It was a nasty week for the bond market, with a significant rise in bond yields without this move being triggered by the release of any significant economic data, or at least the economic data that the bond market has in recent memory considered important.
Paradoxically, the Australian bond market received very bad news in the form of an unemployment rate of just 3.9% last month. The labour participation rate remains near recent highs at 67%. The employment growth was full-time with 52,000 jobs added while part-time employment fell 17,000. The main sectors increasing employment were in government services like Health, NDIS, and Administration. These are long term hires not influenced by seasonal employment patterns.
Interest Rates
US Treasury yields finished at 3-week highs with the 10-year at 4.40%, the 5-year at 4.25% and significantly the 2-year also at 4.25%. The yield on 3-month treasury bills exceeded 10-year treasuries for the first time since 2022. The US curve has flattened significantly since the Federal Reserve began cutting rates implying that inflation will now remain higher for longer. The market is now paring back 2025 rate cuts and hence longer dated treasuries rose, not only anticipating this but also the return to a positive yield curve reflecting normal economic conditions. Nonetheless, several factors are present to drive rate volatility in the first quarter 2025: the Fed, Trump fiscal spend, effect of tariffs and the variation in world economies.
The Australian benchmark yield curve failed to increase in line with the US curve last week, even at the long end where the 10-year closed at 4.35%, a discount to the US 10-year. This reflects the weaker economic activity in the September quarter. The Australian 2-year closed at 3.93% and the 5-year 3.94% with the curve steepening only slightly last week.
Major Credit Markets
US investment grade (IG) markets remained tight reflecting good economic conditions for IG over 2024. Issuer balance sheet leverage has fallen, and profit margins have widened, both a recipe for strong credit markets. IG issuance remains very strong with investors clamouring for new issues. IG funds have had net inflows every week this year bar three.
Australian credit markets also remained strong with a noticeably quiet week for new issues. The Canadian Imperial Bank of Commerce covered bond priced at BBSW+69bp for a 3-year period. Bank Tier 2 bonds were a few points tighter, with the exception being the recent BNP Paribas 12NC7 still bid at +215bps. ANZ issued USD2.75bn across four tranches of floating and fixed-rate notes. The bank sold a US$650m 4.42% 2-year bond at par, a US$350m floating-rate 2-year at SOFR plus 47bp, a US$900m 4.615% 5-year at par, and a US$850m floating-rate 5-year at SOFR plus 85bp (Reuters).
High Yield Markets
US high yield markets remained strong along with all credit markets. Good issuance returned (especially again the leveraged loan market). US high-yield corporate average credit spreads tightened 68bp YTD: (Reuters, ICE BofA).
The big news last week was the APRA release affirming their early September guidance that hybrids will be phased out by 2032 (see next page). Despite this, hybrids essentially traded sideways for the week on slightly elevated volumes. Westpac hybrids dominated turnover given they were cum-dividend, especially the short term WBCPH with over $10m traded for the week.
Late December/ early January typically sees hybrid margins contract as new money is invested only into the secondary market. In December 2023, the average major bank hybrid margin contracted by 0.30%, in December 2022 by 0.55%. With now a lack of issuance going forward, we expect a similar contraction into the New Year and January.
Listed Hybrid Market
Hybrids: 2024 unprecedented.
Despite in late 2023 APRA flagging strongly to the market that the structure, investor base, and market access of hybrids were all under review, the market functioned as normal, mainly driven by new issuance flows. By mid-year, the failure of CBA and BOQ to roll issues was an indicator the APRA was to upend the market. In September APRA announced a program to phase out hybrid issuance and replace this capital with subordinated bonds. This proposal was a left field follow up to what APRA has previously indicated. Whilst consultation was subsequently conducted with the market, APRA appears to have ignored submissions and risk concerns, last week confirming their September plan. The current crop of bank hybrids (not insurance ones) will be repaid at their first optional cash rate. This was the expected repayment date in any case, however now the potential of later maturity or conversion is removed. This is a risk positive. Further given hybrids popularity, a lack of issuance will see demand strongly support current issues. Now that APRA has confirmed the outcome, hybrid margins will remain tight, especially going into the seasonal margin low period of late December/early January, as mentioned previously.
One matter APRA looked to clear up was the potential reinvestment for hybrids with repayment dates in 2025 and 2026. APRA said they would allow the banks to roll these issues if a bank wished (leaving it up to the individual bank) as long as the issue size does not increase. Hence buying a short-term hybrid at a good yield may give the opportunity to be offered a reinvestment offer, possibly valuable given new issues will be lacking. This may explain the recent turnover domination of the three major bank hybrids with 2025 call dates, these being AN3PH March 2025, CBAPH April 2025 and WBCPH September 2025. Outside the major banks, Macquarie Bank have MBLPC in December 2025 and AMP has AMPPB, also callable in December 2025.
The chart below shows the average major bank hybrid margin variation for 2024. A margin near 1.80% appears to be a low from which a bounce looks to happen quite quickly. Overall margins have contracted with some weakness of late, the APRA news flow disrupting investors thoughts, however overall hybrids are now much less risky. We expect margins to contract in 2025 baring a major equity or credit event. In 12 months, 1.80% may in hindsight be a buying level.
Forward Interest Indicators
Australian rates
Large swap-rates rise in line with global bond rates.
Swap rates:
- 10-year swap 4.34%
- 7-year swap 4.20%
- 5-year swap 4.06%
- 1-month BBSW 4.32%
