Western Sees Spreads Narrow From Six-Year Low: Australia Credit

Corporate bond premiums in Australia fell to a six-year low and investors including Western Asset Management Co. predict more narrowing as a global economic recovery withstands bouts of market turmoil.

The average yield on company bonds fell to 101 basis points more than the swap rate on Feb. 7, a level unseen since March 2008, according to a Bank of America Merrill Lynch index. The spread for a comparable U.S. gauge was 122 basis points that day, six basis points above its January low. Western Asset favors debt related to infrastructure, property trusts and lenders including Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc.

“We expect continued bouts of volatility as we go through the year, but we think the fundamentals are solid for credit and we’re comfortable being overweight for now,” said Anthony Kirkham, the Melbourne-based head of investment management for Australia at Western Asset, which manages $452 billion globally. “There’s still a solid running yield advantage in credit and the fundamentals remain sound. We see room for tightening, but not to the same degree we saw in 2013.”

The Reserve Bank of Australia raised its economic growth and inflation forecasts this month as a record-low benchmark rate bolsters consumer spending and business confidence. Sovereign yields are predicted to rise this year as central banks from Australia to the U.S. and U.K. signal an end to unprecedented stimulus measures, prompting fixed-income investors including Goldman Sachs Asset Management and Altius Asset Management Pty to favor riskier bonds that offer higher yields.

Sovereign Selloff

Kirkham’s portfolios have a greater exposure to credit than the benchmarks they track and he has an underweight position on government bonds.

In the real estate sector, Western Asset favors paper from companies including CFS Retail Property Trust Group and QIC Finance Shopping Center Fund Pty, while on the infrastructure side Kirkham prefers issuers such as the Port of Brisbane and SP Ausnet.

Western Asset is the fixed-income unit of Legg Mason Global Asset Management and its Australian bond fund was the fifth-best performer in 2013 and second-best over the past five years, according to Morningstar Australia Pty.

Goldman Sachs AM favors lower-graded credits as rising global interest rates impact more highly-rated paper, according to Philip Moffitt, the fund manager’s head of Asia Pacific fixed income. It also favors infrastructure debt and mortgage-backed securities, Moffitt said in an interview in Sydney last week.

Spreads Narrowing

“Spreads will probably narrow a bit further, but we’re not adding additional risk to our portfolio,” said Gavin Goodhand, who helps oversee about A$550 million as a money manager at Altius Asset Management Pty in Sydney. “We’re overweight corporate credit, although not as much as we were a few months ago.”

Goldman Sachs Group Inc. and Westpac Banking Corp. are two issuers that have decided to test investors’ appetite for company credit, with both offering new Australian-dollar bonds today. Goldman is marketing 5 1/2-year securities at a yield of about 135 basis points more than swap rates. It is the first U.S. bank to enter the Australian market since July.

Westpac Transaction

Westpac is offering the first new local five-year bond from a major Australian bank since November, with the transaction expected to price at a spread of about 95 basis points, according to a person familiar with the matter who asked not to be identified because the terms aren’t set.

The average yield premium over the swap rate for Aussie corporate bonds was 104 basis points yesterday, having almost halved over the past two years, according to Bank of America Merrill Lynch data. The spread narrowed 18 basis points in 2013.

The notes returned 4.8 percent to investors last year, compared with 0.1 percent for an index of Australian sovereign securities. Australia’s benchmark 10-year bond yield is predicted to rise to 4.58 percent by the end of 2014 from 4.18 percent as of 2:30 p.m. in Sydney, according to forecasts compiled by Bloomberg.

RBA Outlook

The RBA this month signaled that it may not cut its benchmark cash target any further from a record low of 2.5 percent, having implemented 225 basis points of reductions since late 2011.

The Australian dollar has risen 2.2 percent this month to 89.46 U.S. cents as of 2:30 p.m. in Sydney as investors adjust their outlook for the RBA. Swaps traders are betting there is a less than 50 percent chance the central bank will raise rates by a quarter-point over the next 12 months, according to a Credit Suisse Group AG index.

Investors pared bets on rate increases today after a report showed the country’s jobless rate climbed to 6 percent in January, the highest in more than a decade.

Australian credit has so far withstood the ructions of global instability as markets from Turkey to South Africa and Argentina have been roiled in the past month. In a bout of risk aversion following policy shifts in China and the Federal Reserve’s decision to dial back stimulus, investors sold off emerging-economy currencies, stocks and bonds, prompting emergency measures from governments and central banks.

“There are always macro factors like a crisis in Europe, China or other emerging markets that could push spreads wider,” said Mark Mitchell, the Sydney-based head of credit at Kapstream Capital, which oversees about A$6.5 billion. “Assuming none of those occur, then Australian dollar spreads should drift tighter this year.”

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