Donald Trump’s first week in office did not disappoint his voters. The plans to build a dividing wall between Mexico and the US commenced, a temporary ban on travellers from specific countries was ordered and the US participation in the Trans-Pacific Partnership (TPP) was revoked. While protestors rebelled, US equity markets rallied as investor concerns surrounding execution risk on key policies abated. A weak US GDP number on Friday tempered the sentiment and highlights the economy is still somewhat fragile. By comparison, it was a fairly quiet week for bond markets. Credit markets continue to grind tighter but the market expects primary issuance to increase in coming months so limited volume is changing hands. In interest rate markets, the net positioning of two of the most widely traded long-term US Treasury futures – 10-year and 5-year Treasuries shows that hedge funds’ Treasury short positions are at a 20-year high. This suggests hedge funds expect the US yield curve to steepen further which may have a knock-on effect to the domestic yield curve as seen in recent months. Finally, the CBOE VIX Index which tracks the US market’s expectation of future volatility closed at 10.3 on Friday, its lowest in 2.5 years. As a result, the market is highly susceptible to any disappointment. This week marks the unofficial kick-off to reporting season with Tabcorp (ASX: TAH) releasing its 2017 first half results on Thursday. We expect the group to give an update on the proposed merger with Tatts Group in which the ACCC is scheduled to announced its decision on approval on the 23rd of February 2017.

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

Interest Rates Last week was all about inflation. On Wednesday, domestic inflation figures for the 4th quarter were released and the data came in below expectations once again. Headline inflation was reported at 0.5% (1.5% for the year annualised) but the closely-watched core inflation rate (which strips out volatile items) was 0.4% over the previous quarter which was below the 0.5% consensus. This resulted in a yearly core inflation rate of 1.55% for the year (versus an estimate of 1.6%) and highlights that deflationary pressure is still weighing on the Australian economy. While this suggests rate cuts by the RBA are still possible, the ASX 30 Day Interbank Cash Rate Futures February 2017 contract was trading at 98.510 on Friday indicating a 5% expectation of an interest rate decrease to 1.25% at the next RBA Board meeting (unchanged from last week). Meanwhile, the US Federal Reserve is widely tipped to leave interest rates on hold following the US GDP release last week. The US economy grew by 1.9% for the year in the last quarter of 2016 which was below estimates of 2.2%. While Trump’s incoming policies hope to rectify this result, we note that any fiscal policies are likely to experience a significant lag before positive repercussions are seen in economic data. However, US core inflation has remained above target and economy is running almost at full employment. For this reason, the Fed will remain under pressure to raise rates throughout 2017.