Investors were given a well-needed boost in confidence by last week’s Federal Reserve minutes which left the door wide open for a rate hike next month. The final piece of the puzzle will be the US jobs report this Friday but given the US economy is nearing full-employment, we believe productivity rather than jobs added will be more closely watched by the FOMC. While this sentiment was broadly anticipated (~95% probability of a rate hike priced into US interest rate futures), the Fed also indicated it plans to begin unwinding its US$4.5 trillion portfolio which it accumulated in the years following the Global Financial Crisis. Although this is aligned with the central bank’s gradual strategy of normalising interest rates, questions have been raised about its impact on broader financial markets. According to the minutes, limits to this unwinding will be set but eased every three months. Due to the fragile nature of the process, there could be an unexpected surge in interest rates if not handled with care. Domestic economic data released this week will serve as an important input into interest rate expectations. Retail sales, housing permits and private capital expenditure have all been disappointing in 2017 and we believe a reversal of this trend is unlikely given the underlying dynamics of the economy. This includes restrictions on bank lending policies, the weakness of ‘bricks and mortar’ retailers (Topshop Australia went into administration just last week) and the slow transition away from capital investment in the mining sector.

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

S&P Australian Bank Rating Downgrade S&P announced that 23 Banks (both domestic and foreign branches) operating in Australia will be downgraded due to concerns around potential economic imbalances. The downgrade was a result of S&P’s downgrade on Australia’s Banking Industry Country Risk Assessment (BICRA) from ‘2’ to ‘3’. This was primarily driven by the Economic Risk score falling from ‘3’ to ‘4’ due to house price growth and household leverage (up from ~110% in 2011 to 123% in 2016-17). In line with the sector, the rating agency also lowered their assessment of the Stand Alone Credit Profile’s (SACPs) of the major banks by one notch, reflecting the increased economic risks stated above. However, their long-term issuer credit ratings (AA- with Negative Outlook) remained unchanged reflecting an expectation that financial support from the Australian Government would offset deterioration in the SACPs. Primary issuance by Liberty Financial felt the brunt of the downgrade with a 0.50% coupon step-up covenant being triggered soon after a new wholesale bond deal was launched. This could be a sign of things to come for smaller Australian financial institutions and we expect relative trading margins to adjust over coming months. See our full analysis here.

Bank Divestments Aligned with the evolving regulatory landscape, the major banks have conducted a string of non-core investments to release capital. The biggest seller has been the ANZ which has spun off a number of its Asian assets, ended its Exchanged Traded Fund (ETF) joint venture and is exploring options to dispose its Australian wealth business. While activity from the other major banks has been lower, Westpac last week announced an institutional offer for the partial sale of its holding in BT Investment Management. The bank sought to sell 60 million shares (~19% of total shares on issue) which was completed at a price of $10.75 per share (~$645 million divestment). The pro-forma effect of the transaction is expected to bolster the bank’s Common Equity Tier 1 (CET1) ratio by 0.10% and management confirmed it will be seeking to dispose its remaining 10% stake. Overall, we expect this growing trend to continue as regulatory pressures force the banks to refocus on their core service offering and reduce the complexity of operations.

Corporate News Corporate news flow was relatively quiet during the week. Goodman Group experienced a credit rating upgrade from both Moody’s and S&P in line with our credit outlook upgrade in February 2017. The group conducted a par-for-par exchange offer of its US bonds and revised its target gearing range to 0-25% (from 25-35%).

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