The AOFM remains focused on ensuring government expenditure obligations are able to be met at all times and that Budget financing needs are delivered cost effectively without undue risk. A focus is also maintained on ensuring a flawless approach to settlement operations and recording and reporting transactions. Additionally, management of the Australian Government Securities (AGS) portfolio is undertaken with a view to promoting market integrity while balancing a range of medium- to long-term portfolio considerations. The AOFM has also been given responsibility for implementing two investment programs on behalf of government: the Australian Business Securitisation Fund (ABSF) and the Structured Finance Support Fund (SFSF), the latter of which arose from the government’s response to the COVID-19 pandemic.
The government’s funding requirements were considerably higher than during last year due specifically to the impact of the COVID-19 pandemic. A balanced Budget was originally forecast for 2019-20, however the pandemic associated fiscal response packages led to a dramatically increased the Budget financing task.
Throughout the first half of 2019-20, central banks maintained a trend of monetary policy easing in response to persistent low global economic growth outcomes and forecasts, including below target inflation outcomes. Coming into the year AGS yields across all maturities out to 30 years traded below equivalent maturities for US Treasuries. While this reflected a range of global market influences and represented relatively favourable borrowing costs for the Australian Government, it had the effect of dampening offshore investor demand for AGS. This was reflected by a noticeable increase in offshore investor allocations into USD investments – including US Treasuries – during the preceding 18 months. Of particular note was a shift in the preferences of the Japanese investor cohort toward USD investments. While this influence, together with other market dynamics, didn’t make it difficult for AOFM issuance at the time, it resulted in AGS yields trading within a relatively steady range. However, a yield differential reversal between AGS and US Treasuries during May triggered the beginning of notable offshore investor flows again toward AUD (AGS and stat-government bonds).
The second half of 2019-20 was clearly defined by the global economic, fiscal and market impacts of the COVID-19 pandemic, which began in late February and fully emerged in mid-March in the form of severe funding market dislocation. During this period there was a mass sell-off in equity markets due to concerns about underlying valuations, which in turn led to a sell-off in bond markets as investors looked for ways to liquidate a range of asset positions. As sovereign bond markets maintained liquidity for longer into this process they became the focus of mass selling by investors, driven in large part by a need to access large amounts of cash (for redemptions and other purposes). The AGS market was drawn into this quickly with very little warning. For several weeks the AOFM effectively lost access to the bond issuance market.
As soon as the US Treasuries market regained a functional trading status other advanced economy sovereign bond markets began to ‘clear’; at the same time the global economic outlook rapidly deteriorated and investors began to focus on buying defensive assets (in the form of a ‘flight to quality’). This together with broad central bank responses in the form of reduced cash rates, announcements of large bond buying programs, and a number of measures to support liquidity in financial markets, resulted in sovereign bond yields reaching historic lows. Yields on AGS did not decline as much as in most other markets, which has left them again trading above US Treasuries; this remains an important factor in having attracted a surge in offshore investor support for AGS issuance since April. Throughout this period the RBA also purchased around $40 billion of AGS with tenors up to 10 years. This market‑clearing operation removed much of the congestion amongst the trading banks, while at the same time supporting the RBA’s monetary policy objective of achieving a three-year AGS yield of 0.25 per cent.
In the event, the financing task for 2019–20 was met through a combination of $128.2 billion in Treasury Bonds, $1.65 billion in Treasury Indexed Bonds , and a net increase to Treasury Notes outstanding of $56 billion. This compares with planned issuance at the time of the 2019–20 Budget of around $58 billion for Treasury Bonds and $2.5 billion for Treasury Indexed Bonds (with no appreciable change in Treasury Notes outstanding).
Absorption of the materially higher issuance was smooth and achieved via regular weekly tenders, together with some large syndication transactions. Initially the AOFM faced very limited demand for maturities longer than three-four years, but ‘followed’ the market recovery out along the yield curve as market conditions gradually improved during the period early April to late May. During this period the domestic investor base was relatively quick to re-engage with the AGS market, with the offshore investor cohort taking longer to re-engage (and this happening more gradually).