The big story last week was the Federal Reserve’s 2-day monetary policy meeting. While US interest rates were lifted as expected, there was little indication of how the potential Trump policies may impact the economy moving forward, with Federal Reserve economic forecasts relatively unchanged. The Fed’s monetary decisions considers many economic inputs such as business investment, unemployment and consumer spending. But in our opinion inflation, which is running at a 5-year high (2.7%), is now the primary determinant. If this trend continues throughout 2017, we can expect the Fed to expedite monetary tightening. Given Australian banks source ~40% of their funding requirements from overseas (including the US), it is not surprising mortgage rates have been lifted to offset higher funding costs. Last week, NAB and Westpac lifted rates across most mortgage products, the most impactful one being the hike in the owner-occupier variable rate (increase of 0.03% and 0.07% respectively). While domestic interest rates still remain historically low, mortgage rate hikes out of sync with the RBA puts additional pressure on the highly leveraged household sector. From a global perspective, there have been 16 company defaults in 2017 versus less than 10 over the same period in 2016 according to Standard and Poor’s (S&P). Unsurprisingly, the Energy sector comprised the bulk of these, which led the global speculative-grade (i.e. high-yield) default rate to reach 4.1% (up from 2.7% at the same time last year). While no Australian companies are included in the tally, there were a string of non-investment grade defaults throughout 2016 including Arrium, Atlas Iron and Emeco all of which went through extensive restructuring. In corporate news, the Australian Competition and Consumer Commission (ACCC) released a Statement of Issues (SOI) regarding Caltex Australia’s (ASX: CTX) proposed acquisition of Milemaker Petroleum (which owns a network of 46 petrol stations in Victoria). A final decision is expected to be made on the 20th of April 2017, with competitive pricing being the greatest area of concern. Given Caltex was unsuccessful in the bidding process to takeover Woolworths’ convenience store network (ultimately won by competitor BP), the potential transaction represents an alternative to retain market share without stressing the balance sheet. Finally, Crown Resorts (ASX: CWN) confirmed it has now bought back 1.09 million notes of the CWNHA hybrids (20.6%) as at the end of last week. The group noted that it reserves the right to vary, suspend or terminate the buy-back at any time.

Chart 1: Bloomberg AUSBond Composite Index (Monthly) Chart 2: Bonds vs Equities 2016/2017 (Monthly) Chart 3: Term Deposit Review – February

Interest Rates As widely anticipated, the Federal Reserve raised US interest rates last week by 0.25%. However, the FOMC did not signal any plan to accelerate monetary tightening in the near future and rather indicating that any further rate increases would be ‘gradual’. As a result, the central bank’s outlook for two more hikes in 2017 and three hikes in 2018 remains unchanged. This was at odds with market expectations and consequently, both the US and Australian 10-Year Treasury yields rallied strongly (~0.10%) on the back of the meeting. Despite this commotion, the futures market’s view on domestic monetary policy has not swayed, especially following weak domestic employment numbers last week (6.4k decline in employment resulting in an unemployment rate of 5.9% – the highest in over a year). On the 16th of March 2017, the ASX 30 Day Interbank Cash Rate Futures April 2017 contract was trading at 98.505 indicating a 2% expectation of an interest rate decrease to 1.25% at the next RBA Board meeting (unchanged on the week prior).