Inflation indexed bonds in AOFM mix

Apart from its twice-weekly government bond issues detailed below, AOFM announced last week that it will commence issuing capital indexed bonds on behalf of the Commonwealth government. This will no doubt satisfy some investor demand. The last such issuance was in 2003 and there is only A$6.0 billion of such bonds outstanding, at original face value.

The issuance of inflation linked bonds will provide an incentive for the government not to use inflation to ease its debt repayment burden in future years. Although given the volume of bond issuance in the pipeline for countries such as the UK and US, controlling inflation in future years may not be easy.

If this eventuates, the capital indexed bonds could become quite expensive for the government. The outstanding capital indexed bonds with an original face value of A$6.0 billion already have a nominal value of more than A$8.6 billion, an increase of almost 50 per cent, and this has occurred while inflation has been modest and well under control.

AOFM said it expects to commence issuance within the next two months and reiterated that it will issue a new 2022 nominal bond before the end of the year.

Nothing was said about the potential for issuing any longer dated nominal bonds.

The advantages of such longer dated nominal bond issuance have been discussed here previously. But it is also worth considering the A$78.4 billion of term debt that the government had outstanding at the end of June this year, more than 30 per cent of which will mature within the next two years.

Given that this needs to be rolled over at a time when AOFM needs to issue more than A$50 billion of new bonds this year and an even larger amount next year, a substantial lengthening of the government's debt maturity profile appears to be called for.

As an aside, the US Treasury's auction of US$15 billion of 30-year bonds on Thursday was well supported, with the bonds achieving a weighted average yield of 4.54 per cent and being oversubscribed 2.54 times.

AOFM issued A$500 million of April 2020 bonds on Wednesday, at a weighted average yield of 5.68 per cent and achieved oversubscriptions of 2.6 times. On Friday, it sold A$800 million of June 2014 bonds with a weighted average yield of 5.48 per cent. The offer was oversubscribed 3.3 times.