Commentary: Naughty or Nice?
2024 was a solid year for Australia credit. Despite increasing investor uncertainty and the ever-present geopolitical tensions, we believe there are enough tailwinds for Australian credit to stand out again in 2025.
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Market Review
I’ve said it before and I’ll it again! What a year! Santa certainly had Australian credit on his ‘Nice List’ in 2024.
We finished the year with final corporate credit issuance around A$29bn – a staggering 150% increase on 2023. Market capitalisation on the Australian credit index has grown to just shy of A$195bn last year, an increase of 19.5%, and this does not include subordinated or any foreign currency issuance. Personally, I feel privileged to have watched the market develop last year and to be an active participant in the Australian debt capital markets at such an interesting time. Not only have spreads outperformed but supply and participation have excelled.
Notably, demand from Asian investors increased significantly in 2024, with levels of deal participation moving closer to 30%, well above historical levels. Demand drivers here include weakness in China, the inclusion of Australian credit in the J.P. Morgan Asia Credit Index (JACI), as well as favourable valuations vis a vis global opportunities.
In 2024, despite a weaker start to the year than usual, we saw greater interest from corporates including the Australian ports (Flinders and NSW), Registry Finance and Qube, where financing has traditionally been via the banks or private markets. We also saw increased interest from international names, including BP and Iberdrola, a large Spanish multinational utilities company. All of these premium businesses add to our already high quality domestic index. Barclays Bank (UK), Santander (Spain) and BNP Paribas (France) all issued Tier 2 into our market last year which demonstrates Australia’s position as a reliable offshore funding market for international institutions or what we like to call ‘Kanga Issuers’.
Furthermore, we had new hybrid supply from Ampol, Scentre Group, ANZ Holdings and Pacific National, highlighting a return of hybrid financing as an important component of corporate financing options.
Market Outlook
I get asked a lot, where to from here? Has the performance of Aussie credit been fully extracted now? To understand this, we need to consider domestic and global outlook, especially given Australian spreads have been broadly more sensitive to moves in rate markets than more idiosyncratic events which have had a more muted, short-lived impact, such as the US elections and the ongoing conflicts in the Middle East and Ukraine. Although, let’s be clear, I am certainly not discounting the potential impact of the geopolitical risk into 2025.
Whilst credit spreads have outperformed, Australian credit is still lagging the spread performance of global markets, notably with US credit now exceptionally expensive. So despite big moves in spreads in 2024, we still believe there is room to travel tighter in 2025, especially with a more subdued refinancing outlook for Australian corporates, leading to a possibility of lower supply.
The prevalence of ‘sticky inflation’ in 2024 was the core driver of our view that Australian rates would be on hold until May this year. However the RBA’s increasingly dovish tone gives us cause to assess the risk of a rate cut as early as February, which could push credit spreads wider. However, the strength of employment is the offsetting factor here and we still believe a May cut is the more likely outcome. Therefore we should continue to see outperformance from domestic credit.
So what at will help us in 2025? There remain plenty of tailwinds for credit: corporate balance sheets are generally in good shape; capital expenditure (capex) / investment pipelines remain conservative, offset somewhat by the energy transition spend; and the 2025 refinancing pipeline is subdued, which will drive technical spread performance if we see a continuation of the supply and demand imbalance. If we do experience rates on hold for longer than expected, we gain comfort from the strength of the inflation pass-through mechanisms which are enjoyed by the majority of the Australian credit universe.
The risks, on the other hand, include the ongoing geopolitical uncertainty, and a collapse in domestic and/or global growth, however this is not our base case assumption.
Positioning
In November, we began reducing our exposure to French banks in light of concerns over the political instability in Europe. Whilst we are comfortable with fundamental risk of these issuers, we did experience spread underperformance at the start of the month. Again this was short-lived volatility and spreads rebounded by month end.
Over the month, we maintained our exposure to Additional Tier 1 and Tier 2 sub debt in both the financial and insurance sectors. Our biggest change was an increase to the infrastructure exposure related to the Pacific National Hybrid. We will potentially see the return of hybrids in 2025 as a valid source of funding for corporates in an environment where capex demands could push credit metrics into a weaker band.
We ended the month with marginally lower spread duration than in November, as rate market volatility could spell increased investor uncertainty and lead to some skittish behaviour leaking into credit.
Learn more about investing in the Schroder Australian High Yielding Credit Fund.
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