As largely anticipated the Federal Reserve last week raised US interest rates for the fourth time since the Global Financial Crisis (GFC). The FOMC maintained similar rate forecasts for 2017 and beyond (known as the Fed dot plot) which appear to be at odds with market expectations. The key factor to this divergence has been US inflation which has slowed throughout 2017 despite a 16-year low in the unemployment rate. While the Fed noted “it’s important not to overreact to a few readings and data on inflation can be noisy”, the US 10-Year Treasury Yield dived to its lowest point since November 2016 (~2.10%) on Wednesday as CPI data revealed the US inflation rate fell to a 6-month low of 1.9%. This compares to the Fed dot plot median ‘long-run’ rate of 3.00%. This suggests financial markets are yet to believe the Fed’s optimistic forecasts are credible and for this reason, interest rate volatility may persist until there is better alignment in US economic data. In comparison, last week’s domestic employment data beat market consensus estimates with Australia’s unemployment rate falling to 5.5%. Importantly, this positive development was driven by full-time job generation (+52.1k) but consistent sub-trend growth suggests there is plenty of spare capacity in the labour market (reflective of weak wage inflation). Nonetheless, the data will support arguments against calls to slash interest rates further but greater economic proof is required before the RBA can consider raising the cash rate.

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

Energy Crisis Despite the Federal Government’s Budget initiatives aimed at improving domestic gas supply, Origin Energy has followed its two major competitors (AGL Energy and Energy Australia) by announcing significant double digit retail energy price increases next year. Due to years of stalled investment as a result of political uncertainty, recent closures of coal-fired power stations and a nation-wide shortage in gas, energy prices have been driven to so-called “crisis” levels. We continue to believe at some point Australia’s energy system will need to undergo an overhaul to create a more efficient network and clearer national policy. This may result in increased government investment into the sector and given recent parliamentary remarks, electricity supply curtailment and the commencement of the LNG projects in Queensland, natural gas seems the obvious frontrunner for future energy consumption in Australia. This has begun with the Government providing $90 million to promote domestic gas supply including securing gas industry commitments (APLNG) but ACCC pricing inquiries into retail gas and electricity prices have implications for dominant players.

Australian Retailers Although not directly specific to Australian credit (yet), Amazon last week announced a bid to acquire US high-end grocery retailer Whole Foods for ~$18 billion. This marks an evolutionary point for the group’s business model and essentially catapults Amazon into the US supermarket industry. As a result, the threat to Australian retailers has increased further and with instore groceries being Amazon’s new strategic focus, implications for Australian supermarket chains (i.e. Wesfarmers, Woolworths) may come sooner than expected. Amazon is scheduled to enter the Australian market in 2018 which is expected to weigh on many ‘bricks & mortar’ retailers in an already fiercely competitive environment.

Bank Levy Last Friday, Macquarie Group distanced itself from the Major Banks as it argued it should be exempt from Federal Government’s bank levy in a Senate Inquiry. Given the group derives ~60% of its revenue offshore and is a minor player in domestic banking (8th largest lender), Macquarie’s argument has its merits but the levy is suspected to be a form of insurance payment for any future government bailout. During the GFC, Macquarie was included in the Government’s wholesale funding guarantee and it’s reasonable to assume it would request this treatment in similar dire circumstances.

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