The third quarter of 2022 saw continued market volatility across all asset classes. Against this backdrop, we assess how the floating-rate segment performed and why fixed-rate repricing should persist into the new year.
Market volatility is often driven by multiple factors. Yet, in the third quarter of 2022, it was clear that the catalyst behind the turmoil was inflation – and when prices in developed economies start to rise faster and more aggressively outside of a central banks comfort band, investors expect central banks to react with tighter monetary policy. Which they did, as global policymakers recognised that inflation was anything but transitory.
However, another factor was in play. Outside of COVID-initiated supply-chain issues and fossil-fuel challenges driven by the Russia-Ukraine conflict, the withdrawal of pandemic-related stimulus has revealed a significant imbalance between supply and demand in most goods that needs to be addressed. And until an equilibrium of sorts is achieved, higher cash rates, tighter monetary policy, and higher yields will be commonplace.
In market terms, floating-rate senior-unsecured Australian-dollar (AUD) bank spreads managed to hold their ground over the quarter. Even as fixed Australian government bond yields sold off sharply across the curve, credit spreads in senior-unsecured bank notes with bullet maturities traded in a predominantly liquid market. Indeed, it was sometimes hard to source investment-grade AUD-issued bank paper. That’s not to say there wasn’t intra-month volatility, and on several occasions, we saw equity markets post eye-watering losses.
On days with blanket selling across most asset classes, credit spreads were dragged wider in sympathy with the risk-off style positioning. Added to this were periods in the latter stages of the quarter when offshore-domiciled liability-driven investment (LDI) funds were forced sellers of their sovereign and credit positions to fund margin calls. This came as the Gilt curve was under enormous selling pressure on elevated inflationary concerns. In this environment domestic investment-grade senior-unsecured credit again mirrored offshore credit in late September by moving wider.
So, as we enter the final quarter of 2022, it appears that in the wake of the sell-off to wides not seen for years, domestic senior-unsecured bank spreads have found an equilibrium of sorts and further substantial widening will face resistance.
We believe that fixed-rate repricing should continue and this may be challenging for long duration bonds. Moreover, yields are expected to weaken further as the market embraces a period of central-bank-assisted healthy inflation. Given where domestic bank spreads have remained amid the market volatility, shortening the interest-rate duration through an allocation to floating rate notes may be a palatable option for some.
Figure 1: Markit iTraxx Australia IG Spread (bps) (Last Twelve Months)
Source: Bloomberg Finance L.P., as of 13 October 2022. Past performance is not a reliable indicator of future performance.
Issued by State Street Global Advisors, Australia, Limited (AFSL Number 238276, ABN 42 003 914 225) (“SSGA Australia”). Registered office: Level 14, 420 George Street, Sydney, NSW 2000, Australia · Telephone: +612 9240-7600 · Web: ssga.com.
The views expressed in this material are the views of Simon Mullumby, Head of Australian Cash & Bonds through the period ended 13 October 2022 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
This material is general information only and does not take into account your individual objectives, financial situation or needs and you should consider whether it is appropriate for you. There is no representation or warranty as to the current accuracy of this material, and SSGA Australia shall have no liability for decisions based on such information.
Investing involves risk including the risk of loss of principal.
Floating rate securities are often lower-quality debt securities and may involve greater risk of price changes and greater risk of default on interest and principal payments. The market for floating rate securities is largely unregulated and these assets usually do not trade on an organized exchange. As a result, floating rate bank loans can be relatively illiquid and hard to value. Diversification does not ensure a profit or guarantee against loss.
The value of the debt securities may increase or decrease as a result of the following: market fluctuations, increases in interest rates, inability of issuers to repay principal and interest or illiquidity in the debt securities markets; the risk of low rates of return due to reinvestment of securities during periods of falling interest rates or repayment by issuers with higher coupon or interest rates; and/or the risk of low income due to falling interest rates. To the extent that interest rates rise, certain underlying obligations may be paid off substantially slower than originally anticipated and the value of those securities may fall sharply. This may result in a reduction in income from debt securities income.
Bonds generally present less short-term risk and volatility than stocks but contain interest rate risk (as interest rates rise bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Government bonds and corporate bonds generally have more moderate short-term price fluctuations than stocks but provide lower potential long-term returns.
All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment.
BLOOMBERG and BLOOMBERG INDEXES are trademarks or service marks of Bloomberg Finance L.P. Bloomberg Finance L.P. and its affiliates (“collectively, “Bloomberg”) or Bloomberg’s licensors own all proprietary right in the BLOOMBERG INDEXES. Bloomberg does not approve or endorse this material and disclaim all liability for any loss or damage of any kind arising out of the use of all or any part of this material.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA Australia's express written consent.
© 2022 State Street Corporation. All Rights Reserved.
5035730.1.1.ANZ.RTL | Exp. Date: 31/10/2023