Tuesday 11 July 2017 by George Whittle Week in review

From the trading desk

Strong demand for short dated fixed rate AUD bonds as yields move higher, while USD trading was subdued due to the independence day holiday

What’s trading

AUD

  • There was strong demand for short dated fixed rate bonds, such as the Liberty 2020, as global bond yields continued to creep higher last week. Clients switched from the longer dated Sydney Airport 2030 inflation linked bond, taking profit and also taking a view on the low inflation reads. Liberty is available in good supply at an indicative yield to maturity of  4.72%
  • G8 Education announced its intention to call its 2019 fixed rate bond in August this year at 102%. Clients wishing to beat the $70m wave of funds to be reinvested in August have been selling their holding now at the call price, and switching in to other bonds. Some clients have chosen to add an investment grade allocation in place of the holding, whereas others have remained in the high yielding space by adding other FIIG originated bonds. One example has been Adani Abbot 2020 fixed rate bond, available with an indicative yield to maturity of 6.70%

Non AUD

  • USD trading was subdued last week as the Independence Day holiday limited liquidity in our time zone. Liquidity returned to normal late in the week, coinciding with cheaper offers in some of our recently added DirectBonds
  • Trading was dominated by the Ensco 5.20% 2025 and Hertz 7.625% 2022 senior bonds as a lower price highlighted value to investors. Supply remains good in both bonds, indicatively offered at 8.37% and 6.91% respectively
  • Rackspace Hosting Inc also proved a popular target for clients hunting USD high yield. Supply remains good at an indicative YTM of 6.54%

Economic wrap

  • Global 10 year yields are at or near three month highs with US (2.39%), UK (1.30%), German (0.57%), and Australian (2.73%) bonds all selling off over the week
  • US non farm payrolls rose by 222,000 versus expectations of 179,000
  • Oil prices showed further weakness with both Brent and WTI falling by nearly 3% on Friday
  • In the FOMC’s minutes released Wednesday, members appeared divided on when to begin reducing the size of the Fed’s balance sheet
  • North Korea successfully tested an intercontinental ballistic missile capable of reaching Alaska, marking an escalation in tensions

Other news

While bond yields moved sharply higher last week, economic news wasn’t to blame. US payrolls data out late in the week showed the economy continues to produce strong jobs growth, or at least strong enough to sustain the moderate economic growth of the past few years. However, wages growth at 2.5%pa remains well below the Fed’s 3.5%pa target rate. Other headlines suggest an increase in rates is warranted – unemployment is at 4.4%, underemployment is at 8.6%, and there is a rising participation rate. These all point to a labour market that is at least strong, and could overheat. But wages growth has been stubbornly low, with the three largest employment sectors below 2%pa growth.

This suggests the Fed will be very patient. Any sudden moves could rattle employers and weaken wage growth further, ultimately harming economic growth through consumer confidence and spending. Bond price changes last week were all about fear of central banks making a sudden move.

It’s not that markets should be worried about the big five central banks’ US$19trn injection being wound back, but rather whether central banks will make sudden moves. For Australians, the question is whether the RBA will follow suit. This seems even more unlikely than a sudden move as Australia’s economy is out of step with the rest of the world, suffering the same anaemic wage growth but also weak employment conditions. The upward move in US long term bonds seems justifiable on the basis that they had rallied too hard, but Australia moving in step with the US is a bridge too far.  

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