Politics and policy will dominate headlines over the next 8 weeks following the Prime Ministers announcement for an early election over the weekend. This capped an interesting week from the government where two government agencies seemed strangely at odds with their forward assumptions. The treasury forecasts in the budget painted a fairly rosy growth outlook but actions by the Reserve Bank seemed to suggest otherwise. On Friday the interest rate futures market reacted swiftly to a downgrade of inflation forecasts from the Reserve Bank. The RBA’s quarterly monetary policy statement (released on Friday) said that core inflation would not meet the 2 to 3% target for 2016 and that it is unlikely to meet this target until mid-2018. They left the estimated economic growth at 2.5 to 3.5% for 2016 and 2017 and predicted unemployment will remain stable. There was no guidance given on the interest rate outlook but futures markets are now pricing in a 66% chance of another cut before Glen Stevens rein as RBA Governor ends. In our mind low inflation is here to stay primarily because it is a function of low oil prices and low wage growth (neither of which are likely to disappear anytime soon) but the primary concern is that this round of monetary policy easing is not going to stimulate growth or inflation but it will force savers and retirees to push up the risk curve which may be the point. Major bank reporting season (first quarter) kicked off last Monday with Westpac with the Commonwealth Bank of Australia completing the set this morning. Across the sector profit growth was mixed with both ANZ & the NAB’s headline Net Profit/Loss after Tax (NPAT) being effected by various one-off write downs. The below table highlights some of the key 1Q16 numbers for the major banks. Click here
for our full wrap up. Given recent company results and the lower interest rate environment its fair to say that the days of investment grade bonds producing a consistent 6% return are well gone. Equity markets will inevitably be much more volatile and credit will be used as a stepping stone for those moving out of deposits in the search for yield. This makes the asset selection process critical and quality of research even more important. A small deterioration in credit quality will erode any forecasted returns and that’s why it is essential to remain vigilant in your asset selection process.
Click below for Interactive Charts
Chart 1: Bloomberg AUSBond Composite Index (Monthly)
Chart 2: Bonds vs Equities 2014/15/16 (Monthly)
The yield curve is slightly steeper following the RBA’s announcement but overall yields across the curve are approaching their all-time lows. 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%. But since December the flight to quality meant the 10-year yield gave back the changes in Q4 2015 and on 6 May 2016 it touched the all-time low of 2.27% again. 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 has since collapsed to reach a low of 1.56% on 6 May 2016. On the same day the ASX 30 Day Interbank Cash Rate Futures June 2016 contract was trading at 98.315 indicating a 34% expectation of an interest rate decrease to 1.50% at the next RBA Board meeting (up from 0% last week).