Tuesday 24 September 2013 by FIIG Research Legacy

From the Trading Desk

Follow-Up on last week’s commentary: Steep yield curve offers rare opportunity

The one-year to six-year interest rate spread has narrowed from a high of 153 basis points to 126 basis points as of yesterday. Those who took advantage of the opportunity were well rewarded, but you had to be quick. As stated, these opportunities are often very short-lived and following the FOMC meeting, where the expected tapering of the quantitative easing program did not occur, interest rates around the globe dropped and our yield curve quickly flattened.

We still view this as a relatively steep yield curve, and many related opportunities in corporate credit are still available.

Sydney Airport recent price performance

FIIG has had a number of queries regarding the recent price performance of the Sydney Airport Capital Indexed Bonds. Since May, the price has dropped nearly $10 from its high of around $105 and it is worth providing some insight into the causes of this underperformance.

The US Federal Reserve Open Market Committee (FOMC) began the long-awaited talk of “tapering” of the quantitative easing (QE) program informally in early May this year and again in a formal statement on 19 June. Markets in inflation-linked products have reacted in a very negative manner, which would imply that markets believe either that any tapering would be premature and significantly detrimental to inflation over the medium term or that tapering would be the first step toward a rapid rise in interest rates.

The effect on Australian inflation-linked bonds has been equally adverse, even though the QE program, and any reversal of such, has no direct links to our market. We do not view this as a concern, as the Reserve Bank of Australia has proven effective at maintaining core inflation around their target of 2% to 3% and we see no reason why that should change.

The recent underperformance of Australian inflation-linked bonds has been wide-spread, and we believe the main reason that most queries have been around Sydney Airport specifically are simply that this issuer is the most widely-held among our client base. The chart below shows the relative price performance of a range of Australian inflation-linked bonds across the entire credit spectrum since early May (with the Sydney Airport 2030 bonds in black). As indicated, the Sydney Airport bonds have performed more or less in line with the other securities in the sample set. The worst performing bonds were (somewhat ironically) the higher-quality government and semi-government bonds.

If we go further back and chart these same issues from 1 July 2012, we see that the Sydney Airport 2030 bonds have actually performed quite well relative to the other bonds in the sample set, second only to the Envestra 2025 bond. Again, the worst performing bonds over this time period were the higher-quality government and semi-government bonds.

We view this more as opportunity rather than concern, for the reasons detailed above, and would continue to recommend both of the Sydney Airport inflation-linked bonds as attractive investments.