3 July 2007
2007-08 INTEREST RATE SWAP PROGRAMME
This notice provides details of the Australian Office of Financial Management's (AOFM) intended Australian dollar interest rate swap programme for the 2007-08 financial year.
In 2007-08, the AOFM plans to execute up to $1 billion of swaps to receive fixed interest rates with maturities of at least 4 years and up to $1 billion of swaps to pay fixed interest rates with maturities not exceeding 3 years. Swap execution will be dependent upon prevailing market conditions; it is possible that the AOFM will not undertake any new swaps during the year.
The AOFM undertakes interest rate swaps to reduce the cost of its debt portfolio by reducing its average term to maturity. This depends on there being a positive term premium between market interest rates on longer and shorter term debt (after allowing for expectations about future changes in rates). Over recent years, both in Australia and elsewhere, yield curves have tended to become flatter, reducing the margins between longer and shorter term debt. At times, the slope of the swap yield curve has been negative. A combination of structural and transient factors appears to have produced these effects.
The AOFM has taken these developments into account in its annual benchmark portfolio reviews. In 2005 the target duration of the benchmark portfolio was increased, thereby lengthening its average term to maturity. A further increase in target duration of the benchmark portfolio (from 2.5 to 3 years) will be made on 1 July 2007. These changes reflect the reduced savings available to the AOFM from interest rate swaps under current market conditions. Guided by the new benchmark, the average term to maturity of the portfolio will increase gradually as debt is rolled over and existing swaps mature. Transition to the new benchmark could take up to two or three years.
New interest rate swaps under the programme announced in this Operational Notice will be undertaken only when they are expected to provide savings to the Commonwealth over the medium term, or a reduction in risk.
The AOFM considered whether it was appropriate to continue the interest rate swap programme in current market conditions. On balance it was judged that there are strong grounds for expecting some positive term premium in the medium term, and that continuing the interest rate swap programme will provide some flexibility to respond to changing market conditions.
The AOFM will execute swaps in 2007-08 using similar procedures to those employed in 2006-07. As has been the case since 1 January 2007, new swaps will be executed only with counterparties who have signed a Credit Support Annex with the Commonwealth.