What is going on with Bills/OIS?

The spread between the Australian Bank Bill Swap (BBSW) and Overnight Indexed Swap (OIS) has, in recent weeks, widened significantly to highs not seen since the Global Financial Crisis. A number of domestic and international factors have converged to bring about this gulf, but as most of the factors are one-off, the IFM Investors Debt Investment team believes the spreads are unlikely to remain this pronounced for a prolonged period. We detail below how, if short end rates remain elevated, the shift could enhance the monthly performance of cash portfolios managed by IFM Investors.

What is going on with short-term interest rates?

Both three-month and six-month Australian Bank Bill Swap (BBSW) have risen by around 25 basis points since the middle of February, as can be seen in Graph 01. This would be normal if the Reserve Bank of Australia (RBA) was increasing interest rates, but the cash rate has been unchanged since August 2016, and general consensus is for no changes to the official cash rate this year. A useful guide for RBA cash rate expectations is the Overnight Indexed Swap (OIS), and this has barely moved for months. Hence the observed spread between BBSW and OIS (often referred to as bills/OIS basis) has widened to levels not seen for years.

The widening in an historical context

How significant has the current widening been? In historical terms, quite significant. Six-month bills/OIS basis is currently +61 basis points, compared to a five-year average of around +35 basis points, see Graph 02. There are only two previous episodes with peaks higher than current levels. One was in 2008, shortly after the collapse of Lehman Brothers, when the spread reached over +90 basis points. The other was at the end of 2011, during the European sovereign debt crisis, when the spread reached roughly +80 basis points.

In Graph 03 we show the one month change in six-month bill/OIS for each calendar month over the past six years. The recent change has been more rapid than any other movement over an equivalent time period.

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GRAPH 1 - BILLS/OIS BASIS

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GRAPH 2 - SIX MONTH BILLS/OIS BASIS

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GRAPH 3 - ONE MONTH CHANGE IN SIX MONTH BILLS/OIS BASIS

Source: Bloomberg, ASX