Review by the Chief Executive Officer
Consistent with its core responsibilities, the AOFM remains focused on ensuring the government’s expenditure obligations are able to be met at all times and its budget financing needs are delivered cost effectively without undue risk. Additionally the AOFM is managing the Australian Government Securities (AGS) portfolio with a view to promoting market integrity while balancing a range of medium-long term debt portfolio considerations.
Term issuance for 2017-18 was $81 billion, considerably lower than for the previous year and consistent with improving fiscal outcomes. Issuance was smoothly absorbed into global financial markets. The AOFM also observed the domestic investor base playing a greater role than had been apparent for some time, particularly in the first half of the year.
With the previous year (2016–17) having marked the conclusion of a long strategy to incorporate a 30-year benchmark bond into the yield curve, operational considerations turned more to efficient market maintenance (as opposed to distinctive market development aims). In terms of cash portfolio management, the AOFM maintained a strategy similar to past years to ensure that a reasonable contingency was in place at all times to cover payment obligations even if the ability to issue bonds were to have been temporarily impeded. While not a lone consideration US Treasury bond yields rising above those for most AGS maturities in early calendar 2018 was a threshold change to the market; however, AOFM issuance didn’t at any time look to be threatened by the potential for a resulting sharp slowdown in offshore investor buying.
The quantitative easing programs of major central monetary authorities (namely the European Central Bank, the US Federal Reserve, the Bank of England and the Bank of Japan) were again central to investor considerations. However, last year the focus was on the impacts in markets of these programs being either terminated or reversed. The year commenced with market expectations of global economic growth in the larger advanced economies increasing in a synchronised manner, leading to a change in monetary policy settings to reflect such conditions. Instead, regional and country specific economic growth rates have not synchronised to the extent anticipated. This divergence and the non-uniform unwinding of quantitative easing contributed to an increase in volatility in the relative level of yields and across financial markets more broadly (compared to the prior year of historically low volatility).
Throughout this volatility the AGS market retained a ‘safe haven’ status. The ongoing support in demand (particularly in long-dated maturities) translated into a ‘flattening’ of the AGS yield curve. During 2017–18, the yield for the longest AGS maturity (30 years) decreased from just over 3.5 per cent to just over 3.0 per cent, while the yield on 10-year bonds remained around 2.6 per cent. Yields on the shortest maturities rose from just over the RBA cash rate to about 1.8 per cent. These conditions supported a bias in the AOFM’s issuance towards long-dated maturities.
During 2017–18, the level of offshore ownership of AGS remained between 55 and 60 per cent. A trend of onshore investor buying being dominated by domestic bank balance sheets looked to have abated toward the end of the year. It is difficult to judge whether any re balancing between non-resident and domestic AGS ownership will occur through 2018–19, but diversity (by both region and investor type) across the overall investor base remains a feature of the AGS market. Offshore investors are attracted by underlying liquidity, the credit quality of the Australian Government and the transparency and regularity of issuance. Should these features persist, the AGS market will continue to exhibit efficiency and resilience, providing the government with good access to financial markets as the need arises.
Issuance, market maintenance and portfolio management
The 2017–18 issuance program was undertaken through the well-established combination of regular weekly competitive tenders and syndications where this was deemed to be a more effective issuance method. The program was complemented by regular bond buyback tenders that have assisted the AOFM to manage funding risk, while supporting the efficiency of the market and reducing bond maturity volumes with the aim of aiding the RBA in its task of managing domestic system liquidity.
Treasury Bond issuance of $75.5 billion focused on achieving the AOFM’s portfolio strategy, while supporting the bond futures contracts. The AOFM maintained its strategy of lengthening the duration of the portfolio in the face of historically low term premium assessments. This also leaves the AOFM with an enhanced range of issuance options depending on market conditions over future years, has established the AGS market internationally as fully comparable to many other sovereign markets that would be considered as ‘peer’ markets, and continues to reduce the Government’s call on markets over the medium term.
Gross issuance of Treasury Indexed Bonds for the year totalled $5.6 billion, about half of which was issued via twice monthly competitive tenders. This segment of the AGS market continues to be predominantly domestic investor focused.
Bonds repurchased ahead of maturity totalled $23 billion, of which $12.2 billion were acquired through buyback tenders, $3 billion were bought back in conjunction with syndication and $7.7 billion were purchased from the RBA.
Residential mortgage backed securities
The AOFM was issued a Direction in May 2015 to commence a program of regular divestment of the remaining residential mortgage backed securities (RMBS) portfolio; this started in June 2015. Having suspended its auction process in November 2015 due to a marked widening of RMBS yields, the AOFM recommenced auctions in November 2017 on the basis of improved market conditions; this resulted in the complete divestment of the remaining RMBS holdings by February 2018.
The financial market outlook continues to be dominated by speculation about non-uniform global economic growth and inflation prospects, further divergences in the conduct of monetary policy overseas, and the relative performance between sovereign bond markets. In addition, the prospect of worsening international trade disputes increases the prospect for volatility across financial markets. These, amongst other factors, remain relevant to the AOFM’s deliberations although the risk outlook for issuance is appreciably lower given the forecast fiscal improvement, which is supported by establishment of a 30-year yield curve, and a broadening of the investor base. Depending on the cause, a sudden and steep deterioration in global market conditions could prove challenging for AOFM issuance, but this would be unlikely to last for an extended period given the underlying appeal of the AGS market to investors.
Sharp elevations in short-term money market rates including the repo market, particularly over quarter-ends, could well persist into 2018–19. The AOFM has consulted broadly on possible causes and it is evident that there are many factors influencing this (some domestic and others international). Isolating one key factor over others is difficult. However, a persistence of this pattern will undoubtedly influence AGS investors dependent on access to repo facilities. While this change in market dynamics is not something for the AOFM to address, a sustained softening in demand would inform our expectations in terms of patterns of planned issuance.
Related to this is the considerable amount of work that has gone into developing mechanisms to capture and monitor internationally available data on capital flows. This has complemented the AOFM’s own data and its comprehensive liaison with market participants. Together, these combine to give the AOFM an enhanced understanding of the environment in which it must operate.
Finally, the AOFM remains focused on portfolio management objectives that will support a diversified investor base and an outlook for declining issuance, but little expected change in the overall size of the debt portfolio. These objectives will take into account the continuing need to communicate clearly with financial markets and to announce issuance plans that are carefully considered and will meet the test of the changing fiscal and market circumstances.
Chief Executive Officer