Equity and credit markets had a strong week driven by a surge in commodities prices. BHP, Woodside and Rio Tinto led the market higher and they were supported by positive news from Telstra and the banks. Bond and credit indices were slightly weaker as the Treasury bond curve weakened slightly (+0.05%). Corporate news flow dominated headlines last week with some major issuers reporting first quarter sales.   Wesfarmers (WES) reported quarterly retail sales growth of 6.8% ($13.8 billion) on Thursday which was attributed to strong performances across all retail businesses. Food & liquor sales were up 5.9% for the quarter (Easter propped up spending by ~1.3%) which we believe is a good result in light of 2.0% deflation on food & liquor prices (hence volumes were up strongly). Kmart and Bunnings performed strongly with revenue up 18% and 11% respectively. Target was the underperformer with sales growth of 2.3% but excluding Easter sales were ~-0.80%. Bloomberg reported last week that Woolworths (WOW) increased its syndicated loan facility to AUD2 billion equivalent up from AUD1.2 billion. The deal was significantly oversubscribed with ~50 banks participating. The deal had three tranches (including a USD tranche) and interest margins were reported to be 1.30% for the 3 year AUD700M tranche, 1.60% for the 5.5 year AUD965M and USD260M tranches. For more detail click here.   Following on from Fortescue’s bond repurchase in 2015, Rio Tinto has launched a tender offer for up to USD1.5bn of its 2017 and 2018 bonds. In a notice to bondholders the company said it would make an offer to redeem USD1.5 billion of debt maturing in the next two years. The initial offer will be holders of USD1.75 illion of bonds that mature this year and should funds still be remaining the company will extend the offer to holders of USD3 billion of bonds due in 2018. Rio’s bond buyback represents about 6 % of the USD25 billion of total debt. There are a number of reasons for doing this but the recent trend in the commodity sector has been purchasing bonds at a discount to issuance and representing this balance sheet gain as “income” in their financial statements.   Commodity prices (especially Oil and Iron Ore in Australia) have become a key determinant of market direction of late and forecasting prices in this sector is almost as difficult as picking the direction of interest rates. Strangely enough these two factors are correlated. In fact, there are a number of reasons why real interest rates affect real commodity prices. For example high interest rates reduce the price of storable commodities by increasing the incentive for extraction today rather than tomorrow. This boosts the pace at which oil is pumped and / or iron ore is mined. Also, high interest rates decrease a company’s desire to carry inventory (think of oil held in tanks). So the decisions of central banks going forward will influence the decision of companies such as BHP and RIO when determining their production forecasts. Both of these companies have now tightened production in response to market oversupply. This has definitely helped the price of iron ore and their share prices. Oil supply is ultimately a political decision and will be driven by Iraq, Iran, OPEC and other oil producers who may or may not agree on a production freeze next month.   In the bank hybrid market we have witnessed the Australian major bank hybrids outperforming relative to senior unsecured and subordinated debt securities over the past two months. With bank share prices having recently been down by as much as 30% from their 2015 peak (as reflected in the S&P/ASX 200 Banks Index chart), investors appear to have refocused upon bank hybrid yields on offer and have seen value when compared to other parts of the capital structure. While investor sentiment towards bank hybrids has improved, the recent rally may pause for a period as investors take the time to analyse how the banks are faring with the ANZ, NAB and WBC all reporting results during early May. With the financial sector facing increased scrutiny from all sides of politics leading into an expected early Federal election on 2nd July, any perceived weakness in earnings and/or hint of a slowdown or reduction in dividend payments may continue to lend support for bank hybrids as investors continue to be attracted by the yields on offer. On the flip side, the banks may decide to increase the supply of hybrids when replacing existing issues that have to be replaced over the coming months or by announcing a completely new issue.  


Click below for Interactive Charts

Chart 1: Bloomberg AUSBond Composite Index (Monthly)

Chart 2: Bonds vs Equities 2014/15/16 (Monthly)


Interest Rates

There was an interesting focus on interest rate expectations last week as the European Central Bank left policy unchanged (expected), the RBA Governor confirmed our thoughts at a conference in New York and the stronger markets increased expectations of a June rate hike in the US.   On Tuesday last week Glenn Stevens (RBA Governor) spoke at the Credit Suisse Global Markets Macro Conference (click here for more detail) and made the comment that “If trend growth is lower and we can’t or don’t want to do anything about that, then expectations about future incomes, tax bases and so on will have to be reconfigured.” That plays into our thesis of lower rates for longer and that the “new neutral” rate is significantly lower than it has been in the past. This plays into almost all investment strategies and should be a core focus of any income strategy.   Economic data releases in Australia were insignificant last week but this week the focus is on inflation (market consensus is CPI weighted medium of 0.20% quarterly / 1.70% annualised which is almost identical to the final quarter of 2015).  We expect that the inflation numbers (released 11:30 Wednesday) will confirm that inflation is low and this will confirm the “conditional easing bias” of the RBA. The RBA forecasts (February Statement on Monetary Policy) are broadly in line with the market expectations so any significant deviation from this will likely result in an adjustment to policy and expectations.   In February 2015, the 10-year bond yield hit an all-time low of 2.27% before lifting to highs near 3.15% on 11 June 2015. In early November 2015 there was a progressive increase in yield from ~2.60% to a high of 2.99%. Since mid-December the flight to quality meant the 10-year yield gave back the changes in Q4 2015 and on 1 March 2016 hit a 6 month low of 2.35%. In the past few months we have seen a bounce back up to 2.66%. The 3-year bond has followed a similar pattern and broke out of its recent yield range (1.90 – 2.10%) in November / December 2015 reaching a high of 2.18% on 7 December 2015. It retraced back to a short term low of 1.70% but since then it has wildly jumped up to 2.05%. On 22 April 2016, the ASX 30 Day Interbank Cash Rate Futures April 2016 contract was trading at 98.035 indicating a 16% expectation of an interest rate decrease to 1.75% at the next RBA Board meeting (unchanged on the week prior).