Against a global environment of easy money and low interest rates the dominant investment theme of 2016 was yield chasing. However, by mid-2016 this thematic showed early signs of unwinding. US inflation expectations began to rise due to reversion in both energy and commodity prices. Compounding this volatility was multiple events increasing political risks. Although the initial reaction arising from the ‘Brexit’ vote was supportive of bonds, the election of Donald Trump as the next US President did the opposite, adding fuel to inflation expectations as he promised to cut taxes whilst increasing spending. Domestically, Australian government bond yields finished the year largely unchanged but this masked a large amount of volatility as the generic Australian 10 year bond yield started the year at 2.89%, reached a low of 1.82% (2 August) and ended the year at 2.77%. As the RBA reduced the official cash rate from 2.0% to 1.5% (during the May & August meetings), this resulted in the Australian yield curve steepening. As a result the ASX 200 Accumulation Index (+11.8%) outperformed the Bloomberg AusBond Composite Index (2.9%) over the year. The ASX listed credit market rebounded strongly from a weak first quarter to finish the year up 9.2% with tighter credit spreads as both institutional and retail investors showed particularly strong support for major bank additional tier 1 hybrids. Although this rally was mainly driven by technical factors (lack of new supply combined with a number of corporate issuers redeeming but not replacing maturing securities), the floating rate note format of this sector offered investors protection against rising bond yields. This is due to the interest rate typically resets either on a quarterly or semi-annual basis depending upon the terms of the security.
Chart 1: Bloomberg AUSBond Composite Index (Monthly) Chart 2: Bonds vs Equities 2015/2016 (Monthly) Chart 3: Term Deposit Review – November
