Weekly Highlights

In a quiet news week investors focused on the outcomes of this weeks central banks meetings. The US Federal Reserve’s (Fed) September meeting commences on Wednesday (Australian time) with the futures market implying an 88% expectation for the Fed to remain on hold (at 0.25-0.50%). Similarly, out of 50 surveyed economists only 15% expect a September hike, with the number rising to 54% for a December increase.

Despite a strong end to the week domestic equities ended lower (-0.80%) with the ASX200 Accumulation Index down 2.51% from the start of September. Bond markets were also lower over the week with the Ausbond Composite Index and Ausbond Credit Index falling modestly by -0.58% and -0.46% respectively as bond yields continued to rise.

Last week the US Justice Department suggested Deutsche Bank should pay US$14 billion as compensation for their part in packaging up toxic mortgages between 2005 and 2007. As a result, equity and Tier 1 securities were down significantly on Friday. Deutsche responded in a statement saying it “has no intent to settle these potential civil claims anywhere near the cited number.” Several other banks have reportedly settled similar claims, including Bank of America (US$16.65 billion), Goldman Sachs (more than US$5 billion) and Wells Fargo (US$1.2 billion). The penalties involved in the US case have some relevance to the Australian market because of the Australian Securities and Investments Commission’s (ASIC) legal action alleging that 3 of the 4 major banks conspired to manipulate the bank bill swap rate prior to September 2013. Whilst the quantum of fines in the Australian context have to date been immaterial in comparison, this does show how serious regulators around the world are taking this type of behaviour. ASIC has already secured voluntary contributions of $1.6 million from Royal Bank of Scotland, and $1 million from UBS and BNP Paribas after those banks discovered “potential misconduct” in their BBSW submissions. The CEO’s of the major banks are due to face parliament in coming weeks and it will be interesting to observe the line of questioning.

Short term funding markets also witnessed signs of stress last week as new rules governing US money market funds (also known as prime funds) come into effect on the 14th October 2016. The industry has an estimated US$2.6 trillion of funds under management and this change will end a 30-year tradition of fixing the unit price of these funds at $1. From 14 October onwards only funds that hold purely government debt will be able to maintain a $1-unit price. For those impacted funds the unit price will start to fluctuate according to the value of the investments held within those funds. This regulatory change has already seen money market funds under management decrease in value by ~US$700 billion since the start of 2015, reducing demand for banks and other company short-term debt and raising funding costs. Australian banks have not been completely immune as our major banks rely heavily upon overseas funding to finance Australian corporates and households. To mitigate this risk our major banks have issued ~A$3.5 billion in 1 year bonds to shore up liquidity ahead of these rule changes. Another reason for the major banks doing this is to prepare for the commencement of the Net Stable Funding Ration (NSFR) by the Australian Prudential Regulation Authority (APRA) from 1 January 2018. The major banks have issued 1 year bonds as they will be able to replace this cheaper short term funding source with longer dated bonds after the NSFR rules come into effect. Local bond market participants have been the main buyers as short term investments have been in short supply.

Click below for Charts

Chart 1: Bloomberg AUSBond Composite Index (Monthly)

Chart 2: Bonds vs Equities 2015/2016 (Monthly)

Chart 3: Term Deposit Review – August 2016