12 May 2005
2004-05 INTEREST RATE SWAP PROGRAM
In Operational Notice No 12/2004 issued on 12 July 2004, the Australian Office of Financial Management (AOFM) announced a planned 2004-05 interest rate swap program of around $6 billion of long dated swaps to receive fixed rates and around $3½ billion of short dated swaps to pay fixed rates. The operational notice also stated that the execution of the swap program would be dependent on prevailing market conditions.
So far this financial year, the AOFM has executed $4.6 billion in long dated swaps to receive fixed rates and $2 billion in short dated swaps to pay fixed rates. It has now revised its swap activities and does not plan to execute further interest rate swaps for the remainder of the financial year. This decision takes account of the prospective transfer of assets from the AOFM’s portfolio to the Future Fund and current market conditions.
The AOFM undertakes interest rate swap transactions in order to reduce the medium term cost of its net debt portfolio, using as a target the benchmark portfolio announced in September 2003. Over recent months financial market conditions have seen a flattening in the swap curve that has at times been quite pronounced relative to the experience of recent years. New interest rate swaps to receive fixed rates in current conditions are not expected to generate cost savings consistent with the assumptions underpinning the benchmark.
With the establishment of the Future Fund, as announced in the 2005-06 Budget, some assets administered by the AOFM will be transferred to the Fund in 2005-06. Where these assets are held in the Long Term Debt Portfolio, their transfer to the Future Fund will act to reduce the duration of the portfolio, significantly reducing its need for interest rate swaps to receive fixed rates.
Operational Notice No 12/2004 indicated that the AOFM expected to complete the transition of its net debt portfolio to the benchmark announced in September 2003 by end June 2005, subject to market conditions and budget developments. This transition has been delayed by the flattening of the yield curve through the course of the year and the revision to the 2004-05 fiscal position announced within the Mid-Year Economic and Fiscal Outlook, which added to the size of the debt defeasance task in 2004-05. Each of these factors acted to increase the portfolio’s duration.
In these circumstances, with the cessation of interest rate swaps during the remainder of 2004-05 and planned Treasury bond issuance, it is likely that the modified duration of the AOFM’s Long-Term Debt Portfolio will remain slightly above the upper operational limit that applies during 2004-05. However it is expected to remain below the upper policy limit.
Information on the AOFM’s planned interest rate swap execution activities for 2005-06 will be provided in July 2005.
Director, Financial Risk
Telephone: +61 2 6263 1136