Fixed Income Outlook for 2018 – Damien Williamson

2017 year has been a positive year in the ASX Debt and Hybrid market, where an absence of shock events has restored investor confidence.  A 0.34% fall in major bank wholesale funding costs has also been supportive of the hybrid market, combined with historically low levels of market volatility.  With a trading range of 9.2% between year high and low, the All Ords is set to record its narrowest yearly trading range since 1966.

Other major economic indicators such as economic growth, unemployment and inflation remaining below the RBA 2-3% target band since 4Q2015 point to scope for the RBA official cash rate to remain on hold at 1.50% in 2018.

The rally in the ASX listed hybrid market raises the question of whether there is a risk of a near term bear market developing, as we had in late 2015 / early 2016.  We have compiled a list of 25 items which we see as having an impact on major bank hybrids across categories of Valuation, Issuance, Sentiment, Bank Profitability and Capital Levels.  In the 2015 / 2016 bear market, we have identified 7 headwinds mainly across the Issuance and Sentiment categories which impacted the market.

In the current environment, we find it difficult to identify factors which appear to jeopardise the strength in the current hybrid market.  The 2 key negatives in late 2015 / early 2016 of Issuance and Sentiment have done a complete U turn.  In terms of valuation, hybrid spreads to senior debt have normalised to where we now view them as fair value. 

Looking out to 2018, the strong performance of new hybrid listings in 2017 and the increasing difficulty of gaining access to new money bookbuilds and Securityholder offers is likely to result in increasing pre-positioning trading in maturing hybrids, providing the potential to participate via Reinvestment Offers.  The two big refinancings for 2018 are the $1.2bn WBCPC by March, and the $2.0bn CBAPC by December.

We see support continuing for the ASX listed debt and hybrid market, particularly when considering the potential for 2018 being a second straight year of net redemptions.  With 2017 ASX listed debt and hybrid market redemptions of $9.3bn exceeding $5.4bn of issuance by $3.9bn, 2018 issuance may not exceed the pipeline of $7.0bn of redemptions.