Australian Market Commentary

The Australian bond market (as measured by the Bloomberg AusBond Composite 0+ Yr Index) returned 0.82% over the month. The yield curve steepened as 3-year government bond yields ended the month down 16 basis points (bps) to 0.65% while 10-year government bond yields were down 11 bps to 1.03%. Short-term bank bill rates ended the month lower. The 1-month rate was down 10 bps to 0.82%, the 3-month rate was down 4 bps to 0.89% while the 6-month rate was down 8 bps to 0.95%. The Australian dollar (AUD) was weaker, closing the month at US dollar (USD) 0.68.

The Reserve Bank of Australia (RBA) left the cash rate unchanged at the record low of 0.75% at the November meeting. The RBA reiterated that they would ease monetary policy further if needed "to support sustainable growth in the economy, full employment and the achievement of the inflation target over time".

Domestic economic data releases were mixed in November. Employment fell by 19,000 positions in October, which was well below expectations. The unemployment rate edged back up to 5.3%. Retail sales also missed expectations, recording a 0.2% gain in September. The NAB Business Conditions index rose by 1 point to +3 in October while Business Confidence also rose to +2 from 0. National CoreLogic dwelling prices continued to rise, increasing 1.5% in November, the fifth consecutive month of gains.

Australian Market Outlook

Global growth has moderated, largely due to the impact of the ongoing US-China trade war which has reduced international trade. Economic data in both the US and China remains mixed however there are signs that global industrial production has bottomed. A pause in US-China trade tensions in recent months has been welcomed by markets, however it is still unclear if an agreement will be reached. We remain cautious about the global trade environment but remain hopeful regarding the overall growth outlook given the US Federal Reserve's recent rate cuts and the dovish view of other major central banks which should help support global growth. Furthermore no-deal Brexit risks have eased, with a UK election set for 12 December and the European Union granting the UK a "flextension" to 31 January 2020.

Domestically, the Australian economy has been growing below-trend, with sustained low income growth impacting household consumption. Despite strong employment growth, unemployment has hovered around 5.2–5.3% in recent months as labour force participation has increased to a record level. Economic growth is expected to increase only gradually, supported by the record low level of interest rates, recent tax cuts and stabilisation in the housing market.

The delivery of three 0.25% rate cuts in quick succession 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 its 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. We expect rates to remain on hold for the next three to six months, particularly as house prices have started to rise and global risk sentiment has improved.

Credit Commentary

Despite uncertainty due to the ongoing US-China trade war, Brexit and the impeachment proceedings against US President Donald Trump, spreads in November tightened slightly. In the Australian physical market the tightening was slight, between 1 and 2 basis points (bps). However in the synthetic markets the US CDX tightened 5 bps, the European iTraxx by 4 bps and the Australian iTraxx by 3 bps.

Domestically, the major story was that AUSTRAC started proceedings against Westpac for breaching the Anti-Money Laundering and Counter-Terrorism Financing Act. Westpac’s failure in process led to the chief executive and the chairman both resigning. ANZ later announced that it was unaware of any AUSTRAC proceedings against it. Earlier in the month NAB, ANZ and Westpac had all released lacklustre reporting. CBA, however, announced strong quarterly growth and Macquarie Bank also reported a first half net profit up 11% versus pcp. Suncorp Bank released its 1Q Pillar 3 report which underscored market trends of reduced loan growth but impairment costs remaining very low. The Reserve Bank of New Zealand announced that it had identified weaknesses in the capital calculation processes of BNZ (NAB’s New Zealand subsidiary) which the bank is now remediating.

In other news, Caltex announced plans for a Property IPO, but on the following day received an indicative non-binding and conditional takeover proposal from Canadian head-quartered Alimentation Couche-Tard Inc. The takeover offer requires that Caltex make no material divestments placing doubt on the IPO. Sydney Airport released its October 2019 passenger data, recording a 1.6% increase on pcp to 3.976 million passengers for the month, driven mainly by an increase in domestic travel. Bank of Queensland announced that it will undertake an equity raising consisting of a AUD 250 million fully underwritten institutional share placement and a non-underwritten share purchase plan for up to an additional AUD 50 million.

In ratings news, after reporting EBIT down 45% from pcp, Incitec Pivot had its outlook revised to negative from stable by S&P, due to elevated leverage and a cyclically depressed operating environment. The company's BBB ratings were affirmed. Moody's placed Incitec on negative outlook in September. Charter Hall Retail REIT had the outlook on its Baa1 rating revised to stable from negative by Moody's. Australian Prime Property Fund (APPF) Retail had the outlook on its A+ rating changed to negative from stable by S&P under the pressure of the fund's equity redemption requirements in November 2019. Kiwibank had its A1 rating affirmed by Moody's with a stable outlook, while the bank's baseline credit assessment was raised to Baa1 from Baa2.

Offshore, Moody's took ratings action on 15 UK banks and building societies, due to a view that the UK operating environment is likely to weaken. Barclays, Lloyds, RBS and Santander UK PLC were impacted. Singapore Power Ltd's AA rating has been affirmed at S&P, and the outlook has been revised to Positive from Stable. BMW had its outlook revised to negative from stable by S&P. Daimler AG had its A ratings placed on CreditWatch Negative by S&P following the company's downward revision of its 2020-21 earnings guidance Total SA had the outlook on its Aa3 rating from Moody's lowered to stable from positive.

Domestic supply in November was slightly higher than October, with just AUD 6.1 billion issued with non-financial issuance well-represented at just under AUD 2.4 billion across six issues: five domestic (Endeavour Energy, Macquarie University, Port of Melbourne, David Jones and Qantas) and one offshore issuer (NextEra Energy). Securitised markets had a second strong month, with AUD 6.4 billion of new issuance: five prime RMBS (Triton from Columbus Capital, Medallion from CBA, Torrens from Bendigo and Adelaide Bank, Barton from Beyond Bank and IDOL from ING Bank), one non-conforming issue from Resimac and an ABS from FlexiGroup. CBA's Medallion deal was the first RMBS issue to be priced off the AONIA (AUD Overnight Index Average) Index rather than BBSW.

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. The weighting can be more focused, however, on shorter dated credit which is less sensitive to spread widening.

Supply has been strong this year particularly in terms of number of issuers. Although non-financial issuers have been increasing in number and size, issuance is 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 already taken advantage of low rates to refinance many of their maturities and the short-term corporate pipeline is limited.

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 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.