Australia: Why are Repo & BBSW heading higher? - TDS

The widening in US Libor - OIS spreads since Nov'17 and the concurrent move out in BBSW - OIS spreads suggests the US has driven the local widening and the US may have had some influence, but other factors appear to be driving the rise in BBSW, explains Prashant Newnaha, Senior Asia-Pacific Rates Strategist at TDS.

Key Quotes

“We believe Aussie repo is the primary driver dragging BBSW higher. Since the start of Q4'17, there has been a more persistent trend for secured lending, as measured by the RBA's OMO repo rate, to exceed the cost of unsecured lending, as measured by BBSW.”

“Increased offshore participation to fund longs via repo, the spike in the cost to borrow AUD via FX forwards into yr-end'17 and the Australian Bank Tax all appear to have a role in explaining the rising cost of balance sheet.”

“There has also been a clearer trend for repo to richen further in advance of the turn. With another two weeks to quarter end, the cost of unsecured borrowing should rise as the cost of secured lending increases. For repo to ease, Aussie bonds probably need to underperform.”

“The potential for Australian banks to increase domestic issuance (given the blowout in Libor-OIS makes it more expensive to issue in the US) could provide an alternative explanation for the rise in BBSW. An ongoing rise in Libor - OIS could also crowd out other issuers and warrant a rise in BBSW.”

“Our US Strategy colleagues expect FRA-OIS could be nearing a peak on slowing bill supply next month. This suggests the rise in BBSW could be nearing a peak too, but a broader structural risk for markets is repatriation of US corporate earnings. This could drive a renewed rise in BBSW.”

“AUD funding via FX forwards generally becomes more prohibitive into the turn. The significant widening in cross currency basis raised the cost of AUD funding into the end of 2017 but it is the rise in BBSW that is driving the current increase!”

“We find no strong evidence that Japan fiscal year end is having an impact on repo or FX forwards or money market spreads.”ith unsecured lending now trading above secured lending, and our US Strategy colleagues expecting US FRA-OIS could be peaking in the near term, this implies a retest of the highs in AUD cross currency basis is unlikely.”