On Friday, President Donald Trump was inaugurated as the 45th of President of United States. His speech asserted an “America first” approach to key policies that will include the US withdrawal from the transpacific partnership. Following the speech, there were some executive orders passed, including the repeal of Obamacare (the Affordable Care Act) and a halt to regulation which stops federal agencies from issuing any new regulations. Markets responded well as US equity indices rose modestly while the 10-Year US treasury yield ended the week marginally higher. Domestic news flow in the bond market was limited last week with the largest ever government bond issue of $9.3 billion being the highllight. The offer was met with strong demand, with more than $15 billion worth of bids. The bonds were priced at a yield of 2.24% p.a. and overtook the previous record set by the government’s inaugural $7.6 billion 30-year bond issued in October last year. The issue follows on from December’s Mid-Year Economic and Fiscal Outlook (MYEFO) which revealed a slight deterioration in the Federal budget and $10 billion funding gap. The transaction was met with some repurchasing activity with the Australian Office of Financial Management (AOFM) advising it had bought back $655 million worth of bonds that mature in July 2017 and $2.41bn worth of bonds that mature in January 2018. In bank news, APRA released its annual paper regarding the countercyclical capital buffer which was again held at 0%. The additional capital requirement can range between 0% and 2.5%. The purpose of this capital buffer is to offset or mitigate housing sector risks (i.e. credit growth, asset prices) but at this point, the regulator does not deem a change as necessary. This seems counterintuitive to us and the three major credit rating agencies, who have all warned that the banks’ ratings could be downgraded because of mounting housing imbalances. Even the International Monetary Fund has called on the banks to raise more capital to obtain unquestionably strong status. Bank regulation continues to evolve but the sentiment for banks over the past week has changed as Bank Equity Index dropped 4%. In corporate news, S&P revised Sydney Airport’s (ASX: SYD) outlook from stable to positive citing that its unlikely the airport operator will exercise its option to develop a second Sydney airport at Badgerys Creek. This follows the Federal government’s decision to not provide additional funding for the project. The rating agency forecasts terminal fees of  $50-70 per person would be needed to compensate for construction costs which is unrealistic given current charges are around ~$35 per person.

Chart 1: Bloomberg AUSBond Composite Index (Monthly) Chart 2: Bonds vs Equities 2015/2016 (Monthly) Chart 3: Term Deposit Review – December

Interest Rates In a speech last week (click here) Janet Yellen’s said the US economy was “near maximum employment and inflation is moving toward our goal”.  In summary, she suggested that if they don’t start raising rates soon it could lead to “inflation, financial instability, or both”. Ultimately the Fed will need to balance raising rates with a debt fuelled infrastructure spend. The short-term implications vs long term benefits will be the focus of markets. Domestically the focus this week is on inflation (Wednesday). This is critical data (Q4-2016) for the Reserve Bank and markets. The expectation is for a slight pickup on Q3-2016 given the improvement in commodity prices but it is the core inflation number which is the focus. There is some suggestion of a pickup in food prices which will drag the core inflation number higher. The Melbourne Institute Monthly Inflation Gauge also expects a rise. On the 20th of January 2017, the ASX 30 Day Interbank Cash Rate Futures February 2017 contract was trading at 98.510 indicating a 5% expectation of an interest rate decrease to 1.25% at the next RBA Board meeting.