Australian investors regain appetite for bonds– Industry roundup: 14 July
by Graham Buck
Australia’s biggest investors bullish on bonds
Recent evidence suggests that some of Australia’s biggest investors are piling into bonds, in a bet that backing the Reserve Bank of Australia’s (RBA) Governor Philip Lowe’s assessment that a series of substantial interest-rate hikes will help get the country’s inflation under control next year.
A Bloomberg report states that Construction & Building Unions Superannuation (CBUS) Fund has been lifting exposure to bonds “across the board” over the past three to six months, according to Chief Executive Officer Justin Arter. Australia’s biggest pension fund AustralianSuper Pty has increased its debt holdings to 10% from just under 6% and Janus Henderson Group’s Australian head of fixed income says yields are peaking now as they usually do early in tightening cycles.
“If what Dr Lowe says is proven to be the case, then bonds at the moment will be very good value,” commented Arter. “Once that inflation starts to gently come out of the system over the next 18 months, you’ll see that bonds will be good value, which is why there’s been a reallocation to bonds by a lot of funds.”
Australia’s 10-year yields spiked to 92 basis points above similar-dated US Treasuries last month, the widest gap since January 2015, triggering a rally that pushed the difference back down to 44 basis earlier this week, a spread that has still more than doubled this year.
Australia’s central bank announced the third interest rate hike in as many months on 5 July, imposing a 50 basis point increase which lifts the official cash rate from 0.85% to 1.35% and surprising economists and traders. Until early May the rate had stood at only 0.10% since November 2010. While some foreign investors are shying away from bonds after being burned by the RBA’s failure to provide reliable guidance on inflation and interest rates, locals are said to believe that the central bank is now on the right track.
“We’ve effectively seen this mini episode’s peak in yields,” said Jay Sivapalan at Janus Henderson. “Bond markets are trying to be forward-looking, so it is actually quite common that as you get actual tightening in the cash rate, bond yields can actually go either sideways or go down,” he said.
The RBA is likely to remain hawkish in its rhetoric as it wants Australian consumers to spend less to help cool inflation, but it’s unlikely to meet market pricing for a cash rate that peaks at about 3.5% in mid-2023 because that would do too much damage to financial stability, he added.
Both CBUS and Janus express confidence that the central bank will avoid pushing Australia into recession. Bonds in Australia “are sending you the signal that maybe things won’t be as bad as expected out there,” said Arter. “They now seem to be saying well maybe this tightening cycle will end earlier than we thought.”
Bonds worldwide have retreated sharply over the past year, with Australian government debt’s 11% drop outperforming an 18% loss for global sovereign securities.
Janus Henderson’s Sivapalan said that the meltdown largely reflected the extraordinary pandemic-era switch into and out of massive policy easing and that bonds are offering value now yields have climbed so rapidly. When bond yields go up, bond prices go down.
“Fixed interest is that great diversifying asset class, and against growth assets this time around it’s failed in that role,” Sivapalan said. “That’s not to say that’ll fail in its role again because the asset class now has yield built into it.”
Barclays: fears of dollar losing reserve currency status are overblown
Concerns that the US dollar risks losing its reserve currency status are greatly overstated, according to analysts at Barclays Research.
In the just published 67th edition of the Equity Gilt Study (EGS), they argue that with the European Economic and Monetary Union (EMU) still not fully integrated fiscally and politically and with the Chinese renminbi (RMB) only partially convertible, there are no good substitutes for the US dollar. Instead, large exporters might try to reduce their US current account surpluses by focusing more on regional trading blocs, in an attempt to diversify their foreign reserves.
A flagship annual publication, the EGS combines “market-leading macro analysis with a unique multi-asset dataset spanning over 100 years”. This year’s report takes stock of the effects of Russia’s war with Ukraine.
Barclays’ analysts note that the war is leading governments and corporations to re-examine the resilience of their supply chains and other economic linkages. That could lead to at least a partial reversal of the multi-decade trend of globalisation. They already see evidence of a “reshoring” of critical processes and infrastructure, and of multinational companies hiring closer to home.
Reviewing the future of the EMU, the team argues that Europe has often moved towards further integration during crises, and the recent past is no exception. The pandemic and the war in Ukraine have forced member states toward more fiscal and political co-operation. This includes a common diplomacy and defence policy, as well as a common energy policy.
Barclays’ analysts also consider the implications for the macroeconomic environment, which, over the past three decades, has benefited from a period of “Great Moderation”, characterised by a relatively stable backdrop of growth, inflation, and monetary policy. “We think this may be changing, with significant implications for macroeconomic stability,” they conclude.
“In this year’s Equity Gilt Study, Barclays’ analysts explore how the war in Ukraine, coming on the heels of the pandemic, will likely permanently re-shape the macro landscape,” says Ajay Rajadhyaksha, Global Chairman of Research at Barclays, adding that it “provides an indispensable tool to understand the themes and trends affecting global economies and markets for years to come.”
Investors shun 20-year US government bonds
Investors are steering clear of 20-year US government bonds, creating a distortion in the U$23 trillion US Treasury market, according to a Financial Times report.
The paper says that a lack of demand for the 20-year government debt security since its reintroduction in 2020 means that its price is far out of sync with the rest of the market and it is harder to trade. The price swings and lack of liquidity have made it even less popular with the long-term, conservative investors such as pension funds that would typically be its natural buyers.
“The 20-year portion of the market is just dead,” said Edward Al-Hussainy, senior interest rates strategist at Columbia Threadneedle, told the FT. Mark Cabana, head of US rates strategy at Bank of America, suggested that the lack of investor demand for 20-year Treasuries could ultimately spread to other parts of a market that act as the bedrock of global finance.
The 20-year currently stands out as the cheapest conventional bond within the Treasury market and its low price means yields on 20-year Treasuries are higher than their 30-year counterparts, at 3.37% and 3.1%, respectively. Typically longer-dated bonds provide higher yields to account for the greater risks associated with holding debt that matures further into the future.
Cabana said the higher yields required to convince investors to hold 20-year Treasuries ultimately cost taxpayers by nudging the government’s cost of borrowing higher. “They discontinued 20s once in the past,” he said. “And why did they discontinue it in the past? Because they felt that it was not advantageous to the taxpayer. It was not achieving the lowest cost of funds for the taxpayer, and that argument can be easily made today.”
BIS committee and IOSCO issue final guidance for stablecoin regulation
The principle of “same risk, same regulation” for crypto has received further confirmation with the release of new guidance on stablecoin arrangements (SAs).
The guidance, which was issued by the Bank for International Settlements (BIS) Committee on Payments and Market Infrastructures (CPMI) and International Organisation of Securities Commissions (IOSCO), applies the Principles for Financial Market Infrastructures (PFMI) for payment, clearing and settlement systems to systemically important SAs that transfer stablecoins.
The document is intended for use by SA designers and operators and extends the PFMI standards to SAs without establishing new standards. It notes: “An SA may need to make changes to its rules, procedures, governance arrangements and risk management framework taking the guidance into consideration in order for its practices to be consistent with the PFMI.”
It defines this SA as “an arrangement that combines a range of functions to provide an instrument that purports to be used as a means of payment and/or store of value.” The guidance suggests considerations for determining which SAs it applies to, since only to SAs that are “systemically important” are covered by it.
The PFMI was published in 2012 in the wake of the global financial crisis. AThe standards apply to SAs under the new guidance, although the authors chose to elaborate on the application of only four out of the 24 principles and key considerations: governance, risk management, settlement finality and money settlements. They noted that a separate piece will be issued to cover multicurrency SAs.
United States Commodity Futures Trading Commission (USCFTC) commissioner Caroline Pham, co-chair of the CPMI-lOSCO Policy Standing Group, stated: “This report is a significant step to establish international standards for stablecoin arrangements and a cohesive regulatory framework that safeguards the global financial system.”
Other institutions working on stablecoin regulation include the Financial Stability Board is expected to propose international regulations for stablecoins in October. In the US, the Stablecoin TRUST Act has been introduced to regulate stablecoin and integrate them into the financial system.
Finastra and HSBC collaborate on BaaS FX capability
HSBC and financial software group Finastra said they are working together to distribute HSBC’s FX services via Finastra's FusionFabric.cloud platform under a Banking as a Service (BaaS) experience. The collaboration “will take advantage of the best elements of modern API-driven connectivity with licensed institutions’ secure, regulated infrastructure.”
A release added that the first phase of the roll out will provide both indicative and executable FX rates to regional mid-tier banks via a plug-in to Finastra’s Fusion Kondor, a solution with low maintenance and ownership cost, backed by the liquidity and robust risk management capabilities of one of the world's largest FX franchises.
“Integrating HSBC FX services with mid-tier banks will allow participating banks to deliver a wide range of currencies to their customers through branch networks and other retail channels, without requiring any additional technology integration. It will also provide clients with highly automated FX pricing capabilities, allowing banks to process higher FX volumes, and to differentiate themselves while maintaining their own customer relationships. Corporate clients will benefit from increased transparency of pricing and market conditions, improved ease of execution, and simpler currency risk management.”
Available in H2 2022, the initial roll out will focus on financial institutions in Asia Pacific (APAC) with other regions to follow soon after. It will also be made available to embedders who require direct access to FX liquidity and pricing.
Angus Ross, Chief Revenue Officer, Banking as a Service (BaaS) at Finastra said: "The ability to integrate FX directly into corporate treasury platforms, as well as competitive pricing and liquidity into a single package will help reduce friction for regional banks and their customers and demonstrates a use case in which BaaS can really make an impact.”
Starbucks to close 16 US stores
Coffee chain Starbucks is to close 16 of its stores in the US, citing repeated safety issues including drug use and other disruptive behaviours that threaten staff. Six stores in its hometown of Seattle will shut down, plus six in Los Angeles, two in Portland, Oregon and one each in Philadelphia and Washington.
Starbucks said that employees affected will be given the opportunity to transfer to other stores and that the closures were part of a larger effort to respond to staff concerns and make sure stores are safe and welcoming.
In a letter to employees, Starbucks’ senior vice presidents of operations Debbie Stroud and Denise Nelson said the company is not immune from problems such as rising drug use and a growing mental health crisis. “We know these challenges can, at times, play out within our stores too. We read every incident report you file — it's a lot,” they wrote.
However Starbucks was criticised by some workers who said they weren't consulted or given any options besides closure. The closures took on further significance due to an ongoing unionisation effort at Starbucks' US stores. More than 189 stores have voted to unionise since late 2021, according to the National Labor Relations Board. Starbucks opposes the unionisation effort.
Russia’s Finam looks to Kyrgyzstan bank acquisition
Russian retail brokerage Finam is considering buying a small bank in Kyrgyzstan, according to its president Vladislav Kochetkov as Russia firms seek ways to simplify cross-border transactions and circumvent western sanctions.
Russia’s demand for banking services in former Soviet republics within the Commonwealth of Independent States (CIS) has increased after western sanctions severed ties between the Russian banking sector and the global financial market.
“We are considering different opportunities to work with counterparty banks: from opening correspondent relationships to buying a share or the whole business,” Kochetkov told Reuters without specifying any names. No binding agreements have yet been signed.
Western sanctions for the invasion, which Russia maintains is a "special military operation" in Ukraine that started on 24 February have cut major Russian banks off from the global interbank payment system SWIFT and restricted inflows of cash dollars and euros into the country, while Visa and MasterCard have suspended operations in Russia.
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