Australian Market Commentary

The Australian bond market (as measured by the Bloomberg AusBond Composite 0+ Yr Index) was up 1.51% over the month. The yield curve flattened as 3-year government bond yields ended the month down 14 basis points (bps) to 0.67% while 10-year government bond yields were down 30 bps to 0.89%. Short-term bank bill rates ended the month mostly lower. The 1-month rate was up 3bps to 1.05%, the 3-month rate was down 4 bps to 0.97% while the 6-month rate was also down 4 bps to 0.99%. The Australian dollar was weaker, closing the month at USD 0.67.

The Reserve Bank of Australia (RBA) maintained the cash rate at the record low level of 1.00%. The RBA noted that it is reasonable to expect an extended period of low interest rates in order to make progress in reducing unemployment and achieve more assured progress towards the inflation target.

Domestic economic data releases were better than expected in August. Employment growth rose a higher than expected 41,500 positions in July, while the unemployment rate remained steady at 5.2%. Retail sales exceeded expectations, rising 0.4% in June. The NAB Business Conditions index fell by 2 points to +2 in July. In contrast, Business Confidence rose to +4 from +2. National CoreLogic dwelling prices rose 0.08% in August, with strong gains in Sydney and Melbourne.

Australian Market Outlook

Global growth has moderated, largely due to the slowdown in China (and neighbouring Asia) and the impact of the ongoing US-China trade war which has reduced international trade. A temporary truce which was agreed at the June G20 Summit was short-lived, with China announcing retaliatory tariffs on USD 75 billion of US goods in August, and President Trump announcing a 15% tariff on USD 300 billion worth of Chinese imports that had previously been spared. We remain cautious about the global trade environment but remain hopeful regarding the overall growth outlook given the US Federal Reserve’s recent rate cut and the dovish view of other major central banks which should help support global growth.

Domestically, the Australian economy is growing below-trend due to a period of declining house prices and sustained low income growth impacting household consumption. Despite strong employment growth, unemployment has hovered at 5.2% in recent months as labour force participation has increased to a record level. Economic growth is expected to increase only gradually, supported by the low level of interest rates, recent tax cuts and signs of stabilisation in the housing market.

We had long expected that the RBA would cut rates in 2019, and the broader market eventually came around to our way of thinking. The delivery of two 0.25% rate cuts in June and July has seen the RBA take action to support employment growth and reduce the spare capacity in the labour market. We maintain our view that they will pause here to assess the outcomes of these recent cuts before taking any further action, but believe there could be another cut in the new year.

Credit Commentary

The US-China trade war livened up in August with President Trump’s remarks creating a volatile month for credit spreads, although offshore in synthetic markets, US CDX and European iTraxx closed just slightly tighter than at the end of July. Domestically, credit was less benign and both the Australian iTraxx and physical spreads finished the month about 5 bps wider.

Many Australian issuers reported in August: mostly either slightly negative or as expected. However, in almost all cases, reported results were solid enough to support current ratings.

In the A-REIT sector, Shopping Centres Australasia, ALE Property Group, GPT Group, Dexus, Vicinity and Stockland were all on the weaker side while Mirvac was more positive. The contrast on failed settlements between Mirvac (<2%) and Stockland (7%) was noticeable, highlighting the differences in their market focuses.

Among the financials, while CBA and Suncorp Group were broadly in line with expectations, Bendigo & Adelaide Bank was on the weaker side and AMP Group continues to be challenged with the main focus on a revised sale of its Life business. In other sectors, Telstra reported results that met expectations but its leverage is rising due to weak EBITDA growth. Woolworths and Wesfarmers were steady while BHP, AGL and APA Group were on the positive side. Caltex, however, reported weak numbers but had foreshadowed them with earlier revised guidance.

Transurban, Lendlease and Aurizon also reported. After its report, both S&P and Moody’s affirmed Aurizon Network’s ratings and assigned BBB+/Stable and Baa1/Stable to Aurizon Operations.

In other ratings news, Energy Partnership Group (EPG) had the outlook on its BBB+ rating moved from Stable to Positive by Standard & Poor’s. S&P downgraded AMP Bank to BBB+/Negative.

Aside from reporting and ratings, news for Australian issuers was limited with perhaps the most significant item being Westpac’s victory against ASIC in a court case on responsible lending. It is reasonable to expect ASIC to respond with tighter guidelines or regulations around this topic.

August saw a further AUD 10.1 billion of new supply with AUD 650 million from non-financial issuers (QIC Shopping Centre, Volkswagen and Mercedes Benz). YTD supply is about AUD 11 billion higher than the corresponding period in 2018. After very strong issuance in May and June, securitised markets provided about 3.25 billion of very varied issuance: a refinance of an old Medallion (CBA deal); two prime RMBS deals from REDS (Bank of Queensland) and RESIMAC; a securitisation of non-resident mortgage loans from Vermillion Trust (Columbus Capital); and an after-pay asset ABS from ZIP Master Trust.

Credit Outlook

Despite a weaker August, this year has seen a substantial tightening in credit spreads. At current levels, in an environment where political or economic uncertainty continues to apply pressure, the risk of widening is increasing, 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—although still biased towards financials. 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 or longer-dated 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 total loss-absorbing capacity (TLAC). Accordingly domestic major banks offer a simpler value proposition due to their liquidity while 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.