What drove Aussie debt negative?

Via Banking Day:

Australia’s Treasury Note tender saw a negative yield for the first time ever, thanks to demand from overseas investors looking for short-term instrument to park cash.

At the AOFM’s weekly tender on Thursday, the lowest accepted yield on the March 2021 T-Note was -0.01 per cent, compared with 0.01 per cent at the tender last week.

The range of accepted bids was -0.01 per cent to 0.015 per cent compared with 0.01 per cent to 0.02 per cent the week before, resulting in a lower weighted average issue yield of 0.0099 per cent versus 0.0145 per cent.

Some traders had been discussing the possibility of T-Note going negative for a few days, so the development may not come as a surprise to them. Others were sceptical because they assumed zero is the lowest possible it could go because the RBA gives zero rate on excess Exchange Settlement balances.

The possibility was, however, real because of an interesting quirk in the forex market that could making buying negative yielding paper profitable for a foreign investor. In simple terms it means currency hedges are so cheap that investors get paid to do it, according to a trader based in the US.

It is likely this aggressive T-Note bid is from an investor in the European region.

It will be interesting to see if this is a one-off occurrence or the start of a new trend.

If demand for T-Note remains strong, there is a possibility of a small further fall given there is limited possibility of increase in Note issuance by the AOFM.

The AOFM’s preference has always been to issue a mix of T-Notes and bonds, with the former used mainly for cash management purposes.

The AOFM could potentially increase T-Note issuance because it is a cheaper source of funding but it has never followed this strategy due to the risk of refinancing.

“Issuing T-Notes to fund short-term asset balances is usually less costly than using TBs (bonds), although having very large amounts of T-Notes outstanding could attract elevated refinancing risk in limited circumstances where financial markets were extremely volatile,” the AOFM said in September last year.

If anything, the AOFM is likely to reduce the volumes outstanding in T-Note next year.

“Treasury Notes will continue to play an important role throughout this year and well into next year at the very least. This is because the size of the funding tasks ahead mean that it will be next year at the earliest before we can noticeably begin to refinance Treasury Note volumes through bond issuance,” AOFM CEO Rob Nicholl said in a speech earlier this year.

Including Friday’s issuance, the total T-Note outstanding is A$56.25 billion. This doesn’t take into account the A$9.5 billion December 11 T-Note maturity. At the peak some months ago, it was over A$65 billion, compared with around A$15 billion in December last year.

David Llewellyn-Smith

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