International investors pushing the dollar up

While the Australian banks have been busy in international bond markets since the start of the year, the domestic corporate bond market has been almost exclusively the domain of supranational and foreign government agency issuers.  

Over the first two full weeks of January supranationals and foreign government agencies issued A$5.9 billion of bonds in the local market. This is the largest volume of such issuance ever seen at the start of the year.

Substantial issuance of this type is common in early January. When the major banks issue significant volumes of bonds in international markets, the proceeds of which must be swapped back into Australian dollars, they create a favourable basis swap that allows foreign issuers in the domestic market to swap Australian dollars into their currency of choice.

While foreign central banks and sovereign wealth funds are the typical buyers of these bonds, there have been reports of local institutional investors taking up larger than usual allocations of the bonds.

This demand is reportedly driven by expectations of lower semi-government bond issuance this year. It may also reflect corporate bond maturities of A$12.8 billion coming up in March.

These factors may account for the larger volume of issuance this year. However, the real story is likely to be about the yields on offer.

The bonds sold to date have offered investors yields ranging from 2.6 per cent to 3.5 per cent. This may not sound like much but with yields on high quality bonds (typically AAA rated) being around zero in Europe and Japan, and only a little higher in the US, the Australian dollar denominated bonds look better than the alternatives.

This may well explain the bounce in the Australian dollar exchange rate against the US dollar, from below US81 cents to over US82 cents over the same period. International investor demand for Australian dollars is counteracting the downward force of falling commodity prices.