It’s almost as if Dr No has cunningly crafted a new plan to kidnap all the world’s bonds, and as a result yields are disappearing faster than 007 and Honey Ryder on Crab Key Island
Last week the Bank of England (BoE) attempted to buyback GBP1.17bn of UK government bonds but was only able to find GBP1.12bn from sellers. This failure was the first since Quantitative Easing (QE) started in the UK in 2009 and starkly highlighted the challenges of the newly announced expanded QE program.
As a result, UK gilt yields (government bonds) continued their downward trajectory; 10 year and 30 year yields traded at record lows of 0.51% and 1.18%, respectively. Furthermore, the UK government issued GBP850m of inflation linked bonds due to mature in 2036 at a record low real yield of minus 1.722%.
Given these low yields, we could assume that demand would wane but this has not been the case. Part of the problem has been created by the regulators that require banks to hold increasing allocations to high quality assets as a liquidity buffer for times of stress. The majority of these assets consist of sovereign bonds; thus creating natural demand.
Switching to the US Treasury market, last week there was strong demand for the auction of 3 year and 10 years USTs. In fairness, a 30 year auction produced only tepid demand.
This demand for bonds has been compounded by certain companies deciding to buy back their own bonds. For example, Adani Abbott Point Terminal announced that it would tender for up to $75m of its $500m 5.75% notes due in 2018. Also, IAMGOLD announced a $200m equity rights issue, with up to $150m of the proceeds expected to be used to buy back some of its $635m 6.75% notes due 2020.
This strong demand has seen US corporate new issuance jump. According to Bloomberg data, in the last seven weeks, US investment grade rated companies have issued about US$250bn or almost a quarter of all bonds issued this year. So far in August there has been more than US$30bn issued, which is already the highest volume issued since 2010. There is another US$10 to 15bn of supply expected this week.
The Australian major banks have been active offshore. ANZ printed US$2.7bn of five year bonds and Westpac issued US$5bn across 3, 5, and 10 year tranches. Investor demand was robust, as bids for the Westpac bonds were almost double at US$10bn.
However in Australia, we are struggling to see any significant pure corporate investment grade issuance. Fixed income investors are struggling to find any assets to buy and like offshore this has driven down domestic yields and credit spreads. For example, the Australian iTRAXX index – a bell weather of credit sentiment – has dropped 24bps to 103bps from 127bps at the start of July.
When will this imbalance change?
One of the key drivers that may derail this demand is central banks, in particular the Federal Reserve and if and when it decides to hike rates again. After the weak retail sales and disappointing consumer confidence figures, investors remain sanguine about the risks; the market is currently only pricing in a 12% chance of a 25bps hike in September and a hike by December is only a 43% chance.
As such, the market is only pricing in a higher than 50% chance of a Fed hike by March 2017. This is a considerable change from the four hikes that the Fed was predicting at the start of this year. Furthermore, it illustrates that any tightening by the Fed should be moderate and they are still highly dependent on data.
So given all the above, it is unlikely that the tide on Crab Key island will turn anytime soon; bonds and yields are still receding. This unfortunately leaves investors seeking income and a safe harbour with little choice but to chase the existing supply of bonds.
Note: We are continuing to scour international markets to make attractive foreign currency bonds available in small parcels. Two recent additions, TransAlta and IAMGOLD are good examples. However, these are only available to wholesale investors.
Wholesale investors can access a greater range of domestic and foreign currency bonds and have a better chance at filling orders. If you think you may qualify as wholesale, please call your local dealer.