Monday 08 May 2017 by Leigh Winton Week in review

From the trading desk

Markets rally after Macron’s win in France and positive US unemployment, we were active in Tier 2 floating rate notes and Talen Energy continues to fall in price

Economic Wrap

Markets continue to improve after the strong jobs data from Friday and French election results. The headline US employment rate beat expectations at 4.4%, and US non farm payrolls also surpassed predictions rising by 211,000. This increases the likelihood of a June rate rise by the FOMC, currently forecasted at a 75% probability according to the Fed Funds futures.

The Australian budget is released Tuesday night at 7.30 pm AEST with some known themes to be housing affordability, cash payments for energy bills and a fund for manufacturers to assist them following the end of car manufacturing. There will also be some comments on the budget deficit and its likelihood of dropping below AUD30 billion in the current year, as well as how the path towards a balanced budget will occur. With corporate profits broadly improving this enables greater taxation revenues, but we remain sceptical on the ability of government to realise a balanced budget or even a surplus.

CPI data is released in the US on Friday with expectations of +0.2% which would make the year over year number 2.3%. CPI data last month was negative, so markets are looking for a bounce back to confirm a June FOMC rate hike.

We continue to recommend portfolios of equally weighted proportions of fixed, floating and inflation linked bonds, noting that this is easier for wholesale investors to achieve. 

US government 10 year bonds are currently yielding 2.36%, which is four basis points higher than the previous week. US bond yields have not risen as much as expected following stronger US data, but we must remember that US yields did rise a lot in anticipation of Trump’s tax reform and infrastructure spending. Consequently, as the enormity of Trump’s policies become apparent and the difficulty of passing legislation through congress is better understood, bond yields are struggling to break and hold above 2.50%. Assuming the FOMC raises rates in June, the question is what will happen to the yield curve – that is the impact on 10 year yields.

Current 10 year Japanese government bonds are trading at 0.03%, 10 year German bunds at 0.42% and 10 year UK government bonds (gilts) are at 1.12%.

Other news:

  • All major stock indices were higher over the last week. In Europe, the Eurostoxx was up 279% and the FTSE 100 was up 0.83%. In the US, the Dow Jones was up 0.32% and the S&P500 up 0.63%
  • Global growth is now running at 4.1% according to a story by Gavyn Davies in the Financial Times, noting that “activity growth in China has now lost some momentum and that there are periodic bouts of severe stress in the Chinese overnight interest rate markets”.
  • Oil prices fell last week, with US NYMEX closing at $46.25 on Friday. Oil producers have been keen to show solidarity with Saudi Arabia’s oil minister, saying production cuts will be extended into 2H17 according to Bloomberg. 
  • The UK has seen real wages fall on average 1% a year between 2008 and 2015, according to Larry Elliott in The Guardian. Brits go to the polls on 8 June with Theresa May expected to extend her majority towards 100 seats.

Credit indices spreads are lower over the last week, with the US Investment Grade Index (IG) finishing Friday at 62bps and the Bloomberg Barclays US Corporate High Yield Index at 1882.50.

Domestically, the 10 year Australian government bonds last traded at 2.67%, 9bps higher on the week. The Australian iTraxx is at 81.0bps (or 0.81% for this index of 25 Australian investment grade names), slightly lower over the week.

The Aussie dollar is trading at 0.7403 today, down from 0.7525 last week. The Australian currency suffered throughout last week from depressed commodity prices, particularly iron ore which fell to its lowest level since 4Q16. The benchmark 62% FE contract delivered to Qingdao China last traded at $62.00 compared to almost $95.00 in February.

Flows

Non AUD

  • Talen Energy supply bonds continued to fall in price.  The recently issued 9.50% 2022 bond has fallen to a price in the low $90s, with many clients switching from the 2025 into the 2022 for a pick up in yield
  • Clients were switching out of Barminco and Broadspectrum before their imminent maturities – common reinvestments of these funds was the Talen 2022 bond, the Frontier lines and the recently issued Barminco 2022
  • We’ve seen good two way buying and selling in NCIG, with modest volume being bid in the street

AUD

  • Tier 2 floating rate notes remained in demand with clients reinvesting funds prior to the call date for Swiss Re – retaining an exposure to investment grade.  Supply has been good and clients have until 15 May to switch their Swiss Re funds prior to the call.  The Suncorp subsidiary, AAI 2022 call bond is available at an indicative projected yield to call of 4.32%
  • Interest has picked up across the inflation bonds range as the RBA released the statement of monetary policy with domestic inflation on track to reach its target range. The bonds have rallied, with current unsatisfied demand for the MPC 2025, MPC 2033 and Civic Nexus bonds
  • The Qantas bonds, since being rerated back to investment grade, have rallied significantly – allowing clients to switch, take profits and move into other higher yielding bonds. Clients who purchased the bonds when they were sub investment grade moved into unrated bonds such as Sunland 2020, at an indicative yield of 6.21%, and WA Stockwell 2021 yielding 6.48% indicatively

 

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