August 2016 Interest Rate Commentary

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30 August 2016

Click here for monthly tables & chartsCASH

At the start of the month the RBA reduced the official rate to 1.50% as many economists had expected. While inflation, or lack of it, is viewed as the drive behind the decision, some analysts are suggesting the ‘high’ currency was equally important in the RBA’s thinking. The August SoMP added little except it confirmed the market’s view the RBA has an easing bias and another cut down to 1.25% is not an unrealistic expectation.

Close Month
Chge
Month
High
Month
Low
Cash Rate%   1.50    -0.25
90d Bank Bill%   1.74    -0.12     1.99     1.80
Aust 3y Bond%*   1.38    -0.03     1.45    1.30
Aust 10y Bond%*   1.83    -0.05     1.99    1.80
Aust 20y  Bond%*   2.39     0.02     2.52    2.35
US 2y Bond%   0.80     0.14     0.84    0.64
US 10y Bond%   1.58     0.13     1.63    1.50
US 30y Bond%   2.23     0.05     2.32    2.22
iTraxx 100.5     -9.2   111.0    99.5
$1AUD/US¢ 75.17     -0.84   77.58   74.90
* Implied yields from Sep 2016 futures

While consumers were slightly more optimistic, comments accompanying the NAB Business survey caused a stir, firstly by its prediction of a slowdown in the Australian economy and secondly by re-iterating a forecast first made by an ANZ economist of the prospect of “non-conventional” monetary policies in Australia.

The RBA minutes were a non-event and at best it was hoped some indication as to the closeness of the decision to cut would be given. Under-employment had been raised as an issue at July’s RBA meeting; July Labour Force figures seemed to confirm this as all the growth was via part time jobs, while full time employment fell.

The prevailing view among economists is the RBA is done for 2017 and it will wait until 2017 to act again. Pricing in cash markets suggests otherwise and November is a 44% chance for another 25bps cut and by August 2017 a 1.25% rate is viewed as a certainty.

Click here for monthly tables & chartsTERM DEPOSITS

Unusually, the major banks announced increases to term deposit rates in the wake of the RBA’s 25bps rate cut and they were focussed on terms from 1year to 3 years. This was part political, as the banks failed to pass on the full RBA cut to mortgage borrowers, and part business sense, as the banks are having to increase deposit funds to satisfy the regulator. At the same time, banks still reduced rates on many other terms. Westpac left most of its rates unchanged but increased rates on 1 year and 3year terms by 55bps and 2 year terms by 45bps. CBA’s moves were very similar and it increased 1 year rates by 55bps and 2 year and 3 year rates 50bps. Bank of Melbourne and St George Bank, being owned by Westpac, made almost identical changes to their parent company. NAB reduced rates on terms of 9 months and under by 25bps but increased 2 year and three year term rates by 45bps and 50bps respectively. ANZ was the odd one out and it cut rates across all terms by 25bps.

Among the smaller banks and credit unions, many changes mirrored those of the major banks; reductions to rates on terms of 9 months and under and some increases to longer term rates. Then again, some institutions did not change rates on any terms and some only increased rates.

The largest single increase for the month was the 61bps rise on BOQ Specialist’s 3 year term. The largest single decrease for the month was the 65bps cut on Suncorp’s 4 month term.

Click here for monthly tables & chartsBANK BILLS/SWAPS

Yields in the bank bill market moved lower through August to finish at 1.74%, down 12bps and just off the low for the month. The August cut had already been priced in after July’s inflation figures to some extent and so the market did not need to move a full 25bps lower. 3 month BBSW also finished at 1.73%, down 13bps for the month.

Swap-to-bond spreads fell across the curve but more so at the short end. Yields have fallen in most, if not all, sectors of debt and cash markets but in August corporate sector yields came a little closer to commonwealth benchmark rates. The 3 year spread fell 6bps from 25bps to 19bps, the 5 year fell 6bps from 37bps to 31bps and the 10 year spread fell 2bps from 23bps to 21bps.

The August rate cut understandably had more of an effect at the short end of the swap curve than the long end but in any case all yields fell. The 1 year rate was down 12bps to 1.64%, the 3 year rate fell 9bps to 1.61%, 5 year and 10 year rates both fell 7bps to 1.85% and 2.03% respectively and the 15 year rate was down 4bps to 2.21%.

Click here for monthly tables & chartsGOVERNMENT YIELD

The yield curve generally flattened over August, but steepened at the ultra-long end. The 3y/10y spread fell 2bps to 46bps and the 3y/20y spread rose 7bps to 101bps. There was not much sense to it; 3 year and 10 year yields fell 3bps and 5bps respectively but 20 year yields rose 2bps to 2.39%.

Click here for monthly tables & chartsGOVERNMENT BONDS

The first week of August turned out to be the busiest of the month in terms of trading. The local bond market started the month reading reports about weak US Q2 GDP data, which was followed by the Melbourne Institute’s inflation reading of 1.0%. Both sets of numbers had bond investors pressing their “buy” buttons and the RBA decision to cut cash rates by 25bps the following day did not alter that view. Offshore, UK yields fell after the BoE pressed nearly every button on its monetary policy stimulus console. Things did not quite go to plan with its asset purchase programme and it failed to fill its buy order. Investors refused to play ball and sell to the BoE and yields for gilts fell as investors and traders anticipated the UK central bank will be forced to accept the prevailing (and lower) yields in future.

Japanese yields rose as its bond market digested the BoJ’s failure to match market expectations of more bond purchases. As Westpac put it, “The doubling of ETF purchases and by inference reduced JGB purchases and no reduction in negative deposit rates clearly left the market stunned.” The spread between Australian and US 10 year bonds hit a 15 year low of 28bps and the search for yield has investors whittling down the premium Australian yields attract over comparative US yields. Bond yields of most countries reached record lows as central banks in Europe, Japan, the UK and the US all continued to engage in quantitative easing, otherwise known as money printing. It may even be coming here.

US July employment figures in the middle of the month were considerably stronger than expected and added to “raise rates” camp’s argument but then any such sentiment was neutralised by soft US retail sales figures.

In the lead up to the Jackson Hole central bank conference, US Fed officials did their best to sound hawkish. Dudley, Williams and Fischer made statements early in the week such “we are close to our targets” and September’s meeting is “in play”. Markets did not pay much attention as these officials have said similar things in the past, only for the US Fed to sit still at the next meeting. However, US yields had been inching up and as a consequence, the Australian-US 10 year spread has been trending down. The spread continued to do so when US yields rose on post-symposium statements from Yellen and Fischer.

By the end of the month the Australia-US 10 year spread finished at 25bps which is back at 2001 levels. As Australia is one of the few advanced economies left in the world with a 10 year bond yield closer to 2.00% rather than to 0.00%, it is not far-fetched to suggest investors are buying Australian bonds in preference to the bonds of the US, Eurozone nations and Japan. According to Westpac “the long end will be very focused on whether the US 10yr can breach the 1.5% level on a sustainable basis, with key inflation data and Fed communications on the agenda.” Over the month, the 3 year yield fell 3bps to 1.38%, the 10 year yield fell 5bps to 1.83% and 20 year yields rose 2bps to 2.39%.

In other news, there was renewed speculation of an Australian 30 year bond. One day there will be Australian long bond but the AOFM is being coy as to the timing.

Click here for monthly tables & chartsSEMIS

Semi-government spreads rose over the month but only because Treasury Corp (NSW) spreads widened in the wake of the Federal Treasurer’s blocking of both foreign bidders for AusGrid. Excluding Treasury Corp securities, semi-government yields followed their Commonwealth counterparts, despite Moody’s downgrade of Tasmania’s credit rating from Aa2 to Aa1. However, the RBA’s purchase of $100 million worth of various semi-government bonds not only added extra buying pressure in the semis market, it also sent a signal to participants of the views of the most-powerful domestic player.

A noticeable widening between ten year bonds issued by Queensland and Western Australia bonds has emerged and it appears as if the widening trend became pronounced in March/April. However, it could be argued the divergence began around the beginning of 2015 when the WATC/QTC 2025 spread was about zero.

State financing authorities issuance is quite often a bit thin on the ground but during August, QTC, SAFA and Treasury Corp (NSW) all issued bonds. QTC kicked things off with the issue of $500 million worth of July 2026s and SAFA then followed with the sale of $1 billion worth of September 2022s. SAFA’s use of an unusually low 1.5% coupon somewhat perplexed the market and, other than investor preference, a reason for the low coupon has not yet emerged. Towards the end of the month TCorp issued $102 million worth of November 2035 ILBs as part of its $502 million buyback of November 2020s.

Click here for monthly tables & chartsCORPORATES

The risk of corporate of default fell according to the index of credit default swap prices. iTraxx finished the month at 100.5, down from the previous month’s reading of 109.7. The other major measure of corporate risk, corporate spread, noticeably contracted across all maturities as investors chased relatively higher yields available in the corporate market.

The main news for the month was credit rating related and it comprises separate contrasting items. Firstly, the major Australian banks’ debt was placed on “credit watch negative” by Moody’s because of risks in the housing market and the Australian economy in general. Secondly, Fortescue’s credit rating was upgraded on the back of a higher iron ore price and lower debt levels.

Part of Fortescue’s strategy has been to repurchase previously-issued bonds and in recent times Rio has started to do the same. This month Adani Abbot Point Terminal joined in with the repurchase of $63 million worth of November 2018s.

Corporate issuance excluding the Kangaroo market was $15 billion in August, down from July’s $23 billion. Two thirds of it was done by ANZ and Westpac with Westpac’s contribution in the form of one $6.5 billion USD deal comprising five fixed and floating tranches. Westpac’s was one of the largest bank deals seen and the largest Australian issue since BHP’s five tranche multi-currency deal in October 2015. Westpac’s deal included a mix of fixed and floating lines with maturities in 2019, 2021 and 2026. It is similar in structure to the five tranche USD-denominated bond sale in May this year which was worth USD$4 billion. ANZ’s two tranche issue which, at $2.7 billion, was still at the larger end of the spectrum as far as primary market transactions go. ANZ was also responsible for a zero coupon bond sale which seem to be becoming more common nowadays.

In the Kangaroo market $3 billion of bonds were issued in August ($5.6 billion in July), with KfW Bankengruppe was the largest single issuer in the month. The Frankfurt-based bank was responsible for a little under half of total issuance in this segment of the bond market and it raised $1.3 billion over the month through four separate sales.

Click here for monthly tables & chartsASX-LISTED FLOATING RATE NOTES AND BONDS

The median trading margin for ASX-listed floating rate notes during August finished at 2.00%, down 34bps from the previous month median of 2.34%.

Shaw and Partners put out a note regarding AGL Notes’ (ASX code: AGLHA) mandatory deferral conditions. For those readers without access to the note, in short AGL must make interest payments quarterly on the notes unless a Mandatory Deferral Condition exists, in which case interest payments are deferred. According to the latest AGL ASX release both ratios are far away from their trigger limits.

Origin confirmed its “intention to redeem the A$900 million Subordinated Notes by the first call date in December 2016.” Beware the seemingly high trading margin of Origin Notes in the chart below; transaction costs and bid/offer spreads can chew that up very quickly.

Qube Holdings announced it was seeking to raise $200 million via the issue of vanilla floating rate notes which mature in 2023. The notes will be listed on the ASX and trade under the code QUBHA.

Click here for monthly tables & chartsASX-LISTED HYBRIDS

Trading margins for hybrids continued their general downward direction since peaking in February/March. The median trading margin fell 19bps over August to finish at 4.02% but the change was somewhat affected by the inclusion of two new hybrids issued by NAB and Westpac (ASX codes: NABPF, WBCPG) and by a plunge in the trading margin of Seven Network TELYS4 (ASX code: SVWPA) after the announcement of an on-market buy-back.

ANZ announced the issue of its latest hybrid in the form of Capital Notes 4 (ASX code: ANZPG) which later had its margin set at the bottom of the range at 470bps although it was still towards the higher end of margins offered by existing comparable hybrids at the time.

Apart from the 180bps fall in Seven Network TELYS4, the largest margin falls over the month came from Westpac Capital Notes 2 (ASX code: WBCPE, -80bps) and Bendigo and Adelaide Bank CPS 2 (ASX code: BENPE, -68bps). Westpac Capital notes (ASX code: WBCPD) and Bank of Queensland CPS (ASX code: BOQPD) went against the trend and their trading margins rose 21bps and 18bps respectively.