Monday 28 November 2016 by Leigh Winton Week in review

From the trading desk

The rise in US government bond yields makes a December Fed hike seem certain, assuming US payroll data on Friday continues positive momentum

Economic Wrap

The weekend press continues to highlight rising bond yields, with articles claiming Trump has blown up the bond market and that investors need to shorten duration.   

Whilst it’s true that a portfolio review is necessary after the US election, the press seems to forget that equities by nature are perpetual instruments without maturity. Consequently one can view comments reflecting on the need for shorter duration to be a call to move monies out of equities!

We continue to suggest rebalancing post Trump’s win to being more equally weighted within fixed income portfolios, with a one third exposure to each of fixed, floating rate and inflation bonds. Additionally, the vast majority of fixed rate bonds we offer are short or medium term by nature – less than seven years – and consequently have less sensitivity to interest rate moves.  

US government bonds are unchanged in yield over the week, with the 10 year bond currently at 2.36%. Other major economy government yields are mixed. Current 10 year Japanese government bonds are trading at a positive 0.02% yield, 10 year German bunds are trading at positive 0.24% and 10 year UK government bonds (gilts) trading at 1.42%.

Other news:

  • Stocks were higher on Friday. In Europe, the Eurostoxx was up 0.26% and the FTSE 100 was up 0.17%. In the US, the Dow Jones was up 0.36% and the  S&P500 was up 0.39%
  • US purchasing manager’s index (Markit PMI) was slightly weaker at 54.7 versus 54.8 previously in October, although the reading still indicates economic expansion by being above 50.0
  • Oil continues to decline ahead of the OPEC meeting in Vienna on Wednesday, with little confidence in any meaningful measures to curb output. Although there is room for a surprise here, the cartel has not recently managed to enable adherence to agreements
  • Theresa May will push a law triggering Brexit through the House of Commons if judges rule against the government in December’s court case, according to the Daily Mail
  • Chinese household debt has risen at an alarming pace, with household debt surging from 28% of GDP to 40% of GDP. News website The Guardian notes however that the household debt ratio is lower than the US and Japan (80% and 60% of GDP respectively) and that Australia has the world’s most indebted households at 125% of GDP

Credit indices spreads are lower over the last week with the US Investment Grade Index (IG) finishing Friday down 3.750 basis points (bps) at 73.00 bps, whilst the US High Yield Index (HY) narrowed 24 bps on the week to finish Friday at 392 bps.

Domestically, the 10 year Australian government bonds last traded at 2.70%, 2 bps lower on the week. The Australian iTraxx is at 110.0 bps (or 1.10% for this index of 25 Australian Investment Grade names), down 3.0 bps over the week.

The Aussie dollar is trading at 0.7460 today, with our currency rebounding over 1 US cent from its recent lows.  

Flows

The US dollar space was where most of the action took place last week, as clients booked profits and took advantage of relatively cheaper prices on other bonds. One such trade opportunity was the recent capital appreciation in the Fortescue Metals Group bonds, as investors switched from the 2022 secured and unsecured bonds and purchased the Genworth 2021 USD callable notes. With the price rallying and yield decreasing in the FMG bonds, investors received a pick up in yield moving to the Genworth 2021 USD bond.  At an indicative yield to maturity of 8.78%, the Genworth 2021 USD supply remains good.

Further, a rally in price from the BHP non call 10 year 2025 USD bond saw investors take advantage and switch to the QBE June 2026 callable bond. The BHP 2025 USD bond has rallied ~$10 in price since being issued last October, and the QBE June 2026 bond is ~$6 away from its highest price.  The switch also allowed investors to trade out of the volatility associated with the commodities sector. The QBE June 2026 callable bond is available at an indicative yield to call of 5.39%. 

In other non AUD trades, clients wanting to exit Emeco March 2019 USD rather than wait for the company’s restructure were able to take advantage of strong institutional demand for the bond. There remains good ongoing demand for any current holders who also wish to sell.

In Australian denominated bonds, the Sydney Airport 2020 inflation linked bond (ILB) was bid for in the intuitional market, with strong ongoing demand. Clients were selling the bond as it moves closer to maturity and purchased inflation linked bonds with a longer maturity date. One such longer dated bond was the Sydney Airport 2030 ILB, which is available to clients with an indicative yield to maturity of 6.00%*. 

* This assumes 2.50% inflation.

Earn over
6% pa* with Corporate Bonds

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