US and European markets have begun the new week a subdued mood. But core global bond yields are showing some life, lower across the board while the USD is a tad softer too
The Australian credit market
2017 has been the best year for both issuers and investors since 2006.
The Australian credit market traditionally has followed and reflected other core markets. We reflect, with a small delay, what happens in the core credit and equity markets of the United States, Europe and to a lesser extent, Asia.
When the offshore markets move tighter, due to our smaller and more tightly held market, we may wait a few days to see if offshore shifts are validated. Australian names tend to follow suit soon after.
Another directional marker for the Australian credit market is global stability or volatility. If equities march higher, economies start to brighten up, commodities are stable, and the geopolitical news isn’t disruptive, then Australian credit tends to build momentum. Spreads then tighten. This feeds into our economy with more expansive bank lending and bond market borrowing.
Finally, bonds tend to take direction from the expected direction of official interest rates. If the cash rate is heading higher due to well-telegraphed intentions from the Reserve Bank, this could assist credit spreads to come in as investors will see this as a positive sign. Core markets in 2017 shrugged off the insularity, escalating rhetoric and tribalism in global politics and stopped reacting to these events. An ICBM can be shot from North Korea across northern Japan and land in the Pacific Ocean – and yet equity markets in our region on the day barely dipped. Twenty years ago there would have been major volatility on such an event. The SPX Volatility Index – better known as the ‘VIX’ – is at all-time lows and yet some pundits still think it is too high.
Global growth in the core economies is starting to swing up. The USA in 2017 gained some momentum to justify the pre-emptive Federal Reserve rate hikes of the last 12 months. Another US rate increase is expected in December. Europe, including the UK, is starting to reactivate. Quantitative easing is being slowly withdrawn. These events are positive for credit markets.
So what happened in the Australian credit markets in 2017? It was – in our opinion – the best year since 2006. As a market intermediary, we don’t judge ‘best’ by percentage returns. Anyway with such a low rate structure, it would be hard for A$ credit investors to match the returns of even just a few years ago where investors could ‘ride’ sharp rallies.
Our focus instead is on accessibility. This year was special because it supplied issuers and investors a high degree of certainty and stability. It provided a steady rally without any significant bouts of volatility. The market did not have any sharp pullbacks. Conditions were perfect for issuance as borrowers didn’t feel exposed. Some investors would argue they had to chase deals and were cut back on allocations. However, it should be noted that in 2017 investors have had more product and name choice, more sectorial supply and were also exposed to new product in the burgeoning green and social bond market. This is the first year since 2006 when we have not seen the A$ credit market closed due to an ‘event’. In the years after the GFC, larger events locked issuers out of accessing the market. When the A$ credit market takes stock or reverses in price this eventually feeds into corporate, business and retail loans, and general sentiment.
We have now moved to an interesting place. As global equities marched higher, commodity prices steadied, cash credit spreads in Australia had moved back to the post-GFC lows. In the final weeks of this year it feels like we may push through the 2013 and 2014 lows and track towards levels last seen in 2006.
Rewind to 2006 and an Australian bank could issue a 3yr bond around 3mBBSW/ASW+9 and a 5yr around +15. The 5yr AUD swap in November 2006 averaged a healthy 6.30%. With the current level on that 5yr swap at 2.40%, fund managers would ‘tune-out’ quickly if they were buying at 2.55%. With the 3m BBSW rate set currently at 1.70%, the argument is even more extreme for floating
rate notes. In 2006 the rate set averaged 6.37%.
In Australia 5yr new issue credit spreads for a major bank have rallied over 30bps. CBA and Westpac successfully opened the year with benchmark 5yr deals at 3mBBSW/ASW +111. In early November, National Australia Bank printed a 5.25yr deal at +80. Curve adjusted to a 5yr this is about +78.
We are back at the price lows recorded in 2013 and 2014. Coincidently in those years, we printed 3m BBSW/ASW+78 5yr deals for NAB that were also the post GFC lows. The thinly traded AUD iTraxx has performed even better and has sailed back to 2007 lows.
What could upset the current benign status is still not clear. Global interest rates remain very low. Maybe the central banks misread inflation, growth or employment and don’t adjust monetary policy fast enough? Maybe the Brexit debacle causes more angst? Maybe the threats from the Korean peninsula go beyond rhetoric? Nothing obvious stands out. This lack of a possible ‘trigger’ worries
people the most. In most fund manager commentary the tone is that of caution.
Finally the sheer diversity of product in the A$ debt capital markets has been staggering. A steady stream of financial and non-financial corporate names have taken advantage of these robust conditions. Securitised product is breaking post-GFC volume records. Capital products both wholesale and retail have successfully been printed. Non-rated wholesale investor targeted bonds are priced next to A$1bn+ corporate deals. Short dated placements have been efficiently executed. Climate bonds, gender bonds, sustainability bonds are becoming more common.
With all of this energy, is the Australian credit market going to have its own momentum rather than following the directional shifts from offshore? This is slowly happening as the pool of superannuation money directed to fixed income increases in Australia. Another factor is the substantial rise of the sub-institutional bid for fixed income in recent years. The sustained Asian bid for A$
assets has also been a familiar feature.
Ten years on from the GFC, the Australian market has truly matured to the point where we do have our own rhythm and where we can offer a diverse fixed income offering to the different layers of investors. This year provided insight into what is truly possible. We welcome what the next 10 years will bring.
This article was first published in 2017 Year in review: Corporate Finance (PDF, 3MB)