Daily Commentary BY THE CURVE TEAM –

Weekly Insights – Terming Out

11th of October, 2021

Key Updates

Tuesday – Business survey

Wednesday – Consumer Confidence

Thursday – Employment

Terming Out

Yields are up over the past month, especially at longer terms. Investors should consider these longer terms as investment options, even if it is only a portion of the portfolio. Benchmark rates have increased, notably:

  • Last month, the 1 year, 3 year and 5 year swap rate was around 0.06%, 0.44% and 0.80% respectively.  They are now closer to 0.10%, 0.60% and 1.10% respectively.
  • US 10 year Treasuries are now above 1.50% whereas last month it was hovering above 1.30%.

This has translated to attractive rates across a range of products. Including:

  • Both NAB and United Overseas Bank’s recent primary 5-year issues have been trading at a discount. NAB issued at +41 and United Overseas Bank at +40. These are now trading at yield to maturities higher than their issue margin, equating to a capital price below 100 to purchase the bonds.
  • 3-5 year term deposit rates have increase 10-15 basis points. Rates are as high as 1.40% for 5 years, 1.15% for 4 years and 0.90% for major banks. For BBB rated ADIs rates are even higher.
  • CBA fixed bonds with 3 years to mature trading around 0.85% for 3 years. This is in line with major bank term deposit rates but would be a liquid investment.
  • A WATC (Western Australian Treasury Corp semi-government body) fixed bond with 5 years to mature, now trading at around 1%. It was trading closer to 0.80% a month ago.

In February, a similar run up in yields occurred. Many investors assumed this marked a continuous increase in rates. It did not. Rates after February began declining again at longer terms. Only now have they started regaining February’s levels.

In contrast to February, central bank tightening is closer. The Fed is expected to taper their QE program at the end of the year and raise the cash rate by the end of 2022 (or the start of 2023 if half the Fed board members are to be believed). This means another impetus for rates to increase further could be around the corner, which could justify delaying investing until rates go higher.

However, markets still seem to be extrapolating the current experience of high inflation and central bank tightening too long in the future. Continuous increases in the cash rate are expected out to 2025, implying either central banks will have a hawkish bent or the economy will be relatively unaffected by cash rate increases.

This seems far from guaranteed, given new debt has taken place with record low interest rates, which would put repayments under pressure if interest rates rise. It also goes against the experience since the GFC, which has seen a secular decline in interest rates across the developed world, including taper tantrums.

Therefore, while market expectations seem to be overestimating longer term rates, current rates pose an opportunity to put part of the portfolio into longer tenors. Especially for those investors holding a disproportionate amount in cash.

Josh Stewart

Associate - Money Markets