Bond traders are bidding big for Australian government debt again

Parliament House in the Australian capital, Canberra. Photo: Andrew Sheargold/Getty Images

Australian government bonds are back in favour.

Demand at Australia’s bond sales in 2017 has risen to the highest level in 12 years, as the government’s planned issuance of new debt has more than halved.

Last year, investor bids fell to 2.89 times the amount of bonds offered on average, the lowest level since 2002. This came as a record-setting global bond rally began to fade and new issuance soared to record levels.

At auctions this year, however, investors have submitted bids to buy an average 4.12 times the amount of debt the government has had on offer, the highest level since 2005.

The figures are based on data from the Australian Office of Financial Management, reviewed by Business Insider.

One sale in March 2017 drew bids for 6.8 times the amount available – almost a three-year high.

“Fears of higher bond issuance as the federal government ramps up infrastructure spending have not eventuated,” Alex Stanley, a senior interest rate strategist at National Australia Bank said. “After the Budget, the forecast profile for commonwealth government securities outstanding is little different to mid year projections. Australian government bonds remain well supported.”

This chart shows the rising bid to cover ratio, reflecting the level of market demand versus the available bonds being issued.

AOFM, the government’s funding agency, estimates net issuance in the year to June 2018 will be $34 billion, compared with $74 billion a year earlier.

“Bid to cover ratios appear to have risen in the last few months with the broad rise in yield and steeper curve,” Martin Whetton, a senior rates strategist at ANZ Bank said. “Another possible factor was the fast pace of issuance over the course of the year had put the AOFM into a position of having a reduced need for funding.”

A look at the budget papers also shows a similar trajectory. The face value of Commonwealth Government Securities (CGS) on issue is projected to rise by $39 billion to $540 billion by June 2018 compared with a $80 billion rise this financial year.

Australian government securities on issue totaled $494 billion as of last week, up from $438 billion a year earlier. The agency raised more $20 billion in just two transactions in the first two months of the year. The $11 billion of November 2028 bonds issued in February is the biggest ever bond sale.

Net debt is estimated to be 19.5% of GDP in 2017/18 and to peak as a share of GDP at 19.8% in the next year, according to the budget papers. It is then projected to decline as a share of GDP
to 8.5% by 2027-28.

Given supply of new bonds is estimated be the lowest since 2013, fund managers are piling into what is still one of the highest yielding developed market government bonds.

Aussie 10-year bonds yielded 2.51 per cent on Wednesday up from the all-time low of 1.84 percent in July. The yield premium the nation’s benchmark bonds offer over their US peers stood at 23 basis points up from 19 basis points last month, the narrowest since 2001.

Aussie bonds have managed to hold on the spreads despite monetary policy divergence. While the consensus expectations is for the Reserve Bank of Australia to stay on hold for the rest of the year at a record low cash rate of 1.5%, the US Fed is seen moving twice to a range of 1.25% to 1.5%, pretty much wiping out the cash rate differential.

Economists’ yield forecasts suggest the premium will remain intact through the year. The Australian benchmark bond is seen yielding 2.76% by the end of the year, while its US equivalent will return 2.46%, according to estimates compiled by Trading Economics.

Demand also got a leg up from the AOFM issuing more longer-dated bonds so far this year compared to 2016. More than 60% of the issuance this year has bonds with a tenure of 10 years or more, compared with about half last year.

Longer-dated bonds offer a bigger coupon rate. And money managers globally have been extending the duration of their portfolios, emboldened by the US Federal Reserve’s indication that it is unlikely to speed up the pace of rate rises.

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