Monday 02 September 2013 by Legacy

Fixed income market update (2013)

Australian iTraxx

The Australian iTraxx Credit Default Swap (CDS) index tracks the performance of Australian corporates and is an indicator of credit risk for investment grade entities.  The lower the spread, the lower the perception of credit risk.  The charts below show performance over one month and one year.Over the month, the Index widened some 7bps as expectations firmed that the US Federal Reserve will start to scale back its monetary stimulus measures next month, meaning the market expects interest rates will rise and risk will increase. This news acted in tandem with a raft of disappointing Australian profit results primarily from the retail and mining sectors to lift the spread.

Bond market in review

The RBA cut the cash rate in August given the government downgrades to growth projections and upward revisions to unemployment forecasts (6.25%). The RBA did not repeat its easing bias in the August press release, but the minutes introduced a weak data-dependent bias, reporting that board-members "should neither close off the possibility of reducing rates further, nor signal an imminent intention to reduce rates further [but] ... continue to examine the data over the months ahead to judge whether monetary policy was appropriately configured".

The Australian Federal election has been called for the 7 September 2013 which removes the uncertainty which has been a headwind to issuance. Year to date 2013 primary issuance of $57.5bn is 16% lower than last year.

Federal Open Market Committee minutes: There was little new information in the minutes. FOMC members were described as being “broadly comfortable” with Bernanke’s plan to start reducing bond buying later this year if the economy improves. The latest public comments however, which came after the July FOMC meeting, showed increasing willingness to commence the taper in September.

S&P/ASX 200 Accumulation Index v UBS Composite Bond Index

The UBS Composite Bond Index is designed to measure the performance of the Australian bond market. The Bond Index consists of approximately 300 fixed interest securities issued by the Commonwealth Government, the State Government and semi government authorities as well as investment grade corporate issuers. This index provides a good representation of the movements in value and interest rates of this asset class.   


Source: UBS, FIIG Securities

Note: S&P/ASX200 Accum Index rebased to 1000 as at 30-Sep-1989

The equities market has bounced back from the last two months’ declines, with the S&P/ASX200 Accumulation Index finishing July up +5.20%. This strong performance is further reflected in the gain of +23.83% which the equities market has returned over the last twelve months. The solid performance of equities over the month has seen that market pull ahead of fixed income on a long term returns basis, as evidenced in the above chart with an 8.94% return compared to 8.86% for the UBS Composite Index.

Credit spreads

The below chart and graph shows credit spreads (over the applicable swap curve) for each of the S&P investment grade rating band based on a five year maturity. Over the last month, spreads continue to contract.  

Significant ratings changes over the month

Australia’s sovereign rating:  S&P affirmed Australia’s rating and stable outlook. The agency remains constructive on the outlook saying "Growth of the Australian economy is expected to slow to 2.6% in year ended June 30, 2013, ... But we forecast growth will improve to 3% in fiscal 2014". On the fiscal and debt outlook, S&P “expects the general government sector's budget balance to post relatively small and declining deficits as a share of GDP, and to be broadly in balance by 2016. Under its base-case scenario, general government net debt is expected to peak at 20% of GDP in 2014 before gradually declining". The key risk to the rating remains around a potential deterioration in the country’s external position.

US’s sovereign rating: Moody’s has released a report which highlights that US budget deficits have been declining and are expected to continue to decline over the next few years. Furthermore, the growth of the US economy, which, while moderate, is currently progressing at a faster rate compared with several peers and has demonstrated a degree of resilience to major reductions in the growth of government spending. Therefore, the US government's debt-to-GDP ratio through 2018 will demonstrate a more pronounced decline than Moody's had anticipated when it assigned the negative outlook. According to the Congressional Budget Office (CBO), the budget deficit for the 2013 fiscal year is likely to decline to 4.0% of GDP from 7.0% in 2012 - a greater decline than Moody's had anticipated in 2011 when it assigned a negative outlook.

QBE LMI: Fitch affirmed QBE Lenders' Mortgage Insurance Limited's credit rating and outlook. S&P said that QBE LMI has maintained a solid standalone credit profile underpinned by strong capital ratios, solid operating performance and a conservative risk approach. Fitch expects the company to maintain minimum capital requirement (MCR) of 1.25x or more to retain the credit rating. A severe housing downturn or a downgrade of the credit rating of QBE can also affect the credit rating.

NAB's Clydesdale Bank: S&P affirmed the long-term rating and short-term rating of NAB's Clydesdale Bank. It said the outlook is negative. A few days later, Moody’s cut its rating noting: "As a result of NAB's intervention, the bank is well capitalised and has substantial liquid assets, and we see no immediate threat to creditors from its near-term challenges." However, it warned: "The weakness of its franchise and uncertainty over its future strategic direction, alongside NAB's stated intention to sell the bank over the medium term, leaves Clydesdale in an uncertain position”.

S&P said the affirmation of their rating "reflects our assessment of Clydesdale's improved capital position [and is] supported by the broader de-risking and simplification of the franchise."  It said the negative outlook "reflects the negative 'trend' that we have assigned to UK banking industry risk”.

HSBC Bank Australia: S&P has downgraded HSBC Bank Australia's credit rating, citing a review of the local bank's status as a subsidiary of the HSBC Group. In a statement issued, S&P said: "The group's disposal of entities elsewhere in the world has led us to reassess the extent to which HSBC Bank Australia is fully integrated with the wider group." It has changed its categorisation of the local bank from a "core" subsidiary to a "highly strategic" subsidiary. "It is not so full integrated that its operational linkages make it practically inseparable from the rest of the group," S&P said. In response, HSBC Bank Australia issued a statement that said: "Australia has been a priority growth market for the HSBC Group since it outlined its group strategy to investors in May 2011 and this has not changed."

US Banks:  Moody's has placed the senior and subordinated debt ratings of the holding companies for the six largest US banks on review as it considers reducing its government support assumptions. Goldman Sachs, JP Morgan Chase, Morgan Stanley and Wells Fargo are on review for downgrade. Bank of America and Citigroup, are on review direction uncertain, as the rating agency considers the potentially offsetting influence of improvements in the standalone credit strength of their main operating subsidiaries, the ratings on which were simultaneously placed on review for upgrade. Bank of New York Mellon and State Street, whose ratings were previously placed on review for downgrade, are also included in this review.