Tuesday 25 February 2014 by FIIG Research Legacy

From the Trading Desk (25/02/14)

Yield direction and volatility

Yields were relatively flat last week, moving only slightly higher after weak US home construction figures were released late in the week. There was a 16% fall on the number of new homes starting to be built last month in the US and a large drop in the National Association of Home Builders Housing Market Index, although these figures, along with most of the recent weak economic indicators in the US, were attributed to the harsh cold winter. The yields on the 5 year and 10 year benchmark swap rates moved only 1-3 basis points (bps) higher to close the week at 3.74% and 4.53% respectively.  Likewise there was a small increase on the Commonwealth government bond yields with the 5 year and 10 year bond yields moving 4-6 bps higher to end the week at 3.49% and 4.22%.

Positioning for the new G8 FRN, the fixed coupon G8 bond weakens then rebounds

Amid switching and positioning for the new G8 floating rate note (FRN), which was announced last week, the margin on the existing fixed coupon bond widened by 36bps before recouping nearly all of that weakness and is now trading back near the lows of just over 300bps (see Figure 1 below). This is encouraging but not totally unexpected as the bond continues to be in short supply and, as our longest dated unrated corporate issue, represents good value in that part of the yield curve.

Source: FIIG Securities
Figure 1

Watch for Qantas results on Thursday

Qantas Airways announce their half year results tomorrow and the newswires will be followed for a potential government response to what is widely expected to be a poor outcome. As discussed last week, possible support may come in the form of a government guarantee over Qantas debt or an amendment to the Qantas Sale Act. While the latter is less likely due to difficulty passing it through parliament, the government has indicated that the former would likely be structured to be very unattractive to Qantas so that it is only used as a last resort.

The yield on the 2020 fixed coupon bond continued to drop last week, falling 15bps to the current level of around 6.45%. Based on price activity before and after the recent downgrade, the short term risk/reward trade-off still favours owning the bond into this event, but the attractiveness is a bit less than it was at this time last week.

New DirectBond

In addition to the Newcrest Finance Pty Limited October 2022 line, last week FIIG also added the Newcrest Finance Pty Limited November 2021 line to the DirectBonds list. Similar to the 2022 line, it is a Senior Guaranteed Fixed Rate note in US Dollars and is available to wholesale clients only in minimum parcels of US$10,000. It has a final legal maturity in November 2021 and pays a semi-annual coupon of 4.45%. Headquartered in Melbourne, Newcrest is among the top 20 companies listed on the Australian Stock Exchange. Newcrest owns and operates a portfolio of predominantly low cost, long life mines and a strong pipeline of brownfield and greenfield exploration projects.

Other credit margins and trading activity

The Tier 1 sector saw some heavy trading last week as a combination of attractive street bids and the allure of the new G8 FRN issue saw many clients turn sellers of Swiss Re and Rabo lines. The Swiss Re May 2017 fixed and FRN’s took top spot on FIIG’s most traded list with $13.5m in turnover recorded for the period.

The new issue also saw a solid week of trading for the rest of the FIIG originated deals as many clients looked to switch exposure into the new FRN. Supply is available in a number of our unrated fixed coupon issues. Indicative current yield to maturity levels are as follows:

  • Cash Converters September 2018: 7.17%
  • Mackay Sugar April 2018: 6.61%
  • Payce Consolidated December 2018: 8.92%
  • PMP October 2017: 7.71%

Trading among ILBs was again generated mainly from the Sydney Airport 2020 and 2030 issues. Supply has been consistent for the last few weeks, prompting high turnover in both bonds. The typically difficult to source Envestra August 2025 ILB saw modest trading last week as some clients switched into the new G8 FRN issue. Given that demand in the Envestra is always high, offers were  accepted as soon as they came to market.

Offer levels are indicative as at 25 February 2014 and subject to change based on demand and market movements.

Yields for floating rate notes are estimated as the sum of the swap rate to maturity / call and the trading margin.

Yields for capital indexed bonds and index annuity bonds are estimated as the real yield plus a 2.50% inflation assumption.