AUD falls after the RBA’s cash rate cut last Tuesday, government bonds at a record low, and strong demand for the Royal Women’s Health fixed rate bond
Economic Wrap
After much speculation, the Reserve Bank of Australia (RBA) cut the cash rate by 25bps to 1.75% last Tuesday. This was followed by the RBA Governor Glenn Stevens’ highlighting a material reduction in the Reserve Bank’s inflation expectations, revising its CPI expectation below the RBA 2.0% minimum target in the short to medium term.
The RBA inflation forecasts increase the likelihood of further rate cuts with some forecasters expecting the RBA cash rate to go down to as low as 1.00%.
The AUD fell on the back of the news, down 0.9 per cent to 74.01 US cents, and closed the day at 73.66 US cents. Furthermore, the 3 year government bonds plunged to a record low.
Stevens is due to retire in September and his replacement was announced this week. His successor is the deputy Governor Philip Lowe who is considered a safe pair of hands.
Prime Minister Malcolm Turnbull announced an election on 2 July, kicking off the debate from both sides of politics on fiscal management, budget balancing and potential changes to superannuation and negative gearing.
US government bonds are lower on the week with the 10 year yield at 1.79%. The range on the US benchmark bonds has been between 1.70% and 2.00% for the last two months.
Overseas news:
- US labour market data was fairly soft with non farm payrolls missing expectations for April (+160k vs +200k expected). Prior months’ increases were also revised downward. The participation rate also fell slightly to 62.8%. As a result, US unemployment was flat at 5.0% against an expectation of an improvement to 4.9%. This has reduced the likelihood of near term rate rises from the FOMC in the eyes of some commentators.
- In China, both export and imports fell short of expectations and were down 1.8% (exp. 0.1%) and 10.9% (exp. -5.0%) respectively. However, FX reserves rose beyond market expectations to USD3.219bn, up USD7bn from March against a forecast decline to USD3.202bn.
- Euro politicians will meet in Brussels early this week to a review a third assistance program for Greece which is required to unlock the next set of funding. This review has been stalled repeatedly and must be completed to repay billions of euros in July.
Credit indices spreads are higher over the last week with the US Investment Grade Index (IG) finishing Friday at 85.3bps (+8bps on the week) and the US High Yield Index (HY) at 463.0 (+30bps on the week).
Domestic market
Domestic interest rates are lower over the last week, with the AUD 3 and 10 year swap rates currently at 1.81% and 2.45% respectively. The Australian iTraxx is circa 135.4 basis points (or 1.35%, for this index of 25 Australian Investment Grade names). This is 4bps wider on the week.
Flows
We saw strong demand for the tightly held Royal Women’s Health fixed rate bond with clients seeking to take advantage of the new found supply while it lasts. RWH March with a first call in 2017 is available to wholesale clients only in minimum parcels of $10,000 and is available at a yield to maturity of over 5%.
The Adani 2020 fixed rate bond continued to trade higher for a second week, with demand remaining steady. Many clients have seen this bond as a buying opportunity, benefitting from the recent coupon step up post Moody’s downgrade and taking a view that the weakness in the sector is only cyclical.
In the non AUD space, the recently announced buy back of the Fortescue Metals Group (FMG) 2019 senior unsecured bonds has interest from the institutional sector, who are bidding for the bonds in the market. This has allowed clients to sell back their bonds at around the 104.125 and reinvest before 1 June 2016. Clients have maintained their USD exposure by switching in to Newcastle Coal with a first call of 2027, Virgin 2019, BHP Billton with a first call of 2025, and both the FMG’s 2022 senior secured and unsecured USD bonds.
Note: The US Investment Grade Index is comprised of the Credit Default Swaps of 125 equally weighted names whereas the HY is comprised of 100 non investment grade names. Changes in them are reflected in prices of securities of varying credit quality.