Australian Market Commentary
The Australian bond market (as measured by the Bloomberg AusBond Composite 0+ Yr Index) returned -0.49% over the month. The yield curve steepened as 3-year government bond yields ended the month up 7 basis points (bps) to 0.74% while 10-year government bond yields were up 13 bps to 1.02%. Short-term bank bill rates ended the month mixed. The 1-month rate was down 4bps to 1.01%, the 3-month rate was down 2 bps to 0.95% while the 6-month rate was also up 6 bps to 1.05%. The Australian dollar was slightly stronger, closing the month at USD 0.68.
The Reserve Bank of Australia (RBA) maintained the cash rate at the record low level of 1.00%. The RBA were materially more dovish than expected and noted they “would ease monetary policy further if needed”. The RBA acted on these comments by cutting the cash rate by 25 bps to a new record low of 0.75% at the 1 October meeting.
Domestic economic data releases were mixed in September. Employment growth rose a higher than expected 34,700 positions in August, although the unemployment rate ticked up to 5.3%. Retail sales missed expectations, ticking down 0.1% in July. The NAB Business Conditions index fell by 2 points to +1 in August. Similarly, Business Confidence fell to +1 from +4. National CoreLogic dwelling prices continued to rise, increasing 0.09% in September, with strong gains in Sydney and Melbourne. Q2 GDP held steady at 0.5%, with the annual rate softening to 1.4%.
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 US 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 were somewhat surprised to see the RBA continue with a third cut of 0.25% in October, as we thought that the RBA would wait to see if the prior two cuts where flowing through the economy. In spite of this we think that the RBA is warranted in providing additional support to the Australian economy amidst concerns that global trade is slowing.
Credit Commentary
With US trade wars, Brexit, increasingly intense protests in Hong Kong and moves at the end of month for the impeachment of Donald Trump, the environment for financial markets is quite challenging. However, in September, the credit markets seemed to shrug off any concerns and credit spreads were relatively stable. The US CDX was 1 basis point tighter and European iTraxx finished flat from the levels at the end of August. Domestically, the Australian iTraxx closed 3 bps tighter while physical spreads were virtually unchanged.
It was a quiet month for credit news. In corporate news, Telstra quantified the effect of NBN’s delay in connecting properties. Overall there is a deferral of some receipts and charges, but, from a credit perspective, the news was minor with no expected rating impact. Incitec Pivot downgraded its FY19 results and announced a potential demerger of its fertiliser business. Coca Cola Amatil announced a restructure along geographic lines and the dissolution of its Alcohol & Coffee unit. New Zealand Milk (Fonterra) announced a loss of NZD 606 as the result of write-downs of some previous acquisitions. This loss had been foreshadowed in August.
In ratings news, Ford Motor Company was downgraded to junk status (Ba1 from Baa3) by Moody’s, due to uncertainty surrounding the extensive restructuring that the company is undertaking.
September saw the US reach its largest recorded fortnight of corporate issuance. However, domestic supply was lower than the previous few months with just over AUD 4.5 billion issued. Non-financial issuance formed a more significant proportion than usual at AUD 1.275 billion across four issues: two domestic issuers (Pacific National and Downer Group) and two offshore ones (Spark NZ and John Deere). Securitised markets remained active, with AUD 4.7 billion of issuance across three RMBS (Bluestone’s Sapphire, Macquarie’s Puma and MyState Bank’s Conquest Trust) and two ABS issues (a credit card deal from Latitude and a personal loan deal from Now Finance).
Credit Outlook
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 sizeable long-term debt issues. Many issuers have already 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 capital requirements with varying rules on TLAC (total loss-absorbing capacity). 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.
