Originally published by CBA
| ■ | Money markets have been transformed by the structural shift from economic capital, to regulatory capital. |
| ■ | 6s3s and 3s1s BBSW basis is structurally wider. Cross‑currency basis is wider and steeper. Bank funding costs are higher. |
| ■ | But we think Australian money markets are stabilising at these structurally wider levels. US money market changes last October had less impact than expected, with Aussie bill volumes and spreads stable. |
| ■ | Aussie banks look well prepared for NSFR. We may have seen “peak regulation” and perhaps the trough in liquidity. |
Regulatory changes have had a profound impact on money markets and the cost of bank funding. Bank bill spreads widened ahead of the Liquidity Coverage Ratio in 2015. The 3s6s curve steepened last year as banks prepared for the Net Stable Funding Ratio in 2018. Liquidity is thinner and bouts of volatility greater.
Pressure on funding costs was amplified by major reforms to US money markets in October 2016 that shut off a key source of cheap funding and widened USD funding costs. 1M BBSW widened to OIS and the 1s3s BBSW curve unexpectedly flattened. Higher repo rates and constraints on buying back short‑term paper lifted 1M spreads. Many feared another step higher in funding costs as pressure on the local bill market picked up.
But domestic money markets have actually performed quite well and bill spreads are a bit tighter than in 2016. Repo remains pressured but 1M spreads have steadied and 6M BBSW‑OIS has snuck back to 50bp for the first time in more than a year (Figure 1).
We still expect spreads to hold wider than in the past. This should become embedded in forward curves. We expect Aussie BBSW 6s3s basis curve to steepen towards spot and recommend paying 5y5y 6s3s basis at +9bp (target +19bp). A trade for the bottom drawer. But we are growing more comfortable that peak pressure on spot bill spreads has been seen.
We highlight developments in the market and historical pressure on spreads. But also how the domestic market has weathered the recent changes in very good shape. Banks did not resort to increased volumes of domestic CDs (one name paper) last year (figure 2). And 6M spreads didn’t widen even though 3s6s steepened. Challenges remain on the regulatory front. But banks appear well prepared for the NSFR. And we don’t expect more pressure on the money market.
Funding costs are higher and terming out of debt should continue. But the good news is the system is safer. And we better understand the new cost of financial intermediation. The risk now is a partial unwind of the Democratic Dodd Frank, by frank Republican Trump. An unwind that may see the liquidity valve open a bit and bank balance sheets more able to warehouse risk in time.
The outlook for long‑term bank issuance suggests a slight widening, and further steepening, in Aussie ccy basis. We expect 5‑year Aussie ccy basis to widen toward 27‑30bp and the 10‑year moving to 35‑to‑37bps. Opportunities will present in AUD/USD ccy basis for longer dated received positions, with attractive carry.
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