June, 2023
Adding to this sticky inflation scenario, yield curves have been forced to reverse near-term anticipated recessionary pricing, as persistent economic data reflects a resilient consumer in the face of higher borrowing costs. Credit spreads performed well over the quarter. The Australian money market is flush with liquidity. Banks are increasingly paying up for funding as some of the extraordinary Quantitative Easing measures implemented by the Reserve Bank of Australia (RBA) are rewound. However, the glut of senior unsecured bank issuance that was predicted by some to fund Term Funding Facility maturities has not eventuated.
What has permeated through the Australian money market has been selective issuance by banks outside of the major four, whereby covered notes with a soft bullet maturity have been offered via the primary market. Although issuance of this style hasn’t been substantial during Q2, it has been interesting to see banks using their name, and not the name of a structured note, to print debt that is covered, or backed, by RMBS assets. The term ‘resilient’ has been used by the Federal Reserve several times during Q2 to describe the spending and consumption patterns of the US consumer. From a domestic perspective, consumer spending has been stronger than expected, particularly in the services sector of the Australian economy.
Coupled with an unemployment rate that is still well below 4% mid-way through 2023, and on the back of consistent monetary policy tightening from the RBA since May 2022, suggests that the Australian consumer is equally resilient1 . From a fixed income perspective this resilience is not what economists were predicting coming into 2023, and economic commentators were adamant that the second half of 2023 would be characterised by widespread technical recessions, stagflation and monetary policy easing by many central banks. This scenario has thankfully not eventuated and yield curves were forced to reprice and move higher across the curve. If unemployment continues to remain near historic lows over the medium-term, or even moves up toward 4.5% over the coming 12-18 months, as the RBA correctly points out and indeed forecasts, this will still be markedly stronger than where the domestic employment data was printing pre-COVID. Add to this a RBA that is determined to engineer a soft landing for the economy whilst still tightening interest rates further, it seems logical to anticipate higher yield curves in the short- to medium-term.
Credit spreads on the other hand seem well positioned to strengthen as primary issuance is actively sought by the market. Credit events, similar to Q1 which bore witness to regional banking wobbles in the US and the forced merger of a large European bank, appear to be thankfully behind us. The portfolio outperformed the index over the quarter whilst maintaining an average credit rating of AA-/A+.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Floating_Rate_Monthly_Commentary-4.pdfDecember, 2022
Floating-rate senior-unsecured bank debt performed strongly in the fourth quarter of 2022. As opposed to the first several months of 2022 when yield and spread curves aggressively widened. This pivot occurred as global markets acknowledged that central bank stimulus would continue to be rapidly unwound as the world came out of pandemic lockdowns.
The latter half of 2022 presented opportunities to lock in senior unsecured bank spreads at levels not seen for many years. Fixed income indices globally endured a very tough fourth quarter of 2022, indeed the entire year was tough for bond investors.
The aggressive repricing of fixed yield curves throughout 2022 was driven by strong inflationary repricing throughout the year combined with the rapid withdrawal by many central banks of loose monetary policy and bond buying programmes. Added to this scenario in Australia was the unwinding by the Reserve Bank of Australia (RBA) of the term funding facility (TTF) on 30th June 2021. Although this move occurred well over a year ago, the downstream effects are just starting to be seen as banks look to source funds from the market. The TFF was an opportunity for Australian banks and branches of International banks operating in Australia to borrow up to three year money from the RBA at a de minimis cost of 0.10%.
The RBA, led by Governor Lowe, launched this loan facility in 2020 in an attempt to avoid a Global Financial Crisis (GFC) style market wobble at the height of the COVID pandemic. While the facility was in place banks were, understandably, reluctant debt issuers in the money market – simply because they could borrow from the RBA at near zero for a maximum of three years. The last possible maturity date for the TFF is 30 June 2024. It does seem likely that there will be an uptick of primary issuance in Australia as TFF loans are repaid, and in part funded from the money market both domestically and globally. The RBA wound-back the TFF as mentioned earlier in mid-2021. Senior unsecured Issuance from that point until mid-2022 was very light from most banks that run AUD debt programs as they had understandably borrowed 1-3yr money from the RBA. These loans from the RBA have started to unwind. Banks have started issuing again at very palatable spreads in both the one year, three year and five year space. This has allowed money market participants to not just be marked with their existing positions wider as spreads blew out, but to actually partake in the wider spreads in the primary market as major four banks, and others, printed senior unsecured floating rate notes in the 5 year space at spreads of over 1.00% in excess of 3month BBSW.
After a tough 2022, the outlook for investors seeking income, looks more attractive and there is an opportunity as TFF maturities drive banks to issue floating rate notes in the primary market, to position portfolio’s to have exposure to high quality domestic floating rate notes to complement traditional duration.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Floating_Rate_Monthly_Commentary-3.pdfSeptember, 2022
The third quarter of 2022 saw continued market volatility across all asset classes. Against this backdrop, we assess how the floating-rate segment performed and why fixed-rate repricing should persist into the new year.
A Notable Imbalance Between Supply and Demand
However, another factor was in play. Outside of COVID-initiated supply-chain issues and fossil-fuel challenges driven by the Russia-Ukraine conflict, the withdrawal of pandemic-related stimulus has revealed a significant imbalance between supply and demand in most goods that needs to be addressed. And until an equilibrium of sorts is achieved, higher cash rates, tighter monetary policy, and higher yields will be commonplace.
Floating-Rate AUD Bank Spreads Remain Steady
In market terms, floating-rate senior-unsecured Australian-dollar (AUD) bank spreads managed to hold their ground over the quarter. Even as fixed Australian government bond yields sold off sharply across the curve, credit spreads in senior-unsecured bank notes with bullet maturities traded in a predominantly liquid market. Indeed, it was sometimes hard to source investmentgrade AUD-issued bank paper. That’s not to say there wasn’t intra-month volatility, and on several occasions, we saw equity markets post eye-watering losses.
Forced Selling and Gilt-Market Pressure
On days with blanket selling across most asset classes, credit spreads were dragged wider in sympathy with the risk-off style positioning. Added to this were periods in the latter stages of the quarter when offshore-domiciled liability-driven investment (LDI) funds were forced sellers of their sovereign and credit positions to fund margin calls. This came as the Gilt curve was under enormous selling pressure on elevated inflationary concerns. In this environment domestic investment-grade seniorunsecured credit again mirrored offshore credit in late September by moving wider.
Fixed-Rate Repricing and Weaker
Yields So, as we enter the final quarter of 2022, it appears that in the wake of the sell-off to wides not seen for years, domestic seniorunsecured bank spreads have found an equilibrium of sorts and further substantial widening will face resistance.
June, 2022
For the majority of debt instruments, the first quarter of 2022 was a very tough start to the calendar year as widening credit spreads hit the asset class hard. Senior unsecured floating rate notes did not bear the brunt of the weakness, purely because of their short interest rate duration, but were not immune to weaker global credit markets.
In attempting to dissect the quarter into palatable bite size snippets of what drove the market, it’s worth discussing the three main drivers - building inflationary pressures, the Ukraine invasion and bank issuance. Inflationary pressures both domestically and offshore repriced the yield curve of most developed markets during Q1. It is becoming increasingly apparent with offshore central banks tightening monetary policy and the much anticipated ‘soon to tighten’ Reserve Bank of Australia, that after two years plus of very stimulatory monetary policy, both via traditional and non-traditional methods, the global economy has made it out of the COVID pandemic.
As global central banks withdraw stimulus, coupled with ongoing supply chain issues, we believe that interest rates are going to move higher. In some countries much higher. Globally, there were many investment grade bond indices that recorded their worst first quarter of performance since the 1980’s. It was a brutal move higher in yields, and spread products via fixed credit markets, were dragged along for the bumpy ride. Secondly, was the Russian invasion of Ukraine. For a brief period in late February, the rates market had a risk-off tone as bonds were bid aggressively. This was however short lived. The realisation came very quickly that Russia is a huge supplier of both oil and gas to the global economy. As sanctions were implemented, countries (especially in Europe) procured replacement markets for Russian goods and services, and were willing to pay higher prices that added to already surging global inflationary pressures. Again, bonds were sold aggressively with some fixed income markets seeing eye watering losses particularly in the long end of the curve as yields blasted off from historic lows driven by the pandemic. Credit and spreads were again dragged along for the repricing however short-duration exposures fared much better than, for example, 10-, 20- or 30-year fixed-rate bonds.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Floating_Rate_Monthly_Commentary-1.pdfDecember, 2020
The final three months of 2020 in the Australian money market were characterised by the Reserve Bank of Australia (RBA) taking monetary policy into un-chartered waters. As we have discussed in previous insights, central banks globally were adamant that this COVID-19 induced market volatility was not going to become another financial crisis of sorts, and at a minimum, liquidity in financial markets would be buoyed to ensure secondary markets functioned properly and yields would be kept low for borrowers of all calibers.
To that end, the RBA in Q4 2020 reduced the official cash rate target to 0.10% and continued the yield curve control measures whereby Governor Lowe has targeted the 3yr Government Bond Yield, and pegged it to the cash rate target, thereby signaling to the market that monetary policy will be maintained at this stimulatory setting for the next three years. Add to this the announcement by the RBA in November that a Quantitative Easing (QE) program via secondary market purchases was to be added to the already bond friendly yield curve control measures and it was broadly acknowledged that the Australian money market was, if not already, very soon to be awash with cash.
The RBA had also extended its Term Funding Facility (TFF) to authorised deposit-taking institutions (ADI’s) into 2021 which meant that banks did not have to issue notes via the primary market but could instead procure up to three years of funding from the RBA at 0.10%. This combination of multiple RBA monetary policy and liquidity measures, coupled with a TFF ensuring limited primary market senior unsecured issuance in the second half of 2020, compressed credit spreads for the last 6 months of 2020 as market participants sought to invest in existing credit issuance in the secondary market. The market dynamic outlined above for 2020 has the potential to change in 2021. Central banks will taper their additional liquidity measures as both the COVID-19 vaccine(s) are distributed and economies get back to the new normal. As global markets, and in particular rates and credit markets, have seen in previous periods where central banks reduce stimulatory measures, there is the likelihood of ‘taper tantrums’ where markets object, albeit briefly, about the reduced access to cheap money.
If there is a tapering of stimulatory measures, this will be a confirmation of the fact that both employment, growth and potentially inflation are back on track and Governor Lowe deems such extraordinary additional market liquidity measures are no longer warranted. If this scenario were to play out and tapering were to begin at some point in 2021, bonds would lose their secondary market QE driven bid from the RBA, inflation would again start to hit economists radars, the TFF would be retired and banks would start issuing senior unsecured debt again into a market that isn’t awash with surplus funds, and investors will be able to buy in the primary space higher yielding, highly liquid senior unsecured bank names. Acknowledging that is a lot of ‘ifs’, even if only a portion of this scenario plays out this year, it still bodes well for floating rate senior unsecured bank debt in 2021. The State Street Floating Rate Fund outperformed the RBA Cash Rate again in Q4. The portfolio as at 31 December was running a spread duration of 2.84 years, had an average credit quality of A+/A and had an average coupon of 0.93%.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Floating_Rate_Monthly_Commentary.pdfticker: SST4725AU
release_schedule: Quarterly
commentary_block: Array
factsheet_url:
https://www.ssga.com/au/en_gb/institutional/ic/funds/state-street-floating-rate-fund-sst4725au
Right sidebar -> quick links -> Quarterly Commentary
fund_features:
State Street Floating Rate Fund aims to outperform the RBA Cash Rate by 1.0% to 1.5% over a rolling three year period before fees. The State Street Floating Rate Fund invests in a diversified portfolio of select Floating Rate Notes, ADI certificates of deposits and overnight cash deposits. Although the constitution of the Fund permits borrowing, we do not intend to undertake any long-term borrowings for the Fund. However, from time to time we may undertake short-term borrowings for operational purposes. The Fund does not permit the use of options, futures or other derivatives.
manager_contact_details: Array
asset_class: Fixed Income
asset_category: Diversified Credit
peer_benchmark: Fixed Income - Diversified Credit Index
broad_market_index: Global Aggregate Hdg Index
structure: Managed Fund
- Manager Address : State Street Global Advisors Australia, Limited Level 14 420 George Street Sydney, NSW 2000
- Phone : 612 9240-7600
- Website : https://www.ssga.com/au/en_gb/institutional/ic
- Contact Email : ssgaaustralia@ssga.com
- Contact Page : https://www.ssga.com/au/en_gb/institutional/ic/contact-us