Australian 10-Year Swap Spreads Near Record Low, Echoing U.S.'s

  • Yields rise globally as bets firm for Fed liftoff in December
  • CBA not ruling out chance of negative Australian swap spreads

Australia’s 10-year interest-rate swaps held near a record low relative to government yields as the impact of rising sovereign debt yields is exacerbated by tighter regulation on bond dealers.

The 10-year swap spread to bond futures was 5.75 basis points on Thursday, after closing at an unprecedented 5.375 points a day earlier. It’s fallen from near 23 basis points at the end of October. Australia’s 10-year government note yield climbed to an almost four-month high after data showed the unemployment rate unexpectedly dropped by the most in five years.

Swap spreads have come under pressure as bond yields rose globally this month amid increasing speculation the Federal Reserve will increase U.S. interest rates this year for the first time in close to a decade. On top of that, regulations enacted after the financial crisis have curtailed the amount of risk banks can take, leading them to scale back trading and lending. Commonwealth Bank of Australia, the country’s biggest lender, says it may only be a matter of time before Australia’s 10-year swap spread follows the U.S. below zero.

“No one is ruling that out, given the size of the moves recently,” said Adam Donaldson, head of debt research at Commonwealth Bank. “One of the things that has exacerbated the move in Australia is the increase in yields, but it’s within a rapidly evolving structural environment as well.”

U.S. Record

U.S. 10-year swap spreads fell to an all-time low of minus 17.6 basis points on Nov. 5. They were at minus 8.8 basis points on Thursday, and have been negative since Sept. 23.

Australia’s 10-year sovereign note yield rose as high as 2.986 percent Thursday, a level unseen since July 15, after a report showed the economy added the most jobs since March 2012, pushing down the unemployment rate. Swaps traders pared bets that the Reserve Bank of Australia will reduce already record-low interest rates.

The benchmark Australian yield has advanced from 2.575 percent on Oct. 28, tracking a gain in Treasury yields after Fed policy makers said that rates could rise at their Dec. 15-16 meeting. The odds of liftoff then have climbed to 68 percent from 46 percent over the period, according to Bloomberg calculations based on futures. The calculations are based on the assumption the effective fed funds rate will average 0.375 percent after liftoff, compared with the current range of zero to 0.25 percent.

Aussie Bonds

Narrowing swap spreads in Australia make government bonds attractive, according to Hideo Shimomura, the chief fund investor in Tokyo at Mitsubishi UFJ Kokusai Asset Management, which has about $97.6 billion under management.

“We are bullish on government bonds relative to non-governments,” he said. “Government bonds are relatively cheap.”

Swap rates serve as benchmarks for a variety of debt purchased with borrowed funds, including mortgage-backed and auto-loan securities. Narrower swap spreads can push borrowing costs lower, even if bond yields hold steady.

There is growing global concern that there may have been a structural change in the provision of market liquidity, an important ingredient for the smooth functioning of financial markets. Since the global financial crisis, reduced risk appetite and tighter regulation, such as increased capital requirements, have resulted in reduced market-making activity.

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