Review by the Chief Executive Officer
A principal task for the AOFM is to finance the Australian Government’s borrowing requirement. In any year, the AOFM faces the prospect of unknown market conditions that will impact upon its ability to achieve this financing in a manner that effectively balances cost and risk considerations. Managing the portfolio of Commonwealth Government Securities (CGS) requires longer-term strategic judgments, together with short-term tactical decisions (such as which bond maturities to issue in any given week). Therefore, the outcomes of AOFM judgements and financial market conditions, including investor demand, combine to influence this task. Several impacts stood out during 2012-13 and the effects of these on the CGS market will likely follow on into 2013-14.
Strong interest in CGS continued throughout 2012-13, although yields rose over the latter half of the year, with this being most pronounced during May, around the time of announcements by the US Federal Reserve that signalled an intention to adjust its accommodative monetary policy stance. Following these announcements, market speculation caused US Treasury bond yields to rise appreciably, and with CGS yields having historically tracked movements in US Treasuries, CGS yields (most noticeably at the long-end of the yield curve) increased in response. At the same time, the yields on short-dated CGS were being determined more by expectations in the market of a prolonged period of low RBA cash rates; therefore, the yield rises at the short-end of the curve were much lower than yields for the long-end. Together these influences resulted in a yield curve that was both higher overall and appreciably steeper compared with how the curve appeared at the beginning of the year.
The strength of the Australian dollar compared to the Japanese yen in early 2013 triggered some profit taking divestment of CGS by Japanese investors, at the same time making new investment by Japanese investors more expensive. This divestment activity had slowed significantly by the end of the year.
Despite yields having risen through the year they remain at relatively low historic levels, a benefit to the Australian community through an historically low cost of borrowing that has been locked in by using longer-dated issuance. In this regard the AOFM’s management of the debt portfolio has benefited from consolidating the length of the yield curve at around 15 years and extending the duration of the portfolio.
The circumstances that have brought the CGS market into a positive light in recent years remained relevant throughout 2012-13 as gauged by the continuing solid demand for CGS. We took confidence from new issuance being smoothly and readily absorbed into the market, as well as receiving feedback from intermediaries and investors that continued to convey underlying strength and market support.
The AOFM remains aware that transparency in its operations, together with the importance it places on using market feedback and engagement with investors, underlie broad confidence in a resilient and well-functioning sovereign bond market for Australia. In this regard, the AOFM remained conscious of the need to keep investors informed as to CGS market developments. This was achieved throughout the year by advising of changes to the financing task arising from Budget updates, as well as considerations for, and explanations about, changes initiated by the AOFM in regards to developments in the CGS market and our operations. This, we believe, helps to ensure that market expectations remain consistent with Government policy intentions.
The strong positive trade links between Australia and the high-growth Asian region continued to be something to which CGS investors refer; and notwithstanding its exposure to volatility in the performance of its largest trading partners in the short-term, they see Australia as being well-placed to benefit from an expected underlying medium to longer-term growth trend in Asia.
Issuance to support the financing task
The issuance program for 2012-13 was executed comfortably throughout the year and the Commonwealth’s financing requirement in 2012-13 was fully met.
Two new Treasury Bond lines were launched: one with a maturity date in April 2029 (in support of a previous lengthening of the yield curve to around 15 years); and one with a maturity date in April 2025 (to support the operation of the 10-year Treasury Bond futures contracts).
As has become normal practice for AOFM, taking account of prevailing market conditions on a weekly basis is important in supporting decisions as to which maturities are issued. Other considerations continued to include the aim of increasing existing bond line liquidity, and the need to manage the maturity structure to limit refinancing risk. Two Treasury Bond tenders were held most weeks, typically comprising a tender of a longer-dated bond line and a tender of a shorter-dated bond line. Treasury Indexed Bonds were tendered once a month in most months, and Treasury Note tenders were conducted most weeks.
The AOFM continues to recognise the need to retain flexibility in undertaking the issuance task throughout the year. This requires ongoing vigilance as to market developments and regular reappraisal of tactical decisions supporting the annual issuance strategy.
Portfolio management and outcomes
Over the last two years the AOFM has sought to increase the duration of the debt portfolio and 2012-13 was an important year in progressing this aim. The sustained demand for CGS throughout the year enabled the AOFM to continue to lengthen the average term to maturity of its issuance. We have appreciably increased the average tenor of our issuance from 5.8 years in 2009-10 to 8.8 years in 2012-13. The weighted average term to maturity of the stock of nominal bonds outstanding has risen from 4.8 years to 5.7 years over the same period.
The strategy of lengthening the portfolio has had a beneficial effect on the level of risk in the debt portfolio. Variability of future debt servicing cost outcomes and spreading the refinancing impact of maturing bond lines over a number of years are central considerations of the AOFM’s portfolio strategy — another being the level of borrowing cost (see the feature article Determining the AOFM’s Debt Strategy presented later in this year’s annual report).
Having spent a number of years building an issuance program targeted at meeting the financing requirements of the Commonwealth through and following the global financial crisis, the last two years have had a focus on long-term development of the portfolio, in particular, ensuring that the profile of maturities across the yield curve presents a manageable refinancing task over the years ahead. A build-up in short to medium term maturities occurred in the aftermath of the global financial crisis. This build-up skewed refinancing risks towards the front half of the yield curve and created the need to assess opportunities to increase the duration of the portfolio.
Residential mortgage-backed securities
Commencing in October 2008 the Government gave three directions for the AOFM to invest in residential mortgage-backed securities (RMBS). The first direction specified an amount of $8 billion, followed by subsequent announcements in 2009 for a further $8 billion, and in 2010 (under the Competitive and Sustainable Banking System package) for an additional $4 billion. These announcements ultimately gave AOFM a cumulative capacity to invest up to $20 billion in RMBS. The Government also announced its intention that the program be part of a transition towards a market that is not reliant on ongoing Government financial support.
In April 2013 the AOFM ceased investment in new RMBS (at the direction of the Treasurer in the context of a stabilised market for RMBS issuance). The AOFM is now managing the existing portfolio to maturity and will continue to consider sale opportunities through reverse inquiry with the aim of supporting price discovery in the secondary market, or to adjust the portfolio in line with the directions as set by the Treasurer.
Over the life of the program, the AOFM invested around $15.5 billion. This was in support of 67 transactions from 20 issuers. Together with $0.6 billion in sales of RMBS, repayments of principal totalling $5.7 billion have left a portfolio of $9.1 billion outstanding at the end of 2012-13.
Current fiscal projections indicate an outlook for net new issuance to continue at around the same rate for at least another year, this will give cause for the AOFM to consider whether further measures are required to manage a larger portfolio. One of these measures could be another yield curve extension (either for the Treasury Bond curve, the Treasury Indexed Bond curve or both). Supporting liquidity in the CGS market will also remain an important consideration in AOFM thinking and operations.
Going into 2013-14 we are already experiencing a carry-over of volatility from a number of international market related events. Improvements in the US economy and the implementation of changes to its monetary policy settings will likely dominate impacts in global bond markets. How individual sovereign bond markets are affected is an open question. The outlook for Australian domestic circumstances will also be a factor in shaping investor demand in CGS for the year ahead. However, strong liquidity and a diversified investor base will be important factors in maintaining a resilient CGS market.
The AOFM has also played an important part in the exchange trading of CGS. This included procuring new debt registry services to facilitate the exchange trading of CGS, as well as replacing the existing domestic debt registry service provided by the RBA. While a registry to handle exchange traded CGS is operational, work is continuing on transitioning the domestic debt registry services provided by the RBA to the new service provider. The aim is to conclude this project by the end of calendar 2013.
Chief Executive Officer
Last updated: 5 November 2013