USD denominated bonds issued by Australian companies have been caught up in the recent weakness in USD bond prices. This has been further exacerbated by trade tensions between the US and China, creating an opportunity for investors to enter or add to holdings
Investment thesis
- In the last few weeks the price of USD denominated bonds issued by Australian entities has declined
The price decline is driven by investor sentiment in light of current uncertainty surrounding US-China trade tensions
We believe this has created an opportunity for investors to allocate funds into USD bonds issued by Australian companies as it is likely that the prices will normalise, assuming some resolution to the trade war dispute.
Background
Australian companies regularly issue bonds in currencies outside of AUD to meet funding requirements. This might be because they have a natural need for funding based in other currencies or due to the relative attractiveness of offshore issuance, such as lower cost of funds.
We have a number of such bonds on our DirectBond menu. They have been caught up in the sell-off of USD denominated bonds since the beginning of 2018, following the rise in US Treasury yields. However, as US Treasury yields recently moved lower, there has been a dislocation between the prices of USD bonds issued by US based companies versus those based in Australia.
The primary reason for this dislocation seems to be rising uncertainty surrounding the incipient trade war between US and China, which has resulted in investor nervousness. This has led to a sell-off in Asian bonds, leading to lower prices, including securities issued by Australian entities. Institutional credit investment funds appear to be opting to sit on the sidelines as they make sense of the implications of the trade war.
This sentiment is also resulting in weaker primary issuance volumes and lower liquidity in secondary trading.
In other words, price easing is not reflective of the changes to credit worthiness.
Investment opportunity
Although we have been concerned about rising US interest rates, a we believe there are some relative value opportunities for longer dated bonds mentioned in this note. Lower prices and yields available are much more attractive and now outweigh the duration risk presented by longer maturities.
The chart below examines performance of seven USD bonds and one Australian dollar bond, also impacted by the trade war, issued by well known Australian entities. For the purpose of illustrating the price move, we have indexed the price at 100 on 1 January 2018 and used the daily movement in each bond’s price to track changes over the last seven months. Similarly, we have tracked the changes in US 10 year Treasury yields by indexing them at 100 on 1 January 2018. As bond prices and yields have an inverse relationship, the movement in US Treasury yields is plotted on a reverse scale on the right hand axis.
As seen, each of these bonds has fallen by at least 3% since the beginning of the year, with QBE and BHP (both investment grade bonds) having fallen over 5%. Weakness in bond prices earlier in the year was driven by rising Treasury yields, illustrated by the navy blue line in the chart below. However, this relationship has broken down in the last few weeks. Since mid May, Treasury yields have steadily moved lower but USD denominated bonds of Australian issuers have continued to track lower.
Usually, such dislocation would indicate that credit spread widening, rather than specific yields curve movements might be driving prices. However, we have not found any evidence that would support this theory as similarly rated bonds issued by these companies in currencies other than USD have not experienced such a dramatic fall in prices.
For example, the AUD denominated subordinated debt issued by QBE, which is equivalently rated to the USD bond was trading at 106.52 on 2 January 2018 and was last priced at 105.10 on 17 July 2018, representing a 1.3% decline since the beginning of the year. Whereas the USD denominated QBE bond was trading at 110.00 on 2 January 2018 and was last priced at 99.40 on 17 July 2018, which is a substantial decrease of 9.6% when the credit quality of the underlying issuer is exactly the same. While the USD bond has longer tenor compared to the AUD bond, the increased duration does not explain such a large disparity in price movement.
Source: FIIG Securities, Bloomberg
Conclusion
We see an opportunity for investors to invest in these bonds as it is likely that the prices will normalise, assuming some resolution to the current trade war dispute occurs. Specifically, we see value for investors in the following:
- QBE-5.875%-17Jun26c-USD, rated BBB
- NCIG-4.40%-29Sep27 (new DirectBond), rated BBB
- NCIG-12.5%-31Mar27c – USD, rated B+
- BARMINCO-6.625%-15May22-USD, rated B
Please speak to your relationship manager if you would like Factsheets or specific pricing around these or any other names.
Note: Prices accurate as of 20 July 2018 but subject to change