Macquarie Australian Fixed Interest (MAQ0061AU) Report & Performance

The Fund outperformed the benchmark over the month, driven by duration and curve as well as sector rotation.

Duration and curve

The Fund moved from slightly long duration to slightly short duration in July. Central banks seemed to shift gear in July, with the Reserve Bank of Australia (RBA) deciding to pause as inflation surprised to the downside, whilst the US Federal Reserve (Fed) and European Central Bank both delivered well-flagged 25bps hikes, but stressed further hikes were not guaranteed. Yields sold off early in the month as the June Federal Open Market Committee minutes tilted hawkish, but this changed tack to see yields finish only marginally higher as inflation data printed to the downside across several economies and soft leading data began to show some weakness. The Bank of Japan relaxed Yield Curve Control towards the end of the month, keeping the 50bps target band but only as a guide, stating yields would be allowed to trade up to 1%. Whilst activity data seems to be somewhat resilient, particularly in the US, it seems most central banks could very well have delivered their last hikes.

Duration moved marginally higher at the start of the month as yields took the swaptions further into the money, then retreated as yields reversed course. Duration primarily moved shorter as we sold September bank bills towards month end as a hedge against the RBA hiking again, before Philip Lowe’s term ends after the September meeting. The rally in the front end of the curve also saw the duration contribution from the 2-year short payer swaption also fall, detracting slightly from duration. As the Term Funding Facility repayments gathered steam, yields in the funding market moved higher as some market participants positioned for potential funding stress. We used this opportunity to take profit on Japanese T-bills and rotate back into bank bills as the basis narrowed. The yield curve steepened materially into month end as major central banks delivered potential last hikes, consistent with end of cycle price action. We were positioned well for this, being overweight the front end, whilst underweight the belly and relatively neutral further out the curve.

Sector rotation

The Fund continued to reduce its long semi government exposure passively through the month end index extension. We continue to hold the semi government exposure against swap to hedge against the risk of a sustained widening given the relentless issuance profile. However, it appears the collective issuance profile is largely in the price, with semi to bond and semi to swap spreads both spiking wider in the month before falling back to finish largely unchanged. Although with the roll off of the Term Funding Facility in full swing, further bank high quality liquid assets demand is uncertain. The Fund’s swap spread exposure moved shorter over the month, which was primarily function of the short September bank bills, with a small contribution from the 2-year payer swaption moving out of the money. The Fund’s modest overweight to physical credit was a positive contributor to performance as Australian credit spreads rallied towards their 2023 tights.

Security selection

The Fund remains overweight futures vs physical securities, held in both the short and intermediate sector. The physical Australian Commonwealth Government Bonds (ACGBs) remain ‘rich’ to the overnight index swap curve, particularly in the front end and belly of the curve. Within ACGBs, we continue to hold our exposure in the back end of the curve where bonds offer more value vs overnight index swap and futures. Within semi-government, exposure is concentrated in the 7-10-year part of the curve. We remain underweight Treasury Corporation of Victoria and overweight Queensland Treasury Corporation and New South Wales Treasury Corporation, for relative value considerations.

The Fund underperformed the benchmark over the month, amid the ongoing rates volatility and the move wider in credit spreads.

Sector rotation

The Fund largely maintained its long semi government exposure, hedged with swap, drifting marginally shorter at month end with the index extension. Semi-governments tightened to bond over the month but widened versus swap due to a relentless tightening in swap spreads, seeing them detract from performance. Despite the tailwind to the sector from Bank high quality liquid assets demand being well past its peak as the Term Funding Facility maturities ramp up, the continued reduction in AOFM issuance should see the semi-government sector retain some high-quality liquid assets bid. The Fund’s short swap spread exposure was reduced over the month as a function of the short payer swaptions, with the duration contribution of the positions increasing as yields rise. The Fund’s modest overweight physical credit positioning was a positive contributor to performance as Australian credit spreads continued to grind tighter.

Security selection

The Fund remains overweight futures vs physical securities, held in both the short and intermediate sector. The physical Australian Commonwealth Government Bonds (ACGBs) remain ‘rich’ to the overnight index swap curve, particularly in the front end and belly of the curve. Within ACGBs, we continue to hold our exposure in the back end of the curve where bonds offer more value vs overnight index swap and futures. Within semi-government, exposure is concentrated in the 7-10-year part of the curve. We remain underweight Treasury Corporation of Victoria and overweight Queensland Treasury Corporation and New South Wales Treasury Corporation, for relative value considerations.

The Fund’s credit security selection was a broadly neutral contributor to performance. Senior financial paper moved a touch tighter, though Tier 2 spreads were the outperformer following Westpac’s long-awaited transaction and were a solid returner. Corporate performance was more muted with recent utility deals outperforming alongside defensive infrastructure names. Securitised credit had a busy month which saw the highest volume in primary issuances so far in 2023. Spreads moved 10bps tighter in senior-AAA deals and were a strong performer for the Fund. Protective credit default swap positions were a modest detractor as spreads rallied into the half-year close. Over the month, the Fund participated in transactions from issuers such as Harvey 2023-1, Lion 2023-1, Westpac Banking Corporation, QBE Insurance Group, AGI Finance and Transpower New Zealand.

Duration and curve

The Fund moved from short duration to slightly long in June, with duration increasing naturally over the month as the sell off increased the delta on the swaptions. The Reserve Bank of Australia (RBA) hiked 25bps in June, which the market took as hawkish, and saw Australian yields underperform peers early in the month as the rates sell off gathered steam. A string of upside surprises in economic data saw the market abandon the impending recession narrative, particularly as US core CPI and UK CPI showed persistence. The US Federal Reserve (Fed) opted for a hawkish pause in June, but flagged two more hikes were likely this year via the updated dot plot, whilst the Bank of England (BoE) surprised the market with a 50bps hike as they struggle to contain inflation. Yields began trading sideways towards the latter half of the month and Australia began to outperform as the RBA’s June minutes proved the June hike was in fact dovish, with the decision between a pause and a hike finely balanced. Yields moved higher into month end, although heading in the US summer this was likely a position covering move rather than a rapid shift in sentiment.

As yields sold off, duration naturally moved longer as we approached the strikes on the 2-year and 10-year swaptions. Prior to the RBA, we took profit on a short June bank bill position, which had contributed positively to performance as a hedge against the RBA moving more hawkish. The yield curve flattened aggressively throughout the month, providing attractive levels to begin entering a steepening position as the RBA is very likely close to the end of their hiking cycle. The sell off in yields saw the market begin testing the Bank of Japan on their resolve to keep the Japanese Yen from depreciating significantly, which provided an opportunity to deploy excess cash in Japanese T-bills for a pickup over Bank Bill Swap Rate. Across the curve, we are overweight the front end as a reflection of central banks nearing the end of their hiking cycles, underweight the belly and relatively neutral further out the curve.

The Fund outperformed the benchmark over the month, driven by sector rotation, as well as security selection.

Sector rotation

The Fund maintained its long semi government exposure, held against swaps. While semi-governments continue to look attractive on an outright yield basis, the potential for the US banking crisis to re-emerge puts spread products at risk to sentiment shifts, particularly as the US liquidity drain commences. Semi-governments widened slightly over the month, both to swaps and bonds, as several issuers delivered their Budget updates. Bank high quality liquid assets demand is likely to continue to support the sector over the coming months, although this effect will begin to wane. The short swap spread exposure was marginally reduced via the addition of 10-year swaptions.

The Fund’s modest overweight physical credit positioning was a positive contributor to performance as Australian credit spreads moved tighter over the month.

Security selection

The Fund remains overweight futures vs physical securities, held in both the short and intermediate sector. Physical Australian Commonwealth Government Bonds (ACGBs) remain ‘rich’ to the overnight index swap curve, particularly in the front end and belly of the curve. Within ACGBs, we continue to hold our exposure in the back end of the curve where bonds offer more value vs overnight index swap and futures. Within semi-government, exposure is concentrated in the 7-10-year part of the curve. We remain overweight Queensland Treasury Corporation and New South Wales Treasury Corporation and underweight Treasury Corporation of Victoria, with the latter materially underperforming post their Budget update.

The Fund’s credit security selection was a neutral contributor to performance. Bank senior paper outperformed, and while Tier 2 spreads moved modestly wider the excess carry more than offset. High quality covered bonds and Kangaroo names also contributed to performance. In corporates, the utilities space provided solid performance as several primary deals set firm spread levels and led to a broad-based sector rally. The Fund’s overweight to NBN continues to perform strongly, with the ratings upgrade by Moody’s to Aa3 catalysing another rally in spreads. Structured securities again contributed to Fund returns, but were offset by a rally in Supranational, Sovereign and Agency bonds where the Fund is underweight. Over the month, the Fund participated in transactions from issuers such Ausnet, National Australia Bank and Suncorp.

Duration and curve

The Fund moved from neutral to short duration in May, trading duration tactically over the month. The Reserve Bank of Australia (RBA) hiked 25bps in May, a mere month after pausing to reassess the data. Governor Lowe cited persistent services inflation and stronger labour data as catalysts for the hike in order to achieve inflation within the target band by 2025. This hawkish shift surprised the market, triggering a sell off which was exacerbated as the US debt ceiling debate generated uncertainty and reduced market participation. The Reserve Bank of New Zealand also surprised the market, but in the opposite direction, delivering a 25bps hike and signalling it is likely the last. The US Federal Reserve (Fed), European Central Bank and Bank of England all hiked 25bps, but these were second order events to the US debt ceiling, which saw yields volatile and at the mercy of rapidly shifting sentiment.

Duration was initially added via swaptions as the Fund sold payers in the 10-year sector, allowing duration to extend in the event yields continue to sell off. We then initiated a paid 2-year/1-year position in Japanese overnight index swaps to provide upside exposure to any Bank of Japan-induced global duration sell off in the event of a change to Yield Curve Control, with limited downside risk, taking us short.

The Fund maintained a small short in the very front end of the curve, which has contributed positively to performance as the RBA tilted hawkish in May. We remain overweight the 10-year part of the curve and underweight the belly.

The Fund outperformed the benchmark over the month, driven by sector rotation as well as security selection.

Sector rotation
The Fund maintained its long semi-government exposure, albeit on a hedged basis versus swap. While semi-governments still look attractive on an outright yield basis, the potential for the US regional banking crisis further permeating global markets puts spread product at risk. Thus, the risk-reward for holding the position outright is not attractive. Semi-governments performed well over the month, tightening significantly to Australian Commonwealth Government Bonds (ACGBs) whilst trading largely sideways to swap, which contributed positively to performance. Outside of the financial contagion narrative, the bank high quality liquid assets demand narrative will continue to support the sector, although this effect will begin to wane, so we remain comfortable with the hedged exposure.

The Fund’s modest overweight position to physical credit was a positive contributor to performance, as Australian credit spreads moved tighter over the month.

Security selection
The Fund is overweight derivatives vs physical securities both in swap and futures, held in the short and intermediate sector. Physical ACGBs remain ‘rich’ to the overnight index swap curve, particularly in the front end and belly of the curve. Within ACGBs, we continue to hold our exposure in the back end of the curve where bonds offer more value vs overnight index swap and futures. Within semigovernment, exposure was partially shifted into the belly as the spread curve flattened materially. We remain underweight Treasury Corporation of Victoria and overweight Queensland Treasury Corporation and New South Wales Treasury Corporation, with exposure to the latter increasing over the month on a tactical relative value basis, as opposed to an improved issuer outlook.

The Fund outperformed the benchmark over the month, driven by sector rotation, duration and curve as well as security selection.

Sector rotation

The Fund marginally increased its semi-government exposure over the month, which contributed positively to performance. Semigovernments tightened versus both swap and bond over the month as there continues to be strong demand from both bank balance sheets and the official sector. Whilst the state governments have large issuance tasks, we continue to believe the semi-government sector offers value given this issuance task is well telegraphed, most issuers are well progressed through the issuance and bank balance sheets should have high quality liquid assets requirements in 2023 given the expiry of Term Funding Facility and Committed Liquidity Facility. The Fund’s overweight credit positioning contributed positively to performance as Australian credit spreads outperformed global peers.

Duration and curve

The Fund’s duration positioning moved from neutral to long in February as a decisively hawkish pivot from the Reserve Bank of Australia (RBA) saw yields sell off significantly as terminal rate pricing reached an intra-month high of 4.40%. Globally, the trend of disinflation appears to have stalled, with upside surprises in US and EU consumer price index (CPI) seeing central bank policy paths reprice higher, and forecasted rate cuts pushed further out the curve. Locally, a stronger-than-expected Q4 CPI was the initial catalyst for the RBA’s hawkish shift, leading them to consider a 50bps hike in February, however the outlook was muddied as employment data printed negative for the second consecutive month and Q4 Wage Price Index missed expectations. This saw Australian duration outperform globally.

We took profit on a short US front end position as stronger than expected US inflation saw the US front end repriced higher as the market began to accept the Federal Reserve is likely to pause after they finish hiking, pushing rate cuts further out the curve. We unwound this US exposure on a spread to AU 10-year as the AU yield curve bear flattened as rates moved higher. Over the month, duration was added in the AU front end primarily via futures, though we also took advantage of elevated volatility and initiated a swaption position that will take the Fund longer on a sustained sell off. Whilst we have reduced some flattening exposure, we continue to concentrate duration in the 10- year part of the curve given the relative steepness of the AU curve versus developed market peers.

Security selection

The Fund is overweight derivatives vs physical securities both in swap and futures, held primarily in the 10-year part of the curve albeit with an increased exposure in the 3-year part of the curve over the month. The physical Australian Commonwealth Government Bonds (ACGBs) remain ‘rich’ to the overnight index swap (OIS) curve, particularly in the front end and belly of the curve. Within ACGBs, we continue to hold our exposure in the back end of the curve where bonds offer more value vs OIS and futures. Within semi-government, we marginally added exposure to South Australian Government Financing Authority as they came to market with a new 4.75% May 2038. We also increased exposure to Queensland Treasury Corporation (QTC) as they continue to have the strongest issuance profile, while we reduced exposure to Treasury Corporation of Victoria given their uncertain funding outlook and material tightening to the QTC curve. We remain neutral to slightly overweight to New South Wales Treasury Corporation as their mid-year funding outlook was slightly worse than expected, whilst the upcoming NSW State election adds further uncertainty.

The Fund’s credit security selection added to performance. Excess returns were driven by BBB credits and higher beta corporates, with further credit curve flattening as the market digests a lack of issuance and higher all-in yields. Senior financials moved tighter despite heavy supply, with Tier 2 bonds also benefitting performance with primary not able to satisfy investor demand particularly in fixed rate tranches. Structured securities were a strong contributor, with spread tightening of over 20bps over the month and very strong demand from investors. Higher than benchmark carry also benefitted the Fund. Over the month the Fund participated in transactions from issuers such as HSBC, Svenska Handelsbanken, Westpac Banking Corporation, FPTT 2023-1 and TRTN 2023-1.

The Fund outperformed the benchmark over the month, driven by security selection, duration and curve as well as sector rotation.

Security selection The Fund is overweight derivatives versus physical securities both in swap and futures, held in the 10 year part of the curve. The physical Australian Commonwealth Government Bonds (ACGBs) remain ‘rich’ to the overnight index swap curve, particularly in the front end and belly of the curve. Within ACGBs, we continue to hold our exposure in the back end of the curve where bonds offer more value versus overnight index swap and futures. Within semi-government, we reduced our underweight to Treasury Corporation of Victoria given considerable progression in their funding task, and spreads have widened to accommodate their irregular issuance pattern. We prefer to be overweight Queensland Treasury Corporation given conservative coal price assumptions provide a tailwind to revenues, with a lower AUD also working in their favour. We are also overweight NSW Treasury Corporation given funding task is largely priced into spreads and prefer to be underweight Western Australia Treasury Corporation given deteriorating outlook for iron ore, with conservative price forecasts for the commodity already reflected in spreads. In addition, we have deployed some excess cash backing derivatives into JPY bills fully hedged back to AUD for a favourable yield pick up to Bank Bill Swap Rate (BBSW).

The Fund’s credit security selection added to the outperformance. Despite the recent major bank senior note issuance, robust demand saw the major bank senior spreads tightened and curve bull-flattened. With the recent purchases of major bank subordinated debt notes at historically wide spreads, the return of demand in the sector this month following the widening seen towards the end of last month and the Australian Prudential Regulation Authority’s letter on “Expectations of capital calls” contributed positively to performance over the month. Structured securities continued to contribute to the outperformance with the carry benefiting the Fund as spreads remained broadly unchanged. Over the month the Fund participated in transactions from issuers such as Westpac Banking Corporation, National Australia Bank, ING Bank, Firstmac Asset Funding Trust No. 1 Series Auto No. 1, Think Tank Commercial Series 2022-3 Trust and IDOL RMBS Series 2015-1 Class A note refinance.