Yield direction and volatility
It was a relatively quiet week last week, with yields reversing their early rally to end the week not far from the open. The Federal Reserve released its meeting comments, saying continued stimulus to decrease unemployment will not result in an unwanted spark in the inflation rate. The statement also made mention of the benchmark rate remaining low for a ‘considerable time’. Also out of the US, the purchases of new American homes increased in April for the first time in three months. This was attributed to buyers taking advantage of falling mortgage rates. There was little economic data out domestically of importance and local rates mainly followed international events.
The 5 year benchmark swap rate opened and closed the week at the same rate of 3.44%, meanwhile the 10 year benchmark marginally increased 3 basis points (bps) to finish the week at 4.10%. Similarly there was little movement across the 5 and 10 year Commonwealth government yields as they increased 2-10 bps to close the week at 3.16% and 3.78% respectively.
Qantas 2022 offers a compelling alternative to the 2020 bond
For yet another week the newly issued Qantas Airways Limited May 2022 line continued to tighten, contracting another 6 bps points over the week as its popularity didn’t wane. Moving out of the shorter-dated Qantas 2020 maturity in to the May 2022 switch was still seen to offer value.
For wholesale investors, the 2022 bond offers a good alternative to the 2020 bond for two main reasons. Firstly, the 2022 offers an increase in yield of approximately 30-35 bps. This is around fair value for the extension of duration as implied by the yield and credit curves.
More importantly, there is a coupon step-up clause in the 2022 bond that is missing from the 2020 bond. In the case of a ratings downgrade, the coupon steps up by 25bps per notch per agency, with a maximum of 75bps per agency; so if both agencies downgraded the bond by a single notch, the coupon would step up by 50bps.
FIIG is well placed to execute switches between the two lines.
Other credit margins and trading activity
The Sydney Airport 2020 and 2030 capital index bonds (CIBs) were once again the most traded inflation linked securities for the week. Supply of the 2030 line provided an opportunity for clients to switch out of the shorter dated 2020’s for an attractive pickup in yield, which helped drive turnover for the Sydney Airports to $7.5m for the week. Both lines are currently available with indicative offer yields shown below:
- Sydney Airport Nov 2020: 6.00%
- Sydney Airport Nov 2030: 6.70%
Trading among inflation annuity bonds was limited as a lack of supply left little choice for investors. The JEM NSW Schools 2031 offers the best value among available lines at an indicative offer of 5.60%.
The above mentioned Qantas May 2022 easily took out top place among FIIG’s most traded issues last week with $21.5m in turnover. The relatively high coupon of 7.75% saw many wholesale clients favour the new line over the lesser yielding 2020 issue. However bid interest was strong in the shorter dated bond as the 2020’s still place as one of the highest yielding options available to retail investors.
High volumes of medium term fixed rate corporate paper transacted early in the week as offers came to market on the back of the new FIIG originated Adani Abbot Point issue. Declining yields towards the start of the week helped buoy institutional sector bids for much of the exiting stock. Among the most heavily traded were the DBNGP November 2018’s with $8.5m in turnover. Tier 1 securities also saw activity as continued appetite from institutional clients saw the Tier 1’s become a favoured switch target for moving into Adani Abbot Point.
Notes:
Offer levels are indicative as at 27 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.