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Global Markets Research
Weekly Strategy
15 July 2013
Adam Donaldson Head of Debt Research T. +612 9118 1095 E. [email protected] Philip Brown Quantitative Strategist T. +613 9675 7522 E. [email protected] Alex Stanley Interest Rate Strategist T. +612 9118 1125 E. [email protected] Tariq Chotani Credit Research Analyst T. +612 9280 8058 E. [email protected] Tally Dewan Credit Research Analyst T. +612 9118 1105 E. [email protected]
Important Disclosures and analyst certifications regarding subject companies are in the Disclosure and Disclaimer Appendix of this document and at www.research.commbank.com.au. This report is published, approved and distributed by Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945.
ACGBs on track for outperformance
Bernanke could soothe Treasuries again this week, but the rally in risk assets foreshadows higher yields ahead.
Slowing growth in China and rising domestic unemployment should keep tightening AUS-US spreads.
Credit under pressure as the AUD falls, but we expect the positive global backdrop to prevail.
The June FOMC minutes and a speech by Fed Chairman Bernanke gave bonds, credit and equities a boost this week. Treasuries consolidated after recent heavy losses, but ACGBs continue to outperform.
Volatility is likely to remain elevated across all asset classes, as the market adjusts to the removal of unprecedented stimulus. Bernanke may provide some further comfort in his semi-annual policy testimony later this week, if he reiterates that fed funds tightening is a different and more distant proposition to withdrawal of QE.
But the fundamental case for withdrawing QE is building, and the market should be left in no doubt it will start as soon as the September FOMC meeting. We expect that to now be a secondary issue. Promises to retain accommodation and delay subsequent tightening mean little relative to the actual pick-up in growth and rallies in risk markets, both of which remain convincingly strong.
The longer term trajectory seems clear. As detailed on Thursday, we expect the US 10Y yield to reach 3.0% by year end, before settling into a 3.0-3.5% range in 2014. Against this backdrop, we expect a tighter Aus-US spread to keep the 10Y ACGB yield in a 3.6-3.9% range over the coming months. Our 10Y trade has now tightened to 114bp as data highlights the weaker Australian and Chinese economic backdrop.
We expect this macro backdrop to keep the market pricing a terminal cash rate of 2.25-2.50% with a bias to the downside. Expectations for a “lower for longer” cycle should keep the 3Y relatively well bid and the 3/10Y ACGB curve trading over 100bp in the near term. But the month-to-month timing on RBA policy is now a tougher call and we are wary that the mid-part of the Aussie curve is well overdue for a sell-off if thinking about the RBA changes. Implied odds of a 25bp rate cut next month have lifted from 42% to 68%, which is looking stretched.
The Q2 CPI will make or break the Aussie curve. This week, the NZ Q2 CPI report is likely to highlight a continued lack of inflationary pressure in NZ. We think the front end of the NZGB curve is a buying opportunity and entered a long Apr-15 NZGB position last week.
The falling AUD and slowing Chinese and domestic growth are also a major headwind for the long-end of the credit curve, including SSAs and semi-governments. But the strength in global equity and credit markets spilled over to the local market last week, with CDS and shorter-dated cash bonds tightening. We expect that global driver to dominate and retain our 115bp target for iTraxx Australia ahead of the August company reporting season and the election. We initiated a new RENTEN 15 vs EIB 15 trade to capture recent under-performance and failure to benefit from confirmation of a German government guarantee.
ACGB and US Treasury forecasts
Source: CBA, Bloomberg
Key Strategy Views
Tactical (<2 mth)
Strategic (>6 mths)
Policy rate* 2.5% 2.5%
3yr bond 2.8% 3.2%
10yr bond 3.8% 4.1%
10yr BEI 240 260
3/10 curve 110bp 90bp
US 10yr 2.7% 3.2%
10yr v US 110bp 90bp
3yr EFP 25bp 20bp
10yr EFP 50bp 40bp
iTraxx 115bp 105*Note: Strategy Team views. CBA Economics are also forecasting a 2.5% cash rate.
0
2
4
6
8
03 04 05 06 07 08 09 10 11 12 13 14
%
CBA(f)
Spread
US 10-yr
Aus 10-yr
Spread
US 10-yr
Aus 10-yr
Global Markets Research | Fixed Income: Weekly Strategy
2
Key Trades:
High Grade:
Trade Entry Current Profit Target Stop Comment Buy the NZGB Apr-15 2.93%
(9-Jul-13) 2.83 10bp 2.60% 3.10%
New Trade: NZ front-end looks cheap vis-a-vie Australian pricing.
Buy the ACGB Oct-15 against the ACGB Apr-15
12bp (4-Jul-13)
9bp +3bp 6bp 15bp New Trade: An RV trade. The 3Y sell-off pulled the Oct-15, not the Apr-15.
Buy the QTC Sep-17 vs the QTC Apr-16
41bp (4-Jul-13)
41bp 0bp 32bp 46bp New Trade: RV and a probably front-end flattening make this attractive.
Buy the ACGB Apr-23 vs the UST May-23.
143bp (24-Jun-13) 114bp +28bp 100bp 125bp Tighten stop: Fed repricing and RBA
easing have tightened spread as expected.
Buy the ACGB Aug-15i vs the Oct-15 Receive ZCS at 2.65%.
250bp (30-Mar-12)
Hold: The trade is now (close to) an 8bp per annum annuity.
Buy the QTC Feb-20 to the NSWTC Mar-19
36bp (13-Nov-12)
41bp -5bp+3.5bp carry = -1.5bp 10bp 50bp
Hold: S&P should keep Qld at AA+/Stable, but NSW AAA/neg to remain under pressure
Buy the Apr-25 against the Apr-23 19bp (6-Jun-13)
18bp +1bp 10bp 23bp Hold: Apr-25 should richen as it approaches 10Y, the Apr-23 the opposite
3/10Y EFP box flattener 25bp (29-May-13) 20bp +1bp
(incl -4bp roll) 10bp 33bp
Hold : Long spreads room to compress given bond supply, credit etc.
Buy Jun-14 against Dec-13 bill futures
25bp (25-Jun-13) 11bp +14bp 5bp 35bp
Hold: AUD front end too cheap following rout in US Treasuries.
2013 to date +254bp (including +196.5bp from closed trades)
Credit
Trade Entry Current Profit Target Stop Comment Buy RIO 3.75% Sep-21 (U$) vs BHP 3.5% Nov-21 (U$) on ASW basis
43.0 (13-Feb-13)
50.3 -7.3 20bp 55bp Hold: RIO US$ long-end is steep relative BHP U$ curve
Buy EIB 6.00% Aug-20 (A$) vs EIB 6.25% Apr-15 (A$) on ASW basis
45.0 (15-Mar-13)
53.0 -8.0 25bp 60bp Hold: Initiated curve flattener
Buy NAB 2.75% Mar-17 vs WSTP 2.00% Aug-17 on ASW
15.0 (13-May-13)
17.4 -2.4 5bp 25bp Hold: NAB U$ 2017 wide relative to WSTP U$ 2017
Buy TLS 4.80% Oct-21 on ASW v 1.60x TLSAU 5yr CDS
-0.6 (17-May-13)
-22.6 +22 Hold: 2021 bonds offer value at current levels. Long position hedged via CDS
Buy WSTP 3.625% Feb 23C18 v WSTP 1.60% Jan 18 on ASW
125.0 (28-May-13)
149.9 -24.9 100bp 160bp Hold: Sub /Senior multiple to wide
Buy TLSAU 6.25% Apr 15 v TLSAU 4.00% Nov 17 on ASW
-10.0 (12-Jun-13)
-14.2 +4.2 -25bp 0bp Hold: Telstra short/mid A$ curve too flat
Buy RENTEN 5.75% Jan-15 (A$) vs EIB 6.25% Apr-15 (A$) on ASW basis
-1.0 (9-Jul-13)
2.1 -3.1 -15bp 7bp Buy
2013 to date +118.9bp (including +146.4bp from closed trades)
Global Markets Research | Fixed Income: Weekly Strategy
3
Short term interest rates
The August RBA meeting is ‘live’. Weak Australian and Chinese data has pushed implied odds of a 25bp rate cut from 42% to 68% over the last week. The final obstacle for the RBA is the Q2 CPI report due on July 24. But the easing bias is likely to persist well after that.
The falling AUD puts less pressure on the RBA to ease right away. But the RBA would want to see if the move extends further and where the TWI settles. We expect a weak labour market to keep the RBA in play for many months, with sub 2.5% cash still a good chance. The risk to our view lies more with the RBA pushing rate cut expectations back to see how the AUD and nascent housing recovery play out, rather than abandoning an easing bias altogether.
Our bias is to use sell-offs to add front end flatteners in STIR as rate cut pricing pushes well into 2014. We implemented a long Jun-14 against Dec-13 bill position to capture this view a few weeks ago.
BBSW spreads to OIS remain elevated by 2013 standards, at 15bp. Beyond the typical intra-month seasonality, we think bill/OIS spreads will remain at relatively tight levels by historical standards, given limited issuance and ample liquidity.
Commonwealth bond curve
The massive US sell-off has been quicker than anticipated, but hardly a shock. The US recovery looks entrenched, with diminishing financial and fiscal tail risks. We have lifted our US 10Y forecast to 3% by Dec-13, and then a slow rise to 3.4% over 2014. We look for the sell-off to slow because we don’t believe the market can price a terminal fed funds rate high enough to justify a 10Y higher than 3-3.5%. The fed seems on track to begin tapering QE in September.
ACGB bond yields have bottomed. While domestic pressure to ease policy will linger, pricing has been pared as the AUD has dropped and global bond yields rise. In line with our US call, we now target 10Y ACGBs at 4% end-year and 4.4% by Dec-14. But domestic factors remain supportive for now, and we expect a 3.6-3.9% range.
Longer ACGBs will track the US sell-off over time (but out-perform as per below). The front-end should retain more support given domestic and regional economic challenges, so further steepening is possible. But the 3/10Y curve is already very steep at >100bp, and we’re not inclined to chase it further though we forecast a further drift higher. 3-5yr bonds are at risk of playing catch-up at some point and we are looking for the right opportunity to add a 3/10Y flattener.
Commonwealth bond spreads
We entered an Aus-US 10Y contraction trade after the spread widened in the FOMC sell-off. The spread has since tightened back to 115bp and we have pulled in the stop. Further contraction is likely, but probably requires another kick-along from either strong US data or weak Australian data (CPI on 24 July seems the most likely).
We see fundamental differences in the underlying direction of the US economy and Australia. In time, the relative weakness of the Australian economy will eventually pull the spread lower as the US recovers. Additional concern about the pace of current and future growth in China should assist that narrowing.
However, currency related movements could introduce short-term volatility. AUD-related buying will probably be slow to emerge and the key risk is that further currency-related selling hits first.
AUD money market
Source: Bloomberg, CBA
ACGB curve
Source: Bloomberg, CBA
AUS-US 10Y bond spread
Source: Bloomberg, CBA
0
20
40
60
80
100
2.0
2.5
3.0
3.5
4.0
4.5
Jan-12Apr-12 Jul-12 Oct-12Jan-13Apr-13 Jul-13
Cash rate
3m OIS
3m BBSW
%
3m BBSW-OIS margin (rhs)
bp
30
40
50
60
70
80
90
100
110
1.5
2.0
2.5
3.0
3.5
4.0
4.5
Jan-12 May-12 Sep-12 Jan-13 May-13
%
3-10yr futures curve (rhs)
bpAust 10yr bond yield
(lhs)
3yr bond yield (lhs)
100
125
150
175
200
225
250
1.0
2.0
3.0
4.0
Jan-12 May-12 Sep-12 Jan-13 May-13
%
Aust-US 10yr bond spread(rhs)
bp
Aust 10yr bond yield (lhs)
US 10yr bond yield (lhs)
Glob
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Global Markets Research | Fixed Income: Weekly Strategy
6
Credit Markets
Credit spreads across both cash and CDS continued their tightening trend as sentiment improved amongst real money investors, albeit with interest limited to the short end of the curve. Accordingly, credit curves continue to steepen. While pockets of strength are forming, the market as a whole remains skittish and volatility is weighing on markets, which we expect to remain the case in the near term.
Continued limited supply, the large near term maturity profile and the improving economic backdrop behind the Fed’s new stance should remain supportive of tighter cash spreads in the near term and in the short-end. A weaker A$ continues to pressure the longer end of A$ curves and, while value is emerging, we prefer to see the markets settle down before pulling the trigger and recommending investors increase exposure to credit.
Not unexpectedly, given we’re approaching reporting season, primary wholesale markets saw no new deal flow last week. Notwithstanding, retail appetite remains strong with both ANZ and Westpac launching Lower tier 1 and lower tier 2 deals respectively. Demand has been strong with both deals over-subscribed.
Medium to longer term we remain optimistic and we expect credit spreads – cash and CDS – to tighten given the relative health of corporate Australia and limited supply profile.
CDS Markets
The iTraxx Australia index tightened 5bp to 129bp but was again volatile amid the release of local employment data and particularly Bernanke comments on the pace of QE tapering. The index is still 21% tighter than its June 2012 levels but 32 bp off its recent tights.
Since the start of 2013, the iTraxx Australia has performed very well relative to other major indices. However, the iTraxx Australia has underperformed the iTraxx Europe since mid-April. The iTraxx Australia is currently trading 21bp wider than iTraxx Europe (vs 12 month average of 10 bps and post GFC average of 11 bps).
The iTraxx Australia is well above our year-end target. While the move out from recent tights has been in line with our view, we have been surprised by the magnitude and speed of the move. We are sellers of protection over the medium to long term, but we expect the markets to remain volatile in the near term.
We have seen protection buyers in the market, getting set at 132 bps, near the bottom of our the recent range for the iTraxx (130bps -150 bps). Further tightening could see these positions stopped out, leading to the iTraxx breaking through 120 bps over coming weeks. We retain our 115bp two-month target ahead of reporting season.
Financials
Bonds saw some bid interest throughout the week. The steep curve even enticed some selective extension trades. Flows, however, were dominated at the front and belly of the curves. Offshore flows and asset allocation should dictate direction for spreads as the markets realign themselves to the fact that the tapering issue has now moved from an ‘if’ to a ‘when’.
Australian banks maintain their strong position relative to global peers. Wholesale funding cost pressures have eased notably, even considering the moves over the last few weeks. The banks continue
Select CDS Indices
Source: Bloomberg
2013 Maturity Profile (Corp+SSA+Semi+ACGS)
Source: Bloomberg
iTraxx Australia RV performance to Major Indices
Source: Bloomberg
80
120
160
200
Mar-12 Jul-12 Nov-12 Mar-13 Jul-13
bps
iTraxx Australia
iTraxx Europe
iTraxx AsiaXJ
0
5
10
15
20
25
Jul Aug Sep Oct Nov Dec
in A$ billion
0.80
1.00
1.20
1.40
1.60
1.80
Mar-12 Jul-12 Nov-12 Mar-13 Jul-13
RV to iTraxx AsiaXJ
RV to CDX-NA
RV to iTraxx Europe
Global Markets Research | Fixed Income: Weekly Strategy
7
to strengthen capital and liquidity positions. Asset quality in the remains stable with NPLs at ~1.5% of total loans (well below the 1.9% post-GFC high). Although profitability and returns have been supported over the last 6 months by lower funding costs, lower credit costs and cost controls, the banks face earnings headwind in a slow credit growth environment. The risk in the near term is growing competition and impact on NIM.
The main concern for Australian banks from a regulatory point of view is the implementation of liquidity ratio under Basel III. APRA has confirmed it will not follow the Basel Committee by relaxing the Liquidity Coverage Ratio (LCR) implementation schedule. But it has adopted the bulk of the relaxed assumptions for cash inflows and outflows, pointing to a lower liquidity bill that we assess to be favourable for the banks.
With that back drop, we expect domestic and international investor demand for 4M term paper to remain strong. At current levels we look to the short end (<2yr) of the 4M A$ curves for a yield pick up over cash rates. Relative to the seniors, we to prefer the callable pre-Basel III LT2 bonds as they offer great value at current spreads. We continue to hold on to our Sub-Senior RV trade.
S&P placed Bank of Queensland’s (BOQ) ‘BBB+’ on CreditWatch positive on the expectation the bank’s capitalisation levels will be stronger. This is despite the recognised negative trend in Australia’s economic outlook. Subject to continued evidence of the bank’s ability and willingness to maintain capital levels supportive of an A- rating, S&P may upgrade the bank in the next 3 months.
NAB issued €360mn 3 Year floating rate notes at EURIBOR + 35 bps, maturity is July 2016
Non-Financial Corporates
As we approach the domestic reporting season and remain within the ‘black-out’ period, we expect supply of Australian corporate paper to be limited in the coming month. Notwithstanding these drivers, due to small capex plans (outside mining) and political uncertainty leading into the next election are also key contributors. Australian corporates will remain opportunistic in tapping domestic debt markets especially when equity markets are buoyant. Over the last few years Australian corporates have done well to manage and repair balance sheets and we expect them to maintain a relatively conservative stance for the foreseeable future.
While it is tempting to consider higher-yielding issuers and select names have performed well, we prefer to be positioned on an individual credit perspective. In select sectors we continue to expect best-in-class names to continue to outperform even though they trade at already tight spreads.
Goodman Group (S&P: BBB/Moody’s Baa2) announced its Goodman European Logistics Fund (GELF, S&P: BBB/Moody’s Baa3) successfully raised €550m (~A$750m) through a rights issue. The rights issue was oversubscribed 1.6x with strong demand from new investors. Total orders received totalled €900m (~A$1.3b). GMG will dilute its ownership in GELF to approximately 20% (from 26.6% Jun-12), which will result in a cash flow to GMG of ~€110mn. (~A$150mn).
SPN AusNet launched a €500mn (A$707mn) 7 year bond at mid-swap +95 (ASW + 155 bps) as part of its general debt refinancing requirements and to fund capital expenditure. This is SPN’s first Euro bond issue..
Select 5Yr Aus CDS - 3M Absolute Change
Source: Bloomberg
Select CDS and Bonds
Source: Bloomberg. Bonds – Spread to ASW
Corporate Spread to ASW
Source: CBA
-50 -30 -10 10 30 50
iTraxx Aus
QBE
BHP
WOW
CWN
LLC
WES
WPL
QAN
RIO
TAH
WBC
Tighter
Wider
50
150
250
350
Mar-12 Jul-12 Nov-12 Mar-13 Jul-13
bps NAB 7.25% 18WSTP 6.00% 17ANZ 5y CDSiTraxx Eu Sn FinCDX America Sn Fin
50
150
250
350
450
550
650
750
Jan-09 Feb-10 Apr-11 May-12 Jul-13
bps
AA (5yrs) AA- (5yrs)
A- (5yrs) BBB (5yrs)
Global Markets Research | Fixed Income: Weekly Strategy
8
Covered bonds
Covered bond spreads have narrowed by around 100bps since issuance in late 2011. That 4yr paper is currently trading at a 40% premium to senior unsecured notes. This premium has widened over the year and points to a cautious near-term outlook. At current levels we believe that covered bonds are trading at fair value relative to the seniors. Covered bonds are viewed as defensive in nature and therefore in a narrowing market we expect the covered bonds to underperform the seniors and vice-a-versa.
With year-to-date covered bond issuance of just ~A$9.5b, there is high possibility, barring a global liquidity crunch, that our earlier FY13 covered bond issuance forecast of A$35b will be not be reached. Although the 5 Australian banks have around A$94b of spare covered bond issuance capacity, the combination of limited wholesale funding requirement (limited to refinance needs) and the strength of other funding options such as RMBS has negatively impacted covered bond issuance volume. We have revised our FY13 covered bond issuance forecast down to A$15-20b.
As the credit market condition calmed down, the AUD senior-unsecured notes tightened significantly. The spreads are now back at their levels observed a month ago. As expected, covered bonds held relatively better than the seniors during the recent volatile market condition. However, the magnitude of AUD senior-covered spread compression was greater in AUD than EUR and USD markets. We believe that the senior-covered spreads will continue to move towards their long-run average.
RMBS/ABS
We expect RMBS issuance to be highly opportunistic and driven by prevailing market conditions. The four major banks (~80% of lending market) are well funded. However, for the smaller ADI’s, RMBS should remain a key source of funding and their share of total securitisation should remain high.
ABS/RMBS issue margins lagged the tightening seen in the broader credit market in 2012. But they narrowed markedly late in 2012 and early 2013. Prime RMBS transactions for 2-3 WAL have compressed by around 30bps compared to end of last year. We believe that the observed rally on issue spreads has reached a plateau and do not foresee any major contraction in the near term.
CNH Capital Australia Pty. Ltd (“CNH”) priced a A$400m ABS deal through its “CNH Capital Australia Receivables Trust Series 2013-1”. The transaction is backed by agricultural and construction equipment. Nine domestic and offshore investors participated in the transaction and it was oversubscribed. Compared to CNH’s last deal in September 2011, the spreads of the Class A1 and Class A2 Notes compressed by ~15bps and ~50bps, respectively. The Class A1 Notes priced at 3m BBSW+45 and the Class A2 Notes priced at 3m BBSW+110.
Aust banks A$ covered bonds vs senior debt
Source: CBASpectrum
Senior-Covered ASW spreads
Source: Bloomberg, CBA
RMBS, ABS and CMBS Issue Margin (2-4yr)
Source: Bloomberg, CBA
30
60
90
120
150
180
210
Jul-11 Mar-12 Nov-12 Jul-13
bps WBC (18-Nov-16)
CBAC (25-Jan-17)
WBC (09-May-16)
WBCC (06-Feb-17)
WBC (20-Feb-17)
10
20
30
40
50
60
70
Apr-12 Jul-12 Sep-12 Dec-12 Mar-13 Jun-13
A$ U$ €
0
50
100
150
200
250
300
350
400
450
Jan-07 Aug-08 Mar-10 Nov-11 Jun-13
bps
CMBS
ABS
RMBS
Glob
iTr
Sou
bal Markets Re
axx Australia
urce: Bloomberg
esearch | Fixe
a: Key consti
rg, Prices as of 5
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tuents and 3
5 July 2013
Weekly Strateg
3M snapshot
gy
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Global Markets Research | Fixed Income: Weekly Strategy
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Key Forecasts
Cash rate 15-Jul Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14
US 0.25 0.25 0.25 0.25 0.25 0.25 0.25Australia 2.75 2.50 2.50 2.50 2.50 2.50 2.75New Zealand 2.50 2.50 2.50 2.75 3.00 3.00 3.25United Kingdom 0.50 0.50 0.50 0.50 0.50 0.50 0.75Euro-zone 0.50 0.50 0.50 0.50 0.50 0.50 0.75Japan 0.10 0.10 0.10 0.10 0.10 0.10 0.10Canada 1.00 1.00 1.00 1.00 1.00 1.25 1.50
2-yr bond yield 15-Jul Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14
US 0.34 0.50 0.75 1.00 1.20 1.40 1.60Australia 2.45 2.50 2.50 2.60 2.80 3.20 3.60New Zealand 2.79 2.90 3.20 3.50 3.80 4.10 4.30United Kingdom 0.36 0.30 0.35 0.40 0.60 0.90 1.20Germany 0.11 0.10 0.10 0.20 0.50 0.80 1.10Japan 0.13 0.15 0.20 0.20 0.25 0.25 0.35Canada 1.13 1.30 1.60 1.80 2.00 2.20 2.40
10-yr bond yield 15-Jul Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14
US 2.58 2.80 3.00 3.20 3.30 3.40 3.40Australia 3.72 3.90 4.00 4.10 4.20 4.30 4.40New Zealand 4.26 4.30 4.50 4.75 5.00 5.20 5.10United Kingdom 2.33 2.40 2.50 2.60 2.90 3.20 3.30Germany 1.56 1.70 1.80 1.90 2.00 2.10 2.20Japan 0.82 0.90 1.00 1.00 1.10 1.10 1.10Canada 2.43 2.60 2.70 2.90 3.20 3.40 3.50
Global Markets Research | Fixed Income: Weekly Strategy
11
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