Australia, flowing sideways

Posted by Tracy Alloway on Jun 21 11:35. 4 comments | Share

Notice anything in the below chart, of five-year CDS for Spain, Japan and Australia?European shocks have managed to feed through into normally-quiet (CDS) markets like Japan’s (though of course, More…

Notice anything in the below chart, of five-year CDS for Spain, Japan and Australia?

European shocks have managed to feed through into normally-quiet (CDS) markets like Japan’s (though of course, that very sharp bump coincided with the March 2011 earthquake). But Australia?

Not so much as a Kookaburra wing-sized flutter.

Here’s Bank of America Merrill Lynch rates strategist Bin Gao with some thoughts:

Though not at the peak level yet before the downward slide following Spain’s success in returning to the bond market with supports of the like from China to Japan’s sovereign wealth fund, the future level will critically depend on what comes out of the negotiation on Greece and the upcoming vote. But the repercussions are felt globally. Even a remote market like Japan felt the jolt, seeing a steady climb of its CDS. Amid all the turmoil, it is remarkable that Australia’s CDS trades in a world to itself, happily flowing sideways, especially when looked through the rear-view mirror. History used to have a different path. Around the time of the Lehman collapse back in 2008, these three CDS levels (see Chart of the Day [above]) were trading more in synch. All three rose sharply and that of Australia actually tops the other two by a small margin, indicating the market’s concern, back then, on Australia’s dual deficits, overleveraged household, banks’ heavy reliance on global capital markets and the frothing housing market.

What happened to those concerns?

Well some of them have largely dissipated, some have stayed the same, and others, Gao says, may have intensified. Or at least they should have, as the market seems to not be paying them much mind.

So here’s the good, from Gao:

Watch those encouraging signs on the road… At least on three fronts, Australia’s situation has improved to warrant the stable CDS. The first is the commitment to return fiscal budget back to surplus by FY2012-13. Though the projection only amounts to a few billion Australian dollars, the surplus contrasts greatly with other sovereignties struggling to manage their own deficits. It takes more significance when put into the context of a very low existing net debt level for the country to start with. The second factor comes from banks. Australian banks heavily relied on wholesale funding and still do. The model ran into deep trouble when the capital market shut down during the global financial crisis. Banks have been concentrating on driving up the deposit base for more stable funding since then. They have been successful in doing so … helped by the rising savings rates in the household sector. The third improving factor is for the terms of trade to keep setting all-time highs.

And the not-so-good:

… but observe those potholes which got bigger and deeper. Not all news is good, even for banks. Clearly expressed on the same chart is the percentage of residential loan as a percentage of all loans bank made, it is close to 60% now, rising 10ppt from early 2008 and about 5ppt higher than previous record. This kind of loan breakdown argues badly for a diversified loan portfolio. Not surprisingly, this happened with the government stimulus on first-time homebuyer incentive, and as a result the housing debt to disposable income has gone up another 4ppt to 139%. With the RBA tightening, the debt service ratio quickly climbed from 9.4% in June 2009 to 11.9% by December 2010. The debt burden for the household a result of rising interests was cited by rating agencies as a factor to downgrade the four major banks, though the citation for the wholesale banking model was widely viewed as being too late. Still, the peaking of housing price should raise some alarms as well. The nationwide median house price is down 2% from June 2010 to March 2011, and the massive concentration of wealth in the housing sector as opposed to the financial sector has its drawback as well in the sense it makes the pain more acute.

Not that Gao is recommending you buy CDS as actual protection against an Australian default – more as a short-term tool to profit off of any ‘event risks’ that might be lurking on the horizon.

Related links:
Live and lend loose, or, mortgages down under – FT Alphaville
Why no Canadian, Australian housing busts? – FT Alphaville
Moody’s puts Antipodean banks on review – FT Alphaville
The mystery meaning of soverign CDS – FT Alphaville

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