Domestic inflation figures were weaker than expected, the US Fed kept rates on hold and the Bank of Japan released its monetary policy statement. Locally, the AUD was lower based on inflation news and our government bond yields also declined. Popular trades included, inflation-linked bonds and the foreign currency bonds from BHP Billiton Finance Ltd
Economic Wrap
Last week was largely driven by news around global central banks. Domestically, the catalyst was poor inflation data, which saw quarter-on-quarter headline inflation 0.2% lower at 0.5%, with the trimmed mean figure halving to 0.3%. The trimmed mean year-on-year figure, which is the measure the RBA use for its target range (2 to 3%), came in 0.1% closer to the lower end at 2.1%. This triggered a realignment of expectations for an RBA rate cut this year. Despite the RBA not voicing any easing bias in its monetary policy statements, futures markets were pricing in a 52% chance of a rate cut this year, which then soared to 73% after the Australian inflation figures.
As expected in the US, the Federal Reserve (Fed) kept rates on hold. In the accompanying statement to the rate decision, it was interesting to note that the Fed dropped its previous reference to global market instability and its impact on the US domestic economy. With some weak US data recently, markets had increasingly discounted the likelihood of a US rate hike, so it came as a surprise when the statement firmly put forward the Fed’s December meeting as a potential juncture to increase rates – however this will still be dependent on the Fed’s assessment of the US economy at that time.
The Fed also put forward a proposal that would require systemically important banks in the US to hold more capital. This proposal is for similar rules that have recently been imposed by APRA on Australian major banks. In large, it requires the eight largest US banks to hold more loss-absorbing capital against their assets to help in the event of crisis. We’ve seen the major banks in Australia raising tremendous amounts of capital and raising interest rates in response to this, so we could expect some similar measures to arise in the US.
In other central bank news, the Bank of Japan released its Statement on Monetary Policy last week and announced that there would be no change to its current Quantitative Easing program. Given lacklustre inflation in Japan, some were expecting the program to be expanded. This has not been ruled out, particularly as the Bank of Japan also released updated economic projections which anticipate a longer term to reach its target inflation of 2%. That is now expected in early 2017, back from the previously estimated mid 2016.
In terms of market movers, it was domestic CPI and its implications for the RBA that played the biggest role. Despite 3 and 10 year US Treasury yields rising 8 and 6 basis points after a hawkish read on the Federal Reserve, we saw Australian Government bond yields fall. Our 3 and 10 years were down 7 and 6 basis points to 1.80% and 2.61% respectively. The RBA also led the Australian dollar lower with a drop of 0.78 US cents over the week, with our dollar finishing at 71.38 US cents. Credit spreads were relatively flat over the week as markets were focused on macro themes, the Aussie iTraxx index finished marginally lower at 117.25.
Flows
Inflation linked bonds were in focus last week with the domestic inflation data release. Supply remains good across several bonds that are usually harder to source, in particular the Jem Southbank Pty Ltd 2035 inflation linked annuity bond, which yields over 5% (assuming 2.5% inflation). There was also institutional demand for the Sydney Airport 2030 inflation linked bond, which opened up opportunities for holders to exit and diversify into other inflation linked bonds. The Sydney Airport 2030 bond is currently available to clients at a yield of 5.93% (assuming 2.5% inflation).
Despite the weaker AUD, the recently issued non-AUD bonds from BHP Billiton Finance Ltd remained popular. In the GBP space, the BHP Billiton October 2022 call bond was the most traded, as clients took a view on the health of the UK economy and added another currency to their portfolios. In USD, BHP Billiton October 2025 call was the most traded followed by the BlueScope Steel 2018. The BHP Billiton bonds were offered at slightly lower prices late in the week as commodity prices softened in overnight trade.