Rob Thompson:
Welcome to the next edition of The Aussie Debrief. I'm Rob Thompson, macro strategist at RBC, and I'll be taking you today through our 2021 semi outlook. Semi spreads have reached their tightest levels to bond and swap in decades, but there are good reasons for this. And we think risk/rewards still favours staying long, for at least the next three to six months. With a positive narrative likely to stay in place for the sector, at least through to the next full set of budget updates through May and June.
Rob Thompson:
There are two main factors behind our view. Fiscal outlooks for the states continue to improve, variative to a somewhat pessimistic set of state budget forecasts made late last year. And second, consistent buying demand, especially from the RBA as part of its quantitative easing program, which is leaving very little supply for the rest of the market. In fact, once balance sheet purchases are also taken into account, net supply to the rest of the market is likely to be quite deeply negative through to at least the end of August this year, to the tune of about negative 2,25 Billion per month. And even after that, Net Supply will likely stay low for quite some time, especially if the RBA continues semi QE purchases at or near the current billion dollars per week pace.
Rob Thompson:
Offshore buyers are also adding to demand. Japanese buying, in particular, is likely to continue, with currency-hedged yields north of 2.5%. Available on longer tender semi debt. And issuers are generally still open to this demand, which is helping them further lengthen their debt maturity profiles and take even more pressure off the domestic benchmark programs.
Rob Thompson:
On the fiscal side, we're expecting a much better-looking set of mid-year budget updates, kicking off this week with New South Wales. This will be followed by more comprehensive set of full-year budgets, which will resume their normal cycle in May and June, after COVID-19 disruptions impacted timings last year.
Rob Thompson:
We think the fast and expected recovery out of COVID-19 conditions will deliver upside revenue surprises for a number of channels, including commodity royalties, stamp duties, and GST receipts, some of which we've already seen in the monthly data to date. Our best case in semi-spreads is that they will narrow by about another five basis points across the 10 to 14-year tenders over the next three and six months. We've also shifted our core term preference up from 5 to 10 year, which worked well last year, to a focus now on 10 to 14-year bonds, which have the steepest spread pickups.
Rob Thompson:
We suggest moving to only a small overweight though, and reflecting this, intend to hold only one to two concurrent semi-trade recommendations, down from about two to three at various times last year. This contrasts with the back end of last year, when we were more bullish, given spreads were considerably wider.
Rob Thompson:
From a trade recommendation perspective, our general approach is characterized by one, a preference for the longer end. Again, as stated, that's 10 to 14-year area bonds on relative value grounds. Two, a focus on picking up primary issuance where it looks attractive, or secondary where it makes sense. And three, a willingness to consider all issuers at the right price. All our [inaudible 00:03:24], prefer Western Australian debt, given its extremely strong budgetary position at the moment. But with current pricing, TCorp arguably holds the most promise, given its asset sell pipeline and wider spread starting point.
Rob Thompson:
We currently hold QDC August 32s by attending futures and our trade recommendation portfolio. And we'll continue to look for attractive switch opportunities. It's also worth mentioning here that we've generally favor Holden semi's versus swap. Given our view that swap spreads will continue to wind back gaps for normal pre-COVID levels. Looking a bit further ahead on semi's. We may look to reassess a long bias after June.
Rob Thompson:
Once those four-year budgets have been mostly released. At this point, we anticipate fiscal positions will have been marked up leaving less room for further positive surprises, and we'll also need to see how the RBS appetite for further quantitative easing has developed. With the current program set to end in August. It's also worth pointing out that we have modeled supply and demand to seeming to more QA extensions, was 75 and 50 billion respectively. And under these conditions, we find that supply could remain negative or at least close to zero. Well into 2022. This would continue to keep a lid on semi spreads, despite historically tight valuations.
Speaker 2:
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