Australia Market Commentary
The Australian bond market (as measured by the Bloomberg AusBond Composite 0+ Yr Index) was up 1.70% over May. The yield curve flattened as the spread between long-term and short-term bond yields narrowed. Three-year government bond yields ended the month down 18 basis points (bps) to 1.10%, while 10-year government bond yields were down 33 bps to 1.46%. Short-term bank bill rates ended the month sharply lower. The one-month rate was down 19bps to 1.41%, the three-month rate was down 14 bps to 1.42% while the six-month rate was down 21 bps to 1.41%. The Australian dollar was weaker, closing the month at USD 0.69.
The cash rate remained unchanged in May at 1.50%. Following a speech from Governor Lowe in April indicating that the RBA will “consider the case for lower interest rates” at their June meeting, the market has broadly priced in two 25 bps rate cuts by September.
The latest domestic economic data releases were mixed in May. Employment growth rose a larger than expected 28,400 positions in April, but the unemployment rate edged higher to 5.2%. The NAB Business Conditions index fell 4 points to +3 in April, while Business Confidence was flat. Residential building approvals for April fell a larger than expected 4.7%, with year-on-year approvals remaining negative at -24.25%. National CoreLogic dwelling prices continued their fall, down 0.5% in May. This sees the year-on-year decline at -7.3%, the lowest since February 2009. Retail sales were higher than expected, up 0.3% in March.
Australia Market Outlook
Global growth has moderated, largely due to the slowdown in China and the impact of the escalating US-China trade war which has reduced international trade. We remain cautious about the global trade environment but remain positive on the growth outlook given the dovish tone of the US Federal Reserve and other major central banks which should help support global growth.
While the Australian economy has completed 26 years of uninterrupted expansion, there are also risks on the horizon locally. As expected, the weak housing market has filtered through to the broader economy, with declining house prices and a period of sustained low income growth impacting household consumption. Furthermore, unemployment has recently deteriorated to 5.2% from 5.0% and there are mixed signals on labour demand, pointing to a moderation in employment growth in the near term.
We have long been expecting that the RBA will cut rates in 2019, and more recently the broader market has come round to our way of thinking. The delivery of a 25 basis point rate cut in early June has seen the RBA take action to support employment growth and reduce the spare capacity in the labour market. We anticipate a further rate cut by September.
Credit Commentary
After a series of positive months, sentiment towards credit turned negative in May as the trade war between the US and China heated up. Although the Australian physical market was slightly positive, rallying by about 1-2 bps overall, synthetic markets sold off substantially: 11.5 bps for the US CDX and the Australian iTraxx and 14bps for European iTraxx.
In credit news, ANZ and NAB reported 1H19 results broadly in-line with expectations. Net interest margins came under pressure for both banks creating a more challenging environment for profits but both balance sheets remain solid. NAB’s capital is weaker than its peers and remains behind APRA’s requirements. In New Zealand, ANZ received negative attention after the Reserve Bank of New Zealand (RBNZ) revoked its accreditation to use its own risk models, resulting in the need for an additional NZD 277m of capital after the CET1 ratio has fallen by 40 bps while total capital ratios are down 60 bps.
Also in banking news, APRA is proposing to drop the 7% interest rate floor requirement for assessment of loan servicing in its mortgage lending guidelines, while increasing the minimum interest rate buffer from 2.00% to 2.50%.
In other Australian credit news, Incitec Pivot reported weaker than expected 1H19 results due to various operational interruptions. Net leverage looks to increase to above management’s target of 2.5 times. Scentre sold a 50% stake in Westfield Burwood with the proceeds used to repay debt. Mirvac raised AUD 750 million of equity capital to fund development and acquisition opportunities. Downer advised the market that its partner on the Murra Warra wind farm, Senvion, had filed for self-administration in Germany causing an 11% fall for Downer’s share price. Singtel Optus reported strong growth with revenue rising 6% on personal contract plans. Its parent, Singapore Telecommunication Ltd, however, reported weaker FY19 results than expected after earnings fell due to higher operating expenses. Telstra announced it will carry out 6,000 of its 8,000 job cuts in FY’19, slightly ahead of plan, as well as writing down its legacy IT assets by around AUD 500 million.
In offshore credit news, Anheuser-Busch InBev filed an application to list its Asia Unit – which is the issuer for its Australian debt - in Hong Kong. Vodafone Group announced the sales of its New Zealand business to Infratil and Brookfield Asset Management for USD 2.2 billion. All cash proceeds from the sale will be used to pay down debt.
In credit rating news, Moody’s upgraded Glencore’s long-term and senior unsecured ratings from ‘Baa2’ to ‘Baa1’ and concurrently changed the outlook on Glencore’s rating from ‘positive’ to ‘stable’. S&P revised its outlook on Nissan Motor Co. Ltd and its overseas subsidiaries (including Nissan Financial Services Australia Pty. Ltd) to ‘negative’ from ‘stable’. The long-term and short-term ratings were affirmed at ‘A’ and ‘A-2.
After slowing for the holidays in late April, issuance rebounded in May and was the strongest for 2019 at AUD 9.1 billion almost all of which was from financial issuers – in particular, Westpac issued AUD 3.5 billion and NAB AUD 1 billion. Non-financial issuance was limited to a small AUD 115 million Deutsche Bahn issue for the month. Securitised markets also experienced strong issuance with AUD 5.6 billion of new supply across four RMBS issues (in the prime market, Firstmac, SMHL and new issuer Mortgage House, and in the non-conforming sector, Pepper and Liberty).
Credit Outlook
This year has seen a substantial tightening in credit spreads. At current levels, there is the risk of 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 remains an expensive position.
Supply has been strong this year in terms of number of issuers. Domestic non-financial supply is often less abundant 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. High-yield spreads offshore appear reasonably tight and are vulnerable to widening; as such, the extent of compensation for taking exposure to lower-rated credit is less compelling.
Domestic and offshore financials tend to be the most common issuers in the Australian market and can offer value. However, for offshore issuers, caution must be applied due to the complexity of the variations in treatment of TLAC (total loss-absorbing capital). Accordingly domestic major banks offer a simpler value proposition due to their liquidity and some of the smaller local approved deposit institutions (ADIs) provide a solid spread with conservative management. On the non-financial side, the lack of supply has resulted in many deals being expensive but stable sectors such as the utilities and quality REITS remain more attractive sectors. Securitised product remains another area of value given solid spreads and in many cases superior credit quality.
