What an Australian ratings downgrade means for fixed income investors

Speculation over a downgrade to Australia’s S&P sovereign credit rating is ramping up. There are numerous credit ratings tied to Australia’s sovereign rating and a downgrade would impact various segments across the domestic fixed income market. Here the Colonial First State Global Asset Management Fixed Income team share their varied perspectives on the knock-on impact of a sovereign downgrade.

Ratings outlook
"Australia’s AAA rating has been on negative outlook with S&P  since the 2016 election, when the agency  cast doubt on a  return to a balanced budget by FY21. Substantial expenditure reform still looks to be challenging. Given the current make-up of Parliament  we believe a sovereign downgrade is still likely over the course of the next year," - Toni Spencer (Head of Credit Research) & Stephen Halmarick (Chief Economist)

Sovereign Bonds
"The impact on government bond yields is expected to be relatively minor  because it has been well flagged and fully priced into markets in advance.  By global standards, Australia’s financial stability and metrics still compare favourably and we will remain one of a select few of very highly rated (AA or higher) sovereigns available. We also offer good economic diversity, a liquid currency and interest rate derivatives market, both of which provide an additional level of support for ongoing foreign demand of Australian paper," - Stephen Cooper (Head of Australian Fixed Income)

Semi Government Bonds
"It is very difficult for a State Government to be rated higher than the Sovereign, so any AAA rated State would in all likelihood be downgraded to AA+  if Australia was downgraded by one notch. While the lower rated States would not be similarly impacted, the ratings of NSW, VIC and ACT would be lowered to AA+, equalling the rating currently assigned by S&P to QLD and WA. The compression in relative ratings would likely place narrowing pressure between the bond yields of the currently AAA rated and non-AAA rated States. However, the differential is unlikely to approach zero, as ratings are not the only driver of relative Semi Government bond spreads," – Kris Bernie (Portfolio Manager)

For views  on domestic credit, inflation, Australian/US yield spreads, supras and agencies, read the full article here.