are seeing large investor demand for our funding, though. With US$17 trillion worth of negative-yielding bonds globally, Australian high-grade bonds remain a very attractive opportunity especially given the steepness of our yield curve.
We see a lot of opportunities to issue and meet the task at hand. We will not know our full task for this financial year until the New South Wales budget, on 17 November, but we are progressing nonetheless. So far this year we have issued around A$14 billion.
Davison TCorp recently returned to the green-bond market. How does this help with any capacity issues that might arise from a larger task?
TRIGONA This deal was ground breaking as it is was the first time we have ever had more than 40 per cent of participation from offshore in one of our green bonds. It was 15-18 per cent in our last two green and sustainability bonds.
Issuing in this format opens a lot of opportunities for us to attract new investors. Our capacity to issue depends on the eligible asset pool. We now have A$5.2 billion of bonds outstanding in green and sustainability programme, we continue to build out the pool and we will look to increase our sustainability- and green-bond lines in the new calendar year.
AOFM funding strategy in depth
The Australian Office of Financial Management (AOFM) has seen a quantum leap in its bond issuance task. How it approaches funding that task will shape the Australian dollar market for years to come.
NICHOLL Liquidity completely disappeared in March. It began to reappear in Australia in early April, in concert with the RBA [Reserve Bank of Australia] beginning to buy bonds as part of its market-clearing operations.
When we first regained access to the market we were issuing very short duration, which is consistent with most issuers’ approach. There was a complete lack of appetite for duration at that point in time.
We monitored conditions and tracked the recovery as it unfolded. This allowed us to follow the recovery out with our issuance until we observed liquidity in the 10-year futures part of the curve returning to something close to normal.
From our syndication statistics, even the 2024 bond showed a higher allocation to offshore investors than the average for all of our past syndications, except the 2047 transactions in 2016. This suggests a step-change in offshore participation has taken place.
Davison The RBA support programme has anchored the three-year yield point and created a relatively steep curve. How is this affecting market dynamics and demand?
JAMPALA To the extent that there is a pre-specified price on duration it will reduce the volume and frequency of trading – both speculative and for hedging purposes. This is a global phenomenon as we find most major markets are effectively anchored at the front end.
As a consequence, one would expect to see increased trading in the long end, aided by greater issuance in that space. Market participants should be trading 20 years in the same way they previously might have traded the 5-10 year part of the curve.
Davison Historically, liquidity in the Australian market has focused around the futures baskets at three and 10 years. Will we start seeing the trading focus shift towards 10 and 20 years?
JAMPALA I am sure we will get there – it is just a matter of time. It is largely a chicken-and-egg scenario where the 20-year future needs more physical supply, and for this to happen the future needs to be more liquid.
In time, I imagine the AOFM and semi-government issuers will increase supply in this part of the curve to the extent that the pool of investors will grow, too – creating a natural increase in trading and liquidity.
“I still do not believe the RBA will go to a negative cash rate. I think it will validate where the market has taken the cash rate and exchange-settlement account rate. The TFF rate will also drop, which will have benefit through the lower cost of funding encouraging people to buy assets and maintain liquidity.”
Davison To what extent is the push to a longer-dated market being driven by investors – for instance in a hunt for yield?
ANDERSON We have seen evidence of a heavy international investor bias in some long-dated sovereign and semi-government syndications. In our own books, we are more comfortable investing in the long end when we are managing money for liability matches and captive investors. However, in my experience most domestic investors have not ventured out meaningfully into 10-20 year duration, in large part because a lot of them are index driven.
More importantly, though, liquidity in the long end is still a challenge. From time to time there have been sensational relative value opportunities but, overall, I have found this part of the curve frustrating. To go there we really need the supply concession we get from some syndications. This has been a valuable trading opportunity.
As a term investor, I do not think we are there yet – and it has been a slow process even to get to this point. While 10-30 years tends to be quite steep in all markets, Australia is arguably steeper than others. I think this is a reflection of the way our market funds and the lack of captive investors compared with markets such as the UK.
Davison If the long end has not developed to a point of comfort and the front end is not an exciting trading option, does this mean the focus remains in the 5-10 year part of the curve?
ANDERSON Yes. There are still directional opportunities – there has just been a good rally in 10 years and the Australia-US spread has been a tradable theme. There is relative value as you roll up the curve and try to anticipate the actions of the market in response to possible QE options, and from time to time there have been good opportunities in 10s-30s. But when you go in there as a term investor you need to be mindful of what you are prepared to pay if you need to exit.
Davison Can we assume the AOFM is happy to extend its funding curve as much as possible and will respond to demand in primary for long-dated issuance?
NICHOLL We are not capping the volume we will put into our ultra-long maturities. In fact, we are constantly looking for opportunities to do appropriately sized tenders or syndicated taps. We have found these very effective in the past and they tend to create a liquidity event in their own right, as they give an opportunity for offshore investors to participate in good volume.
We are mindful of the fact that this part of the curve is not nearly as liquid as others at the moment. We do not want to push supply and create volatility that would scare away investors. We will be looking for every available opportunity to responsibly get stock into that part of the curve, though.
At various times we have thought about whether we would go longer than 30 years but at the moment we have no plans to do so. In my view, this is a market for the big currencies – euros and US dollars. We are sure there would be some demand out there but I do not think it would be nearly sufficient or consistent enough to develop a meaningful 50-year Australian dollar market.
Davison Does the AOFM have any particular preference for providing supply into the 20-year futures basket relative to the 30-year point where the curve currently ends?
NICHOLL We would not pick one over the other as a strategy. We monitor the feedback we get from the market and banks and focus on maturities where interest appears to be building at the time.
Davison Do match funding issues give TCorp more constraint on ability to service long-dated demand?
TRIGONA Lengthening the curve is definitely a focus given our main borrowing client is NSW Treasury so we are currently able to accommodate the long-dated demand. This calendar year we have issued more than A$4.8 billion in long tenors. Our 2041 bond now has A$2.1 billion on issue.We are looking to increase this line as well as our other long-dated bonds including our new 30-year line.
Davison Australia seems to be developing an increasingly primary-focused market. What does this mean for the trading environment and the market generally?
JAMPALA The proliferation of bond issuance globally, leading up to and after the onset of COVID-19, has been quick and extraordinary. We have seen the return to primacy of cash markets. The pool of investable fixed-income securities is not going to diminish any time soon so I imagine this trend will be pervasive for some time yet.
The yield structure we have before us is such that there will be significant challenges for cash and income funds. Navigating primary issuance as part of the collective and all-pervasive search for yield will be a dynamic consideration for investors for some time.
Davison Given there is a premium paid for syndication would the AOFM’s preference be to rely on it less?
NICHOLL The concession we pay has diminished since our 2024 syndication. The market was very crowded back in April and May so issuers were forced to give away slightly higher concessions. But this seems to have unwound in the months since.
We are happy to do it – but only if it is required and to the extent of demand. If you build up a new line by tender, you are still paying for it indirectly because investors will demand some illiquidity premium for smaller lines. You do not avoid the cost – it just comes in a different form, through tenders.
We will continue considering whether to use syndications for new maturities. We think of it in terms of execution risk. If we go back to April and May, there was huge demand on us to provide more liquidity quickly. Syndications were a sensible way of getting large volume away and not putting too much pressure on trading accounts to do it. But the pressure has certainly abated.
We did not use syndication much at all over the last couple of years, because our programmes were much smaller. In this situation a syndication would take up a large part of our issuance programme and affect our regular tender operations.
ANDERSON The supply concession is a welcome opportunity for investors to make some money. This is not just an Australian phenomenon, to be clear. We saw supply backed up even in the US market last night, for instance
Taking down supply is a bit of an artform and it is also a tradable opportunity – which obviously as an active investors I think is a good thing. The market makes room and we attempt to value the premium.
It may not be material but in this world of very finely priced securities and the a low absolute level of yields we need to adapt what we are prepared to trade for to make capital gains.
Davison The RBA has been clear in its messaging about three years being the best point of transfer of its purchases to the real economy, and that negative rates do not achieve their intended goal. Why do so many people assume it is likely to enact longer-dated purchases and negative rates?
ANDERSON I think the RBA has been good at navigating messaging over many years. The quality of its communication around the drivers of its thinking is second to none. In fact, in re-reading governor Philip Lowe’s and assistant governor Christopher Kent’s recent speeches, it is clear what the RBA is trying to solve for.
They speak about being as transparent as possible but, ultimately, the RBA needs to make a judgement about using its policy toolkit in the most effective way to solve a challenging paradigm.
I still do not believe the RBA will go to a negative cash rate. I think it will validate where the market has taken the cash rate and exchange-settlement account rate. The TFF rate will also drop, which will have benefit through the lower cost of funding encouraging people to buy assets and maintain liquidity.
This enables households to repair their balance sheets, which in turn reduces financial-stability risk. The cash mechanism also gives people greater ability to consume. It is working – it is just slow.
What I am personally grappling with at the moment is whether further asset purchases in the form of QE will be effective to address the divergence in our economy.
It feels like the RBA wants to be somewhat procyclical – to deliver more stimulus when the economy is opening, which is where we are now. However, we have just had the budget and we are waiting for it to work through the system. Whether the RBA announces QE next month or gives it a bit more time is the big question. There is a cacophony of voices from the market and the RBA would weigh market disappointment.
The question is what disappointment looks like. If 10-year bond yields rise by 10-20 basis points I do not think it would be a significant policy consideration, given the level of transparency the RBA has offered in its communication. My views are informed first by what I hear from central bankers then shaped by the market.
JAMPALA If I had to mark the RBA on its actions in response to COVID-19 it would be a 9.5 out of 10, and I think the market recognises this. Its credibility as a central bank is second to none and I think we have seen this in the way other central banks have looked into the RBA’s policy instructions as a learning tool.
Having said this, there are significant challenges and implications now as we grapple with the concept of negative rates. If we move into negative territory we may have cash funds returning negative yields to their investors even before considering fees. We may have end users and corporate borrowers paying out on both sides of an interest-rate swap. There are all sorts of considerations we need to think about.
On the flip side, a much-expanded QE programme could diminish the liquidity and real activity in the long end of the curve that has been a feature of the market in the last six months.
The RBA has done a great job so far but significant challenges lie ahead. What seems clear to me is that the RBA, in its dovish movements, seems to want to ameliorate outcomes from an inflation and employment perspective. Its focus is on doing what is right for main street.
Davison The last time the AOFM’s funding task was rising quickly it got on the road to engage with as many investors as possible. Putting aside the fact that a global roadshow is impossible at the moment, how has the investor-relations strategy changed?
NICHOLL In April and May, we felt the need to get as much information out to investors as possible to give guidance around fiscal impacts and how issuance would respond. We conducted a teleconference campaign, which was quite short and sharp because we did not have a budget update. This also helped us understand the path of market recovery. We also tried to give guidance on weekly issuance rates just to give investors some reference points.
We have just kicked off another campaign where we will do around 50 teleconferences to follow the budget release, having done around 80 in the first round in April-May.
We have also enhanced the information we make available online. We are looking for different instruments by which we can engage the buy side. This is through our quarterly Investor Insights note as well as the updates we give after official budget releases. As part of this, we are also about to launch a short video webcast to complement the investor packs we put out.
We are also engaged with the banks and speaking to investors continuously. We have not broadened the nature of our task, but it has been intensified. We are looking for meaningful ways to communicate transparently.
TRIGONA We have not marketed to the same extent as the AOFM. After the NSW budget on 17 November we will put out a video explaining our funding task over the remainder of the year and in future. We are working on our investor presentation pack and will look to meet investors when it is complete – which will be predominantly online.
Davison Does the EU’s borrowing programme make it more difficult to attract European investors?
TRIGONA We have seen increased European investor interest in our bonds this year and, for the first time, we issued in euros. The 30-year bond that we first issued in February is now at €430 million (US$506.4 million) outstanding, so it is not far away from benchmark status.
NICHOLL Our market is now quite familiar to most of the buy side as a product of everything that has happened since the financial crisis. This is a strong foundation.
I think as long as there is value for investors – either taking currency risk or taking the cost of hedging the currency into account – and they are confident about liquidity in the market, we will continue to see reasonable demand. I do not get the sense from our experience in the last few months that there has been a diminishment of offshore interest. In fact, we have seen more of it: we are seeing a lot of new names in our syndication books from Europe and North America.
Davison Will offshore demand wane with 10-year Australia-US bond yield now flat or slightly negative?
NICHOLL If it is prolonged we may go through another cycle of what we saw 18-24 months ago, but it is not likely to be an instantaneous response. There needs to be a clear differential and investors need to believe it will be sustained in order to switch markets. In the short term I do not think it will have a meaningful impact.
Davison Has the dial shifted somewhat for semi-government foreign-currency issuance?
TRIGONA I can certainly see us issuing more in euros. US dollar issuance is more difficult as we do not have a 144A programme. But the cost of issuing in the US market has improved, so it may become more compelling in future.
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