Tuesday 06 May 2014 by FIIG Research Legacy

From the Trading Desk (06/05/14)

Yield direction and volatility

The Federal Open Market Committee (FOMC) met last week and, as expected, continued the tapering of the Quantitative Easing (QE) program by another $10bn to $45bn. The fourth straight cut was relatively in line with market expectations, with a statement following the meeting saying further reductions in “measured steps” are likely.  This was followed on Friday night by unexpectedly strong employment figures, with payrolls up 288,000 and the unemployment rate falling to 6.3%. US treasuries continued drifting lower, with the 10 year note ending the week 7 basis points (bps) down at 2.59%. In Australia, the 5 and 10 year benchmark swap rates dropped 4-8 bps over the week, to close at 3.52% and 4.19% respectively. Meanwhile, there was less movement across Commonwealth government yields, as they lowered only 1-2 bps over the week to close at 3.28% and 3.91%. 

As broadly expected, the Reserve Bank of Australia (RBA) left interest rates unchanged at 2.50% following yesterday’s meeting. The accompanying commentary included an improvement in global conditions offset by expectations that resource sector investment spending would decline and unemployment would remain at the current elevated levels for some time. The Australian employment situation will be released tomorrow, with expectations for the unemployment rate to rise slightly to 5.9%.

Long-term interest rates have been declining steadily over the past four weeks, both domestically (29bps) and in the US (22bps). Increasingly, we have seen investors with an overweight position in fixed coupon bonds locking in profits and shifting to a more balanced mix of fixed rate, floating rate, and inflation-linked bonds as yields fall.

Impending US tax legislation triggers selling in a range of bonds

New US legislation termed the “Foreign Account Tax Compliance Act (FATCA)” has resulted in an intergovernmental agreement between Australia and the US to target tax avoidance and will take effect 1 July 2014. Investors who hold bonds issued out of US entities will be required to complete W8-BEN forms to certify they are not subject to US tax. While the process is not overly cumbersome, we have seen some holders of these bonds selling out of their positions early as a result. 

The most common bonds sold on this basis have been the Rabo Tier 1 fixed and floating rate bonds callable in December this year, as well as various Morgan Stanley bonds. If you would like to ascertain whether you hold any of the bonds that will be affected by this legislation, please contact your FIIG representative.

Other credit margins and trading activity

Inflation-linked assets were in demand last week as many clients sought to switch exposure from the Sydney Airport 2020 capital indexed bond (CIB) into the longer dated 2030 line for a pickup in overall yield. Continued demand in the 2020s led to an active two-way market. Supply in the 2030s however has become difficult to source, putting FIIG in a good position to execute client sell orders.

Envestra August 2025 CIB traded in modest volume last week, cleaning up available supply. The Envestra CIB is typically a very tightly held security, and as such future supply is difficult to forecast. FIIG is well placed to execute sell orders at an indicative current bid yield of 6.05%.

Qantas April 2020 fixed rate bond became eligible for retail investors on Monday of last week, prompting a flurry of activity among retail clients seeking the comparably higher yield. Supply is still readily available, however continued demand coupled with the declining trend in interest rates have caused the Qantas bond to rally hard and it traded 8bps tighter over the week. Similarly, the Mackay Sugar Limited (MSL) April 2018 fixed rate bond traded actively among retail clients leaving demand outstripping supply.

Following strong 3Q14 earnings, the Cash Converters 2018 fixed rate bond rallied strongly last week, sending the yield 15bps lower. The bond is currently in short supply at an indicative offer yield of 7.03%.

High turnover was recorded among Tier 1 securities last week as bid interest from the institutional sector remained strong. Clients took the opportunity to exit out of some of the shorter dated securities, as liquidation can become difficult closer to maturity. Coupled with the impending FATCA legislation discussed above, the Rabo Dec 2014 fixed and floating lines were the most traded with $22m in turnover recorded across both lines.

Secondary trading on the recently issued CBL Corporation Limited (CLB) Apr 2019 fixed rate bond has remained consistent, steadily pushing the offer yield down. Supply remains available in size at a current indicative yield of 7.70%.


Offer levels are indicative as at 06 May 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.