Insight: AOFM’s Dilemma: Continue with T-Notes or Focus on Bonds?

By Sophia Rodrigues

Investor interest at Australian Treasury Note tenders have been increasing in recent weeks, posing a dilemma to the government debt manager on whether to continue tenders at elevated levels or scale them back in favor of bonds as overall market improves.

One indication of increasing interest is the narrowing in the lowest and highest accepted yield at recent tenders. For example, for the first time since mid-March, the average gap between the lowest and highest accepted yield at the three tenders on June 4 was 2bps. This included the March 2021 T-Note where the gap was just 1bp, a record for a T-Note tender beyond six months.

Another indicator is the rise in coverage ratio. The June 4 tenders saw average coverage ratio for three tenders of 5.2 times, compared with 3.8 times average since March.

The Australian Office of Financial Management stepped up borrowing in March to fund the government’s additional spending for measures taken in response to COVID-19. Because financial markets were in turmoil back then, T-Notes were the preferred method of funding because of their short-term nature.

The focus on T-Notes issuance continued since then but has slowly been declining as AOFM became more confident with bond tenders. So, from a peak of A$5 billion of T-Note tenders between mid-April to mid-May, the weekly issuance fell to A$4 billion, and last week saw a further decline to A$3 billion.

The AOFM is currently sitting on a huge pile of cash because it is running ahead with its borrowing program and since the government’s JobKeeper spending is now estimated to be A$60 billion less than initially projected. At the end of May, the AOFM had term deposits totalling A$64 billion which is a record high.


Based on its current comfortable cash position, the AOFM could easily scale back T-Note issuances and it is entirely likely the tenders for next week would be dropped further to A$2 billion.

However, the decision is not straight-forward because for the first time, there is an opportunity to develop the secondary market for T-Notes in Australia because of the sharp rise in recent issuances.

As of Friday, T-Notes on issue have risen to a record A$54 billion, more than three times the level just three months ago.

An underdeveloped secondary market for T-Notes makes it difficult to identify market makers in the same way as for Treasury Bonds and Treasury Indexed Bonds. One way to increase secondary market activity is to increase rate of T-Notes issuance, AOFM said in a note last year.

In recent months and for the first time ever, the yield on T-Notes have been consistently higher than BBSW, meaning the AAA risk-free rate is more than the AA-rate, and this is because T-Notes are less liquid than bank bills.

As more T-Notes are issued and secondary market activity increases, there is an opportunity for T-Note yields to fall further, which could give the AOFM a compelling reason to continue with elevated issuance.

AOFM knows which way it would like to go but the decision rests entirely on the cost factor. As things stand, T-Note is a slightly expensive route given markets have stabilized and there is strong demand for government bonds.