Wednesday 28 November 2018 by FIIG Securities FIIG Securities Sales commentary

BondCast – Mackay Sugar, global inflation and lifting the Tier 2 capital buffer on major banks

Learn more about which bonds are on the move with the weekly podcast with Elizabeth Moran, Stephen Mackie  and Jake Koundakjian. 

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[00:00:00] Zoe: Good morning and welcome to BondCast. My name is Zoe Lai and I'm standing in for Liz Moran today who is travelling. With me I have Jake Koundakjian and Stephen Mackie to talk about things happening in the market lately. So, as our markets continue to be volatile and investors are looking for guidance, the market continues to look at ways to ensure that Aussie banks can withstand any future crises, and recently announced that they will lift the Tier 2 capital buffer of the major banks. How has the market taken this news?

[00:00:33] Stephen: Well obviously, there’s going to be more supply coming to market over the next few years. APRA’s sort of penciled in 2020 as the time where they're going to raise the Tier 2 buffer, I think threefold from where it is currently. So obviously the existing Tier 2 debt is reflected in the price, so we've seen a bit of a blowout in Tier 2 spreads in the majors – not massively, but some of the recent issues have definitely suffered. So, for example the recent Bank of Queensland issue, that's at about 20 basis points. From where we're sitting, it's an opportunity as well – subordinated debt to us represents pretty good investment at these sort of levels.

[00:01:19] Jake: Yeah, typically there are investment grade investments to good quality blue chip type names that fit nicely into a portfolio. It's not going to make up the high, high yield spots, so when we say things like blow out, it sounds aggressive but it's a pretty marginal move when you squint your eyes. So often these prices become lower, not in an aggressive manner, and we can get some better returning assets for investors.

[00:01:54] Stephen: Yeah I think it’s maybe a better deal for the investors and with the talk about the dividend imputation being taken away in the hybrid space, then sub-debt is becoming a real alternative for investors. So, for us we're pretty excited. I mean to be more sub-debt bond supply  means more opportunity for investors going forward.

[00:02:10] Zoe: So, while here in Australia people are focusing on the banks in the US, all eyes are on the Fed Governor Jerome Powell. Given the market volatility Jake, do we think that the Fed might tone down the hawkish rhetoric?

[00:02:24] Jake: I hope so. I've already kind of sensed a bit of a tone difference. Jerome Powell’s got a – and as always – the Fed governor’s got a very big task at hand. They've got to manage the biggest economy in the world and think about other economies as well and how they might influence. So hopefully it does slow down the rhetoric of raising rates aggressively because from where I see it I can see that the rate of change of jobless claims, potentially the GDP, CPI figures all coming down. Durable goods numbers look like they're probably going to come down. We came from an economy a year and a plus ago where we had stimulus from Chinese government and the U.S. government and other governments too. And then eventually a tax which also primed the grass to all that being taken away. So you've got a bit of a vacuum of growth that's forming and I can see profit margins pulling or compressing. I could see GDP slowing down from where we were, and I could see inflation numbers coming down.

[00:03:20] Stephen: I think we've been in a bit of an abnormal environment. We've had ultra low interest rates. We've had the U.S. Treasury holding down long end interest rates, so as we continue this unwind of accommodative fiscal and monetary policy, we'll start seeing asset prices correct generally. But, if we look back through history this is pretty typical. So every major asset expansion has ended with rates going up. So you can go right back through history and whether it's the Fed prompting that increase in rates or just the market increasing the cost of capital – that’s how the good times have ended – one person or the other, normally the Fed president. As they say in the Americas, “taken away the candy bowl and ended the party”, which is what we're seeing. So I think looking through or reading through the tea leaves of the Fed minutes, and what's coming out of Donald Trump as well, I think Powell will probably want to, maybe not totally tone it down, but just to say that they've got time on their side. So rather than being in a rush to get to a terminal Fed funds rate, they'll take their time to get there.

[00:04:28] Jake: I hope so. You've worked very, very hard to go from the GFC to where we are now. You've kept low rates very, very low to try to build up the confidence in the economies and it certainly has come to fruition, especially in the last three years. To be in a rush to take that away, I think, might end up being a mistake. I think you want to go slow and steady. I guess as Powell intoned last time we had a conversation publicly, “walking through a dark room with no shoes on”. So certainly does tone down the rhetoric but historically speaking, there's not very good evidence of Fed governors doing that. They tend to overshoot, but hopefully for the GDP sake, they just slow down a bit.

[00:05:13] Stephen: But I think the conditions are right at the moment that the scorecard, if you look at what the Powell's predecessors Janet Yellen and Ben Bernanke have set up, the US economy unemployment's at 3.7% and inflation is around 2%, these are two big ticks on their on their scorecard. So I think the big one for them is a big variable X that they can't control, that is prices. They're watching wages that they really can't control as a Fed governor. That's sort of beyond their control and also prices which are driven by global commodity markets. So something positive that we've seen recently is the oil price going back a little and that's definitely going to put a damper on inflation going forward.

[00:06:01] Jake: Yeah, which should give Powell more reason to not raise rates as aggressively as some of the concerns are inflation could get too hot. But with the GDP, the numbers look like they're probably to come down. Jobless claims which is a number I've been watching for 25 years on a weekly basis starting to tick back up a little bit. You'd expect those inflation numbers to come down and clearly the commodity complex are pointing to that oil down 25% in the month. Typically quite correlated with inflation.

[00:06:30] Zoe: Well while we're on the subject of commodities what's going on with the sugar market?

[00:06:36] Jake: Is this referring to Mackay Sugar by any chance?

[00:06:38] Jake: Well sugar contract hit lows – that are really the sugar number 11 contract trades in Chicago hitting the lows of eleven – but a couple of months ago now. Zipped up to about 14 bucks and is now back down about twelve and a half. So surprisingly it's quite correlated with the coffee market as well. But if the question is more directed towards Mackay Sugar then I guess in past podcasts, we've intoned that things seem to be improving.

[00:07:16] Stephen: Yeah they do. The bid that's been put in by Nordzucker seems to be progressing along quite well. And again, we'll keep our listeners well informed of any new developments we hear. So I think it's a positive that there's people sitting around the table and coming up with a resolution for Mackay Sugar.  

[00:07:28] Jake: It would be good if the commodity kept coming up, but it has bounced off of lows and hanging at higher levels or less so it's good to see.