Market Commentary
The Australian bond market (as measured by the Bloomberg AusBond Composite 0+ Yr Index) was up 0.64% over the month. The yield curve steepened as the spread between long-term and short-term bond yields widened. 3-year government bond yields ended the month down 10 basis points (bps) to 1.75% while 10-year government bond yields were down 8 bps to 2.24%. Short-term bank bill rates ended the month lower. The 1-month rate was down 4bps to 2.01%, the 3-month rate was down 2 bps to 2.07% while the 6-month rate was down 3 bps to 2.19%. The Australian dollar was higher, closing the month at USD 0.73.
The cash rate remains unchanged at 1.50% with a softening in a tightening rhetoric in recognition of recent market volatility and apparent downside risks. The Reserve Bank of Australia (RBA) maintains its view that the Australian economy is performing well with growth expectations holding at 2.75%, which is expected to result in further progress in reducing unemployment. An improving wage cost index is seen as supporting consumption and raising the inflation to the target 2.0%.
The latest domestic economic data releases were mixed in January. Residential building approvals for November fell by 9.1%, largely due to the higher density sector which fell 18%. Employment rose in December by a greater-than-expected 22,000 positions. Meanwhile the unemployment rate ticked down to 5.0%. The NAB Business Conditions fell 9 points to +2 in December, the sharpest monthly fall since the GFC, while business confidence held steady at +3. Retail sales rose 0.4% in November, which was above expectations. The headline Consumer Price Index for Q418 rose a faster-than-expected 0.5%. The annual inflation rate was 1.8%, remaining below the RBA’s target band.
Market Outlook
Global growth has desynchronised and we remain cautious given ongoing geopolitical risks and shifting central bank policy settings. The US Federal Reserve turned more dovish during January, dropping their bias to hiking rates. The US instigated trade war remains ongoing, despite the temporary truce called between the US and China at the last G20 Summit.
The Australian economy continues to grow and has officially completed 26 years of uninterrupted expansion. We expect the monetary policy easing that took place in 2016 to continue to support a slow but robust growth environment.
Over the past six months the consumer has struggled despite a strong business and employment outlook. Corporate profits are robust and business confidence remains positive, however historically low retail sales and poor consumer confidence driven by very low wages growth makes the outlook for growth quite mixed. Signs of an end to the residential construction boom are another cloud on the horizon.
We expect the RBA to continue to keep rates on hold into 2020 with a growing risk that rates will need to be cut in 2019. Given the soft inflation backdrop the RBA will likely have little justification to move cash rates higher in the near term, and looks to be at risk to provide a more dovish tone than they had during 2018 when they consistently hinted that the next move would be up. In the bond market, we expect Australian bond yields to follow global yields higher. Provided there is no sharp sell-off in risk assets we would expect credit spreads and swap spreads to remain well supported.
Credit Commentary
The news flow in January continued to be negative with trade wars, Brexit and the partial closure of the US Government dominating the headlines. However credit markets shrugged off the negative backdrop with the US market tightening by approximately 25 bps and the European market by 6 bps. Australian spreads however were flat over the month. Synthetic indices all rallied strongly with the Australian iTraxx 17.5 basis points tighter and, in offshore markets, the US CDX 21.5 bps and European iTraxx 17 bps tighter respectively.
News flow was limited over the month apart from company reporting which was mixed with UBS, Ford and Hyundai showing weakness while Caterpillar and Intel announced improved results. Verizon and AT&T were mixed with the focus in AT&T’s case particularly on its deleveraging. Apple lowered its guidance at the start of January due to China weakness and then met the revised targets at the end of the month. Closer to home, BHP flagged weaker production numbers earlier in the month before the tragic dam burst at Vale’s Brumadinho was seen as placing constraints on iron ore production boosting Rio Tinto and BHP. Air New Zealand cut its earning guidance, impacting Qantas’s share price. Wesfarmers lowered its guidance stating that it expected Kmart sales to fall by -0.9% YOY.
The Australian Competition and Consumer Commission further deferred its decision on the TPG-Vodafone merger due to the slowness of response from involved parties and signalled a ruling on 11 April. TPG also indicated that it would not roll out a 4G network in Australia, boosting Telstra’s share price.
Corporate issuance for January was strong totalling AUD 8.95 billion. However AUD 8.85 billion came from issues by three major Australian banks (Commonwealth Bank, Westpac and ANZ) with Mitsubishi UFJ adding the last AUD 100 million. There were no non-financial issues over the month. In securitisation, two deals were priced, totalling AUD 0.64 billion: a refinance of an existing senior issue from Puma and a new Triton RMBS issue from Columbus Capital.
Credit Outlook
Domestic credit spreads were stable over the month, remaining tighter than the post-financial-crisis levels of 2015. As such, there is room for further widening in an environment where global or economic uncertainty continues to apply pressure: however, underweighting credit at current spreads for any sustained period of time has become more expensive than at the beginning of last year.
Supply in 2018 exceeded that of the previous year boosted by strong issuance from the major banks and other financials. Domestic non-financial supply was less robust and is always uncertain given many Australian investment-grade issuers tend to be lowly geared and so require less debt. In addition, the bank loan market remains attractive for shorter maturities and offshore markets offer competitive pricing for sizable long-term debt issues. Many issuers have also taken advantage of low rates to refinance many of their maturities and the short-term corporate pipeline is thin.
Given the possibility of further weakness of spreads, caution needs to be applied especially when investing in lower-rated credits. Despite the differing performance in terms of ratings, high-yield spreads in the US still appear reasonably tight and in Europe are close to normal but vulnerable to further widening; as such, the extent of compensation for taking exposure to lower-rated credit is less compelling.
Select offshore banks can also provide strong opportunities but caution must be taken due to the difficult operating environments and regulatory uncertainty for banks in many jurisdictions especially in light of increasingly broad focus on TLAC (total loss-absorbing capital). Many non-financials seem tightly priced. Accordingly, our preferred sectors remain domestic or select Asian banks, RMBS and the stronger utilities.