Broad market confidence took a turn for worse last week as allegations surrounding President Trump spooked investors. The allegations are another pothole in the road to success for implementing stimulatory policies and this in turn effected implied inflation expectations in the US (from high of 1.90% to low of 1.78%). As a result, equities sold off and treasury bonds rallied (yields down). As we expected the “Trump Trade” is losing steam as economic data is finding it difficult to keep up with market expectations. Both the Australian and US 10-Year Treasury yields are sitting around their lowest point since the US presidential election in November 2016. Interest rate volatility is likely to remain high for the foreseeable future until the political uncertainty dies down. The RBA minutes released last week (click here) confirmed our thesis that although the global economic outlook looked positive it had “not, to date, led to a sustained increase in inflation”.

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

S&P Downgrades Ratings on 23 Financial Institutions Early this morning Standard and Poor’s announced that 25 Banks (both domestic and foreign branches) operating in Australia will be downgraded due to concerns around potential economic imbalances (click here). The agency suggests that “economic imbalances in Australia have increased due to strong growth in private sector debt and residential property prices in the past four years, notwithstanding some signs of moderation in growth in recent weeks. Consequently, we believe financial institutions operating in Australia now face an increased risk of a sharp correction in property prices and, if that were to occur, a significant rise in credit losses.” As a result, the agency lowered the long-term issuer credit ratings on 23 financial institutions in Australia by one notch each. In October 2016, Standard and Poor’s announced it was putting these same financial institutions on “Outlook Negative”. Their base case assumption was “property prices and private sector debt will moderate” but their alternative case (33% chance) was “that the strong growth trend will resume and economic balances will continue to build, which in our view would increase the risks that a sharp correction in property prices could occur. In that event, credit losses incurred by all financial institutions operating in Australia would be significantly greater.” This action will have implications for bank regulatory capital instruments (including hybrid securities) and as a result, we will release a full review later today.

Rating Agencies Affirm Sovereign Outlook In response to the 2017/18 Federal Budget, credit rating agency Standard & Poor’s (S&P) last week affirmed Australia’s AAA sovereign credit rating but maintained the nation’s outlook at negative. Importantly, S&P shared our concerns surrounding some optimistic budget projections citing “the potential for wage growth and inflation to remain low remains a downside risk to the government’s current projections”. This was broadly anticipated with markets more or less unreactive to the announcement. Nonetheless, Q1-17 Wage Price Index figures last Wednesday revealed wage growth (1.9%) has now fallen behind inflation (2.1%) meaning real wage inflation entered negative territory for the first time since June 2014. Another record broken was private sector wage growth which fell to an all-time low of 1.79%. While we acknowledge the unemployment rate remains steady at 5.7%, this is being masked by part-time jobs (+49k in April 2017 vs full-time unemployment -11.6k) and as a result, we hold the view that the labour market is underutilised. With personal and company tax cuts and increases in social welfare off the political agenda, consumer spending is tied solely to wage structure and given the Government is projecting wage growth of 3.75% by 2021, we remain cautious of significant slack in the labour market.

Bank Levy The introduction of a bank levy has been widely discussed over the past week. This morning Westpac released an announcement on the impact of this levy (click here) suggesting that the annualised after tax cost would be ~$260 million but it is dependent on a number of assumptions around the composition of their liabilities. While this is a significant amount of money and will affect dividends if passed onto shareholders we continue to believe it is small relative to the potential changes coming as APRA gets set to announce the definition of “unquestionably strong”. In our opinion the real question here revolves around the “price” of implicit Federal Government support to the major banks. The budget has in effect kept Standard and Poor’s from downgrading Australia’s AAA sovereign rating and in turn the major banks senior unsecured credit ratings. The question for the banks is do they actually want this support and what is it worth? We expect this story will continue to evolve and we will watch it closely as it is proposed to the senate.

Corporate News A key rating event for the week was Moody’s decision to upgrade Qantas’ (ASX: QAN) credit rating. Although we expect Standard and Poor’s to follow suit in due course, history would suggest this may be mitigated by shareholder friendly activities and a competitive international market. Due to strong demand from investors, NEXTDC (ASX: NXT) last week closed the offer its 3rd series on unsecured senior notes raising $300 million (up from the indicative offer size of $200 million). The notes were priced at bookbuild at a coupon rate of 6.25% p.a. and are scheduled to settle on the 9th of June 2017. Finally, Crown Resorts (ASX: CWN) completed the partial buyback (~42%) of its 2019 senior unsecured notes. This further reiterates our issuer investment thesis as management simplify the balance sheet to accommodate its large capital expenditure pipeline.

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