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Weekly Highlights

The major banks continued their strong run last week leading domestic equity markets slightly higher (up 17 points or 0.32%) while corporate names such as CSL and Woolworths were a drag on performance. Australian Government Bonds reversed the weakness from the previous week as the long end of the bond curve (5+ years) tightened by ~0.12%. This rally in government bonds can be primarily attributed to the European Central Bank’s extended stimulus program and the Federal Reserve stating that it will raise interest rates slower than previously anticipated. These announcements are strong for global bond markets but may ultimately force the hand of the RBA to lower rates as the Australian Dollar continues to rally (currently ~$0.76).

 

New issuance remains quiet in the domestic corporate sector but banks are using this window of opportunity to extract senior funding across multiple currencies. We have also seen more activity from small banks and building societies such as Newcastle Permanent Building Society pricing a new senior unsecured (three year) FRN at 3 Month BBSW + 1.60% p.a and AUSWide Bank pricing a small 1 year issue at 3Month BBSW +0.90% p.a.

 

In another short week for Australian investors (Easter break early this year) the domestic bond market is likely to track European and US leads. The perennial question about whether liquidity in OTC fixed income markets is waning is certain to be hotly contested in 2016. Although interest rates rises in the US have been delayed they are still present and the untested waters of the first rising interest rate environment coupled with the unabated growth of the US corporate bond markets has set the stage for an unprecedented evolution in the trading landscape. As always the Australian bond market will have to wait and see but our central bank is in a much better position than most to support the system if and when a liquidity issue starts to emerge.

 
Click below for Interactive Charts
Chart 1: Bloomberg AUSBond Composite Index (Monthly)

Chart 2: Bonds vs Equities 2014/15 (Monthly)

 

Interest Rates

 

Although the Federal Reserve left rates unchanged last week they adjusted down what is known as the “dot plot”. This is effectively the guide they give to market participants as to their expectations for in interest rates over coming years. For 2016 they reduced the rate hikes from 4 down to 2 and their median forecast for inflation has been cut from 1.6 to 1.2%. This is significant because it impacts commodities, currencies and interest rate expectations for Australia but expected by the interest rate futures market. The RBA remains confident in their neutral position but the strength of the currency will likely lead to further “jawboning” and if this doesn’t work we may see further cuts.

 

Timing of interest rate changes is always difficult to predict but we would expect the Fed would act sooner rather than later if it were to increase rates in 2016 especially due to the US election later this year. Relevant economic data is almost non-existent this week but last week’s employment data was again far stronger than expected with the unemployment rate reducing to 5.8% (albeit off a lower participation rate rather than a big increase in new jobs).

 

In February 2015, the 10-year bond yield hit an all-time low of 2.27% before lifting to highs near 3.15% on 11 June 2015. In early November 2015 there was a progressive increase in yield from ~2.60% to a high of 2.99%. Since mid-December the flight to quality meant the 10-year yield gave back the changes in Q4 2015 and on 1 March 2016 hit a 6 month low of 2.35%. In the past few weeks we have seen a sharp bounce back up but the yield is now consolidating around 2.60% (current 2.58%). The 3-year bond has followed a similar pattern and broke out of its recent yield range (1.90 – 2.10%) in November / December 2015 reaching a high of 2.18% on 7 December 2015. It retraced back to a short term low of 1.70% but then jumped back up to 1.97% in the past weeks. On 18 March 2016, the ASX 30 Day Interbank Cash Rate Futures April 2016 contract was trading at 98.030 indicating a 14% expectation of an interest rate decrease to 1.75% at the next RBA Board meeting (up from 10% previous week).

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