Last week was fairly neutral for Australian equity investors but the bond market continued its rally with the 10-Year Australian Government Bond Yield hitting new all-time lows (again) of 1.84%. On Thursday, Rating Agency Standard and Poor’s (S&P) announced it had put the Australia Sovereign Rating on “Negative Outlook”. In essence, this report gives us a 33% chance of a rating cut in the next two years but in reality the market took it in its stride and the announcement had a negligible influence on the yields for government bonds. However, the change had a knock on effect to State Governments, Government Agencies and the Major Banks but it is too early to suggest this will influence funding costs.   Overall market confidence remains linked to international factors. On Friday, the US Bureau of Labour Statistics released employment data (287,000 new jobs) for June which were well above market expectations (175,000). While this data reassured investors about the health of the US labour market, there was only a small rise in expectations for Fed policy tightening this year (a December hike is now priced at about a 20% probability). This suggests the futures market is placing a higher probability of broad market instability rather than focusing on recent economic data points. The US Treasury 10-Year bond set an all-time low of 1.35% while the 30-Year bond hit a low of 2.09%. To us this suggests that the debate surrounding the effectiveness of central bank stimulation (to generate growth and inflation) is increasing. There is ~$12 trillion of bonds with yields less than zero which naturally forces investors up the risk spectrum at a point in the economic cycle which probably doesn’t warrant the risk.   Brexit implications linger – In the past fortnight seven large open-ended property funds in the UK holding about £15 billion in assets have been forced to suspend trading, trapping investors’ money. This is a great example of the direct vs managed investments debate. Open-ended funds only work when prices are going up as manager’s source assets and manage the cash drag from inflows. But on the way down the promise of liquidity in an illiquid asset can cause major distress. This structure failed in 2007 and is failing again only eight years post Lehman Brothers’ collapse.  In 2007, funds which halted trading and were forced to sell buildings at fire-sale prices. This amplified the drop in real estate markets and contributed to the credit crunch.   At this stage we think risks are firmly to the downside in the UK. In the short-term the main risk comes from their banking sector. We believe it is extremely important that the banking system is not left defenceless during the prolonged period of uncertainty due to Brexit. Banks are the arteries of the economy, leave them clogged and the economy collapses.   In hybrid world, we continue to see large institutional bids supporting the recent new issues. National Australia Bank confirmed on Thursday that 3 million units (or 20% of the overall value) of NAB Capital Notes 2 was taken by an institutional investor.   Reporting season in the US is due to kick off this week with JPMorgan Chase providing their quarterly reporting.   Click below for Interactive Charts Chart 1: Bloomberg AUSBond Composite Index (Monthly) Chart 2: Bonds vs Equities 2015/2016 (Monthly)