Weekend Bond Special : New 15Y SGS Auction

Busy weekend full of nasties from battling the invasion of a monitor lizard in my drain to fighting an influx of little grasshoppers till someone sent me a picture of a squashed monkey in Penang and I started getting visions of animal spirits coming after me.

squashed monkeyA good exorcism is required and it timely indeed that we have a new 15Y government bond auction coming up this coming Thursday, 26 June, giving me something to write about.

I stopped publishing my SGD rates weekly last year when I realised that normal people are not bothered by the interest rate difference between 2.9 and 3% which, for the past 17 years, have been more than a big deal to me. It has been therapeutic because it allowed me to focus on the bigger and more important things around.

The MAS bond auction calendar has been a fast and furious for 2014 with all the auctions squashed into the first 10 months of the year. They threw in 2 extra auctions as precaution vs the 8 auctions we had last year, choosing a balanced approach with more re-openings and less new issues.
For more information read my post from last year. https://tradehaven.net/market/through-the-looking-glass-sgs-auction-calendar-2014/

This is what the government yield curve looks like compared to Jan 2014.

SGS YIELD CURVE

Ugly. The 10 to 15 year has come off more than 0.2%.

Thus the most profitable auction we have had is the 10 year bond auction in Feb which was alloted at 102.11 and currently trading at 103.15. The 5 year auction in Jan is not far behind, alloted at 104.91 vs current price 105.75.

2014 SGS AUCTION CALENDAR

Does it make sense to buy this new 15 year issue at yield levels much lower than Jan this year ?

I have 2 answers which starts with the word “Depends”.

Retail Investor

If you are a retail investor with no access to the competitive auction, you will have to buy via your ATM machine this weekend (I am not exactly sure when is the cut off day and time for ATM applications, but I think you can definitely apply through the ATM machine today).

A non competitive bid = 100% success in allocation.

Buying the bond in the SGX subsequently will not be easy to stomach (and quite disadvantageous) because the bid-offer spread is 0.10% eg. the 20Y bond SGS 3.375% 09/2033 is trading at 105.51/107.01 3.065/2.965%.

This is compared to the interbank spreads (that some private banking clients have access to) of 0.02%.

Buying through an auction is advantageous as well because you have the chance of nabbing a long tail because Singapore govis practise the Dutch auction allocation at cut-off method and thus if the bonds are alloted at a high cut off (because of insufficient demand), the chances are that the price will revert to its mean subsequently.

For more information on retail SGS buying, please read my post :  https://tradehaven.net/education/bond-revolution-in-singapore-lesson-5-idiots-guide-to-singapore-government-securities/

Sophisticated Investor

If you are a sophisticated investor, you have the option of buying the bond via a competitive bid in the auction through your bank or the non competitive bid. And if your bank is not a primary dealer, it matters not for they can piggyback on a primary dealer for the auction.

Note that the non competitive bid is subject to quota constraints of 1% of the total issue size which is usually reserved for certain clients. Thus if you are thinking of the non competitive bid option, I suggest running down to the ATM machine.

Then you have the option of buying the bond in the secondary market after it has been issued too, and I am sure you can arm twist your banker into quoting a decent bid-offer spread.

Risks

For an auction of this size coming  in times of bond market uncertainty (but low volatility) like the present where we have the US treasuries stubbornly holding to the current 2.6% in the 10 year, institutional investors may be hesitant to buy at the auction which may result in a sell off following as primary dealers will have to mop up/underwrite the unsold bonds.

There is, however, a possibility that the market would pre-hedge for the auction and thus, push yields higher into the auction to secure a decent result for themselves.

No need to be too enthusiastic because there is a 10 year auction 1 month later.

My Comments

Pricing off the current yield curve, the expected yield on this new 15 year which will mature on 1 July  2029, the yield I am looking at is approximately 2.938% (using Friday’s closing bid prices).

I hear that the leverage on SGS is 90% and 80% at other places but I would not recommend leveraging too much on a 15 year paper whose price is more sensitive to yield fluctuations despite the attraction of a >20% return (using 90% leverage at 0.8% funding).

CPF Special Account still gives a better return at 4% whilst the Ordinary Account gives us 2.5%. (note that this bond qualifies for CPF investment)

Inflation expectations in the recent MAS Survey of industry professionals is at 2.8% (down from a high of 5% back in 2011 and average inflation expectations of 2.5-3.5% last year).

15 year SGS 5 year average yield – 2.58%. High 3.43%. Low 1.57%.

15 year SGS lifetime (considering the bond was first introduced in 2001) average yield – 3.08%. High 4.54%. Low 1.57%.

* all numbers are approximations and unverified

Like I said in my post, Strategy : Bonds For Secular Stagnation, long term interest rates tend to even out over time.

I would dearly like to launch into the topic of bond swap spreads and how the current tightness (cheap) in the SGS swap spreads is sending a a strong message on the state of affairs in the corporate bond markets (expensive). But I better check myself here and write about cheerful things.

If I were a retail investor, the buy and hold strategy should work because even if you are lucky to get the bond via non competitive bid, you would have to wait for the bond to rally quite a bit before you can breakeven selling through the SGX.

If I were going for a competitive bid, I would be aware that the Sep 2030 bond is yielding 3% or thereabouts, and the April 2042 bond is just giving us 3.14%. We could gamble for a long tail of 2.98-3% cut off for a potential little windfall if that transpires (assuming no major sell off the US).

The demand for high quality long end bonds is still healthy although I would not rush because its half yearly books closing cum end June (window dressing the balance sheets could work both ways) and missing out would not matter much because,

1. we have a 10 year auction coming up in a couple of weeks.
2. there could be switching activity out of the other bonds which allows us to pick up say the Sep 2030 cheap.
3. interest rates, like the squashed monkey above, are not going anywhere at the moment.

Verdict : Not bad but no rush.