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Weekly Highlights – 19 May 2015

Over the past month we have witnessed a sell-off in the fixed rate bond market as the process of normalising long-term bond yields continues across the globe (this can be partially attributed to fears of deflation in Europe). However, over the past week the bond  sell-off seems to have stalled as US economic data releases were patchy and Greek policy issues  caused a slight flight to quality to bonds (albeit one of many reasons). Although the sell-off has stalled temporarily our expectation is that yields will remain volatile over the coming months as uncertainty increases  i.e the Fed’s timing for raising interest rates and the Greek situation. Therefore, all risk assets will experience some volatility in the period ahead.

Weakness in Bank hybrids an Opportunity

In the domestic fixed income market floating rate notes remain our preference at this point in the cycle, but  even these have experienced  negative sentiment as retail investors sold floating rate Bank hybrids alongside Bank shares . Bank hybrids (especially  Tier 1 securities) with longer maturity dates were the worst hit. Holders of this type of security (i.e those with an expected maturity greater than 5 years) have not been compensated for additional term risk (compensation being a % premium and term risk being an increased probability of default/conversion) , so when there’s weakness in the market these securities are more volatile and have greater capital price sensitivity to movements in trading margins.

We think this sell-off is a short term correction rather than a bear market for hybrids and therefore it presents an opportunity for investors. We review each recommendation on a Friday and will make any adjustments accordingly.

Overseas

In international markets we are focussed on a a number of policy comments which will affect asset prices over the European summer:

  • The European Central Bank has commented that asset purchases for its bond buying program (quantitative easing) will be front loaded ahead of the summer. This will no doubt drive asset prices higher in the short term;
  • In the US , a Federal Reserve official (Evans) suggested the Fed should not move on rates until early 2016 and raise them only gradually thereafter as inflation is well below target.
  • Soft economic data in the US is pushing out expectations of the timing of the Fed’s first rate hike (again), rate hikes are not even on the horizon in Europe, Japan and Australia and in China rates are set to fall  further. It’s hard to be bullish on bonds –  yields remain low with mediocre returns ahead – it’s hard to be too bearish also as the world remains awash with savings and spare capacity.
  • Global economic growth remains below trend;
  • Inflation is weak everywhere – this will drive policy decisions in most countries making it difficult to predict bond yields. It’s also important to recognise  fears about deflation still exist especially in Europe (note  UK inflation data shows the country has already dipped into deflation territory).

Reserve Bank of Australia

The RBA has decided to make life more difficult for the interest rate market by stating  they have decided against giving any guidance on the future direction of monetary policy. The minutes left  the door open to changes to rates up or down as they dropped the easing bias commentary. The recent cut was debated but given the quarterly economic forecasts were weak they felt it was appropriate to consider an easing of monetary policy. What does this mean? Basically markets are not reacting to historical models and this is because the QE policies around the globe are impacting our markets far more than any policy changes the RBA can implement. This is not new information

NEW RESEARCH:

PRIMARY ISSUES:

  • Bank of Queensland – New Issue Report click here

ARTICLES:

  • The major banks and Macquarie have all reported in the past few weeks. See our updated outlook on each bank in the article “A Review of Bank Results”. Click here
  • Flashnote on Woolworths – relative value since the Q3 Sales Results and Investor Strategy Day. Click here
  • Michael Saba from Evans and Partners gives an update in his article “Where the Action is?. Click here