April 2020: A month in review
The daily headlines of flattening the Covid19 curve, central bank responses and now fiscal policy, have brought risk assets off their March lows.
The equity market has reacted quicker than the bond market. There are several reasons for this some of the more significant reasons are:
- Banks are no longer willing to be liquidity providers if it does not suit them. Therefore, in times of crisis, bond trades only occur if an end buyer is matched with the end seller.
- Many of the large global pension and superannuation funds are faced with large bond redemptions. This is not because bonds have fared poorly but because they need to meet redemptions as investor re-balance to enter equity markets.
- Despite the excess liquidity being created by central banks, many company’s long-term prospects remain in question due to the contraction in economies due to shut downs.
The Fed enacted a series of measure to support the functioning of corporate bond market. The RBA stated it would target 3-year government bonds at a YTM of 0.25%, but It was not until 5 May that the RBA established its first policy to directly support the functioning of the corporate bond market.
Review of the US Market
The US 10-year bond ended the month at 0.64%, 3bps lower than the March month end of 0.67%.
There was a similar movement in 2-year US government bonds which also decreased in yield by 5bps to 0.20%.
Review of the Australian Market
The 10-year Australian bond finished 13bps higher in yield at 0.89% with resulting lower prices.
The 3-year government bond’s yield rose (prices lower) by 2bps to 0.25%.
What about corporate bonds and BBSW?
The corporate bond market remains dislocated. Bonds issued by banks recovered much of the credit spread widening seen in March.
AA bonds showed positive returns even though yields in government bonds increased in yield.
Corporate bonds rated with a rating BBB+, BBB and BBB- had a much greater divergence in outcomes. On average, if the bond was 5-years or less it fell in YTM (higher prices). Longer dated corporate bonds did not gain support of the market and also rose in YTM. This poor performance was a combination of lack of liquidity and concern over underlying credit worthiness of the issuer – Virgin Australia being the most obvious example in the domestic market.
Part of the RBA QE strategy is to make funds available to banks who will hopefully on lend to corporates. An example of this is the RBA term funding facility (TFF) which provides 3-year term funding at 0.25%. This combined with increased repo facilities, means there is little need for the banks to fund through the bill market. 3-month BBSW at month end was 0.10%. This will lower coupons in the immediate future for FRNs.
The Bloomberg AusBond Composite Index for all maturities (the common benchmark) produced a negative return of 0.07% from the slightly higher yields of government bonds (lower prices).
The Treasury Index (government bonds) for all maturities, which is the single largest contributor to the Composite Index, produced a negative return of 0.43%. This sector under-performed the Composite Index due to the contribution of longer dated government bonds with prices more sensitive to interest rate changes due to their longer maturity.
The Credit Index (corporate bonds) for all maturities produced a positive return of 0.12%. The Credit Index has a much smaller number of longer dated bonds than the government bond index. (please see above comment of the disparity of returns within the corporate bond market).
When comparing corporate bonds to government bonds of the same maturity (3 to 5-years), we see the Treasury Bond Index returned a positive 0.07% return while the equivalent corporate bond index (Credit Index) returned 0.48%.
The best performing sub-index was the Credit Index (corporate bonds) 3 to 5-year maturity index with a return of 0.48%.