SINGAPORE: The retreating Australian dollar and the resumption of monetary easing have yet to dampen offshore demand for Kangaroo bonds. Japanese investors, in particular, are turning to Australian dollar debt in the hunt for yield.
The elevated international bid has contributed to a sharp increase in Kangaroo offerings from sovereign, supranational and agency issuers, with IFC, Rentenbank and Kommunalbanken among those in the market again last week.
So far this year, SSA issuers have raised A$8.6bn (US$6.7bn), up from A$5.5bn in the first two months of 2014. This is the highest January-February total since 2011, the year the Australian Prudential Regulatory Authority, surprisingly to many, excluded Kangaroos from the list of eligible assets to meet short-term liquidity coverage ratios under Basel III.
"There has been an ongoing trend among central banks to diversify away from US dollar and euro holdings and into mature, high-yielding areas like the Kangaroo market," said one Sydney-based fund manager. "Asian central banks have led this move, but participation from other regions, including Latin America, has also grown."
Domestic and foreign investors have been drawn to the greater relative pick-up SSAs offer over sovereign paper in a falling interest-rate environment.
The Reserve Bank of Australia cut its key official cash rate on February 3 for the first time in 18 months, with a 25bp cut taking the benchmark to a record low 2.25%. Many analysts are predicting a further 25bp reduction on Tuesday.
Five-year Australian Commonwealth Government bond yields fell below 2% last week from 2.33% at the start of the year and 3% at the beginning of Q4 2014.
The latest five-year Triple A SSAs have been priced at around 50bp over ACGBs for a 25% or so additional yield over the 2% sovereign, having paid similar 50bp spreads five months ago, when five-year ACGBs were yielding 3%. From Abe to Australia a large chunk of rising offshore demand emanates from Japan, with HSBC Global Research estimating that 12.6% of Japanese investors' US$44.3bn overseas bond purchases in 2014 (excluding bills) flowed into Australian debt, according to a recent research paper.
With Prime Minister Shinzo Abe's policies pushing investors to seek higher yields, the bank sees as much as US$500bn being allocated from Japanese Government Bonds to international bonds over a three-year period. This suggests inflows of up to US$63bn from Japanese institutional and retail investors into Australian bonds in the next two to three years.
HSBC expects most of these inflows to target ultra-safe ACGBs, or around 25%-30% of the sovereign's annual gross supply, until fiscal 2017/2018.
SSA Kangaroos are expected to get the second-largest chunk of these inflows, underpinning the market going forward.
The Australian dollar has been in steep decline in recent months, shedding over 17% against the US dollar and more than 5% against the yen since September 2014.
This weakness would normally be problematic, given Japanese institutional investors' historically low risk appetite, which leads them typically to hedge the currency risks of their bond portfolios. However, HSBC believes this may not be a great impediment at this time.
"The prospect of further yen weakness, driven by more Bank of Japan easing, may allow these investors to relax such hedging. Therefore, despite the scope for further depreciation in the Australian dollar, currency considerations may be less of a concern for Japanese investors, given the potential for the yen to depreciate even more," the report says.
Furthermore, HSBC notes that Japan's insurance companies have recently introduced Australian dollar-denominated life insurance products, which have been increasingly popular, given higher guarantees than yen-denominated equivalents. This should lead to strong institutional demand for Australian bonds.
Currency considerations are typically more important for Japanese retail investors. This explained why their holdings of Australian bonds remained flat US$24bn) during the last four months of 2014, the bank stated.
However, after such a large depreciation in the Aussie dollar recently, HSBC found that retail investors have been progressively returning to Australian bonds this year.
So far in 2015, Australian dollar-denominated Uridashi bond issuance (a strong gauge for Japanese retail investor demand) has reached US$550m. In 2014, the Australian-denominated Uridashi bond issuance totalled US$4.2bn, which record redemptions of US$7.6bn more than negated.
With only US$3.9bn of Australian-denominated Uridashi bonds maturing in 2015, HSBC expects Japanese retail investors' net demand for Australian bonds to increase this year.