Australia's 6 month Treasury notes close gap with BBSW on liquidity

Sophia Rodrigues

By Sophia Rodrigues of Central Bank Intel

Australia’s six-month Treasury note yields fell to a record low on Thursday driven by ample liquidity and expectations of a cut in the Reserve Bank’s cash rate target.

The decline has finally closed the unusual gap that existed between Note yields and BBSW in the last few months when bank bill yields traded below the AAA-rated Notes.

At the tender Thursday, the Australian Office of Financial Management sold A$500 million of April 2021 Notes at a weighted average yield of 0.106 per cent, with the lowest yield at 0.10 per cent and highest at 0.11 per cent.

This yield of 0.106 per cent compares with the 0.1077 per cent yield on six-month BBSW a day before.

Bank bills have traditionally traded at a higher yield compared with T-Notes to account for the credit premium. However, in March when markets turned volatile bank bill yields began falling sharply as investors chased short-term liquid assets. The T-Note market is largely illiquid and therefore their yields stayed elevated, thus creating a positive spread between Notes and BBSW.

But as markets settled and as liquidity continued to ample in market, investors began chasing T-Notes and bidding strongly at tenders. This led to a fall in three-month yield to a record low of 0.0982 per cent last week, with the lowest yield at 0.085 per cent, well below the RBA’s cash rate of 0.13 per cent and target of 0.25 per cent.

The RBA is expected to cut the cash rate target to 0.10 per cent at the November board meeting, along with a cut in rate on Exchange Settlement balances, mostly likely to 0.05 per cent. The RBA is also expected to lower three-year yield target to 0.10 per cent and cut the rate on Term Funding Facility.

These rate cuts are expected to push cash rate to 7bps, assuming the ES rate is lowered to 5bps. If this happens, there is scope for further fall in T-Note yield.