The broken state of the bond market was a surprise in Rob Nicholl’s AOFM update for the debt market yesterday.
The need for an early Reserve Bank rescue mission was a key theme of Nicholl’s webinar hosted by Australian Business Economists.
“There are two things we hadn’t fully anticipated,” Nicholl told the ABE.
“One is the extent to which widespread investor-selling of AGS would create extreme market congestion, and added to that the time it would take for investors to meaningfully reengage, particularly offshore investors.
“Furthermore, the scale and speed of the build-up in outlays resulting from the pandemic related fiscal response is not something we could have foreshadowed.
“We will never know how long the market would have taken to recover had the RBA not intervened. While having liquidity to at least meet ongoing outlays into April, it would not have been sufficient to cover the start of the government’s pandemic response, a deterioration in the underlying revenue position, and the volume of bond buy backs required to clear intermediaries’ trading accounts.
“In principle a long enough suspension of issuance should allow the market to clear, but there was no way of knowing at the time how long that would require.
Most of the March congestion “arose from investor selling of maturities out to about 10 years,” Nicholl said.
“Although there was significant investor selling across the curve the focus was on bonds between the three and 10-year futures baskets. And while it didn’t seem the main action at the time we know that investor positions in ultra-long maturities were also unwound.
“In any case, the long-end of the market also recovered without the need for RBA intervention but again this required a prolonged period of targeted issuance suspension.
Nicholl then considered the utility of syndications. As the market was recovering during April and May, each of the new 2024 and 2030 bond line syndications allowed large volume testing of the market without the execution risk of an uncovered tender. At the same time they gave valuable insight into investor views on AGS.
“The importance of these transactions in gauging market conditions via investor appetite for duration risk and volume in AUD fixed income cannot be overstated, Nicholl said.
“Syndications continue to complement the importance of our regular market liaison but after the turmoil of March they really helped to reinforce a view that an early start to the large issuance task ahead could be smoothly achieved. The sequencing of them also allowed us to follow recovery of the market as trading liquidity gradually improved from the very short end toward the 10-year futures basket.”
This week’s launch of the new 30-year benchmark bond “has now given us better visibility into the dynamics of the ultra-long-end of the yield curve,” Nicholl said.
“ And as we just saw in the previous chart it highlights in particular the underlying strength in demand from the offshore investor base.
“A number of factors drive this and there will be wide-ranging views as to what factors are more or less important.
“However, our view is that a strong sovereign credit rating, attractive yields, transparency in the market (including consistent clear messaging from the RBA), active support from intermediaries, and up-to-date issuance guidance combine to promote investor confidence.”
The AOFM’s current plan for gross Treasury Bond issuance this year is around A$240 billion.
This will comprise about $50 billion to fund maturing debt and $190 billion of net new issuance.
This is materially higher than the $128 billion issued last year, although almost $90 billion of that was issued in the last quarter.