Tuesday 18 July 2017 by Leigh Winton Week in review

From the trading desk

Investors were active in USD denominated bonds based on a strengthening AUD. Fed chair Janet Yellen signals more US rate hikes may be further away than previously thought

What’s trading

AUD

  • Offerings in the Residential Mortgage Backed Security (RMBS) space are usually limited due to lack of supply, but last week we had an institutional seller of the RedZed 2017-1 Class C notes in decent size. This gave clients an opportunity to add some diversity to their portfolios, adding an investment grade security yielding approximately [5.4% pa Due to the nature of RMBS bonds paying a floating rate coupon, it was ideal for clients with a heavily fixed rate bond portfolio wanting to rebalance. RedZed is a privately held, specialist lender founded in 2006, focusing on lending to self employed or self certified income borrowers. All supply was snapped up, but to check current RMBS availability please speak to your dealer
  • Liberty Financial’s 2020 fixed rate bond was the most popular bond in the AUD space for another week running.  For its investment grade rating, senior debt position in the capital structure and offering an indicative yield to maturity of 4.63% it is viewed as one of the best relative value bonds on offer. Clients continued to lighten their subordinated debt holdings, such as the Bendigo & Adelaide Bank callable in 2021, taking profit and a yield pick up by switching to the Liberty bond

Non AUD

  • Trading in the foreign currency space was active last week as a strengthening Australian dollar attracted investors to USD denominated securities. Most popular was software and services provider Rackspace Hosting Inc. Their 8.625% November 2022 senior debt issue remains in good supply, at an indicative yield to worst of 6.48%
  • Newcastle Coal Infrastructure Group’s March 2027 bond saw decent two way flow last week, following the announcement it had successfully refinanced its US450m bank debt due in March 2018. The news was overall credit positive, prompting a number of clients to take profits while others chose to add NCIG exposure to their portfolios. Limited supply remains at an indicative yield to worst of 9.49%

Economic wrap

  • Fed chair Janet Yellen testified to Congress on Thursday and gave the impression that further US rate hikes may be slower in arriving than previously thought. This caused a selloff in USD and a corresponding appreciation of other currencies
  • The AUD got a lift to its highs for the last 18 months, courtesy of a rally in iron ore over the week. Iron ore benchmark contracts are up 18% to circa $65, compared to prices in June
  • Credit spreads continue at low levels with the investment grade index at its lowest level in three years at 58.00
  • US data continued to be generally softer with CPI, retail sales, capacity utilisation and consumer sentiment all missing expectations
  • Australian jobs data is released on Thursday, with expectations of a 5.6% unemployment rate and a jobs increase of 15,000 according to Bloomberg
  • US corporate earnings for 2Q17 are starting to be released. JPMorgan reported last week and beat estimates, however they lowered interest income forecasts for the year. Other Wall Street behemoths report this week

Other news

The stubborn Australian Dollar continued its climb to over 78 cents last week, pushed up by a sudden rise in speculative investors and hedge funds. Positions of speculators are often strongly correlated with short term movements in the currency.

While short term speculative positions tend to correlate with the current spot exchange rate, long term correlation is much weaker. Speculative traders’ performance on forecasting the currency’s larger movements over the past few years has been poor. In July through to October 2014, speculators were long as the currency fell from 94 cents to 87 cents, only going short in October 2014 after the large fall.

They remained short and captured the next large fall down to 78 cents, but were neutral on the next large fall to 71 cents in mid 2015. Speculators also missed the large drop in early 2016, when global concerns about China pushed the AUD to below 69 cents.

When the currency is rangebound as it has been since early 2016, hedge fund positions typically perform well. However, these positions have three to four month cycles and aren’t strong predictors of the next major move – which is what should be of most interest to our investors.

On that next major move, the differential movement of the US Federal Reserve and the RBA will be the key. US CPI out last week fell, largely driven down by consumer discretionary prices.

Australian rates are unlikely to rise with weak inflation and wage growth. However residential property auction clearance rates rose again this weekend, so the heated property market will continue to dampen the RBA's enthusiasm to cut rates. The most likely outcome is in our view, that the US Fed will slowly increase rates while the RBA will leave rates on hold, letting the US do the hard work. This will push the AUD:USD rate down and support our economy through long term currency depreciation.

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