In a shortened (Easter) week for markets, Treasury bonds benefited from broad based risk-off sentiment last week as a result of geopolitical tensions. The 10-year Australian government bond saw its yield drop to 2.45%, touching the lowest level since November 2016. Last week, Standard and Poors released the “2016 Annual Global Corporate Default Study And Rating Transitions” report which is a key element of our quantitative company analysis. As at 31 December 2016, the global speculative-grade default rate rose to 4.2% (its highest level since 2009) and just above the 36-year annual average of 4.1%. This follows a similar trend to 2015 where the increase was largely a result of a higher rate of defaults in the energy and commodities sectors. As at 31 December 2016, the global speculative-grade default rate (excluding energy and natural resources) was 2.3% while the speculative-grade default rate for the energy and natural resources sector was 21.1% (up from 9.8% in 2015). This does not seem to have deterred credit market investors, despite the Federal Reserve’s rate hike in March. The U.S. speculative-grade bond issuance surged to $37.1 billion from $18 billion in February. This was the highest monthly issuance volume since March 2015. In Australia, the RBA released its Financial Stability Review on Thursday last week (click here). The focus is primarily on potential instability as a result of the high level of household debt. While this is not new, the review focus is particularly on riskier types of borrowing, such as interest-only loans. The report noted: “Indicators of household financial stress currently remain contained and low interest rates are supporting households’ ability to service their debt and build repayment buffers.”  It also stated that interest‑only loans represent ~65% of investor mortgages, which is where all the credit growth is derived. This suggests that the recent curbs on investors loans are likely to impact system credit growth in 2017 but more importantly, shows how sensitive the recent credit growth is to changes in interest rates. The RBA’s April board meeting minutes will be released today (11:30am Sydney) and we do not expect any change to its current stance (futures pricing in 94% chance of no change).

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