Global equity markets continued to rally last week while government bond yields took a breather. Financial stocks led the way in the US on expectations that President-elect Donald Trump will follow through on promises to cut regulations (more specifically Dodd-Frank Act) and reduce taxes. The S&P 500 Financials Index is now up 18% since the election which is more than double the next best performing industry group (the energy sector). The Australian 10-Year Bond Futures Yield was slightly down on the week (down from 2.84% to 2.79%) but has opened higher this morning (2.85%) as futures traders position for this week’s Federal Open Market Committee (FOMC) meeting following strong US consumer sentiment data last week. The market story is similar in Australia with banks leading the charge last week on renewed optimism of improving net interest margins from the increase in mortgage rates over the past month. We view this as optimistic in the currently environment especially because APRA (and the current government) has different views than Trump on regulation. APRA’s November Statement suggested that “capital accumulation remains the appropriate course for most banks” and this was confirmed last week by the IMF Deputy Managing Director (Tao Zhang) in an article with the AFR. “We’re talking about prudential policies needing to be intensified, with targeted macro-prudential measures and banks being encouraged to robustly increase their capital position into unquestionably strong territory.” Click here to view article. If anything, the GDP data last week (September Quarter fell -0.5%, only the 4th negative quarterly growth in 25-years and the lowest annualised growth rate in 7 years – 1.8%) spoke of the diverging economic performance between the US and Australia. A deteriorating economic outlook will not help private investment nor the labour market which will inevitably pressure the domestic banks’ asset quality. There is also a dislocation between recent movements in domestic bond yields and economic fundamentals. The steepening of the yield curve is in “normal markets” a sign of economic growth but the recent move is simply an unwind of unnatural central bank policies. The economy is not operating optimally and the construction industry cannot prop it up forever. The recent data suggests we are approaching a peak in this sector at a time when the overall economy is arguably at a low-point in its transition from mining investment. We remain sceptical of any rate rises in the near future but our recommendations will reflect our outlook for the yield curve. In the listed market, we have net redemptions of ~$1.75 billion over coming weeks (new issuance of $350 Million for IAGPD, redemption $900 Million for ORGHA and redemption of $1.2 billion for ANZPA) which should keep a reasonable bid tone to the market over the Christmas period. For this reason (and a broader supply / demand perspective), we remain reasonably comfortable in broader credit markets at present but expect more issuance in the new year.
Click below for Charts Chart 1: Bloomberg AUSBond Composite Index (Monthly) Chart 2: Bonds vs Equities 2015/2016 (Monthly) Chart 3: Term Deposit Review – November
