Australian Market Commentary

The Australian bond market (as measured by the Bloomberg AusBond Composite 0+ Yr Index) was down 0.42% over the month. The yield curve steepened as the spread between long-term and short-term bond yields widened. 3-year government bond yields ended the month up 7 basis points (bps) while 10-year government bond yields were up 15 bps to 2.67%. Short-term bank bill rates ended the month lower. The 1-month rate was up 2 bps to 1.88%, the 3-month rate was down 1 bp to 1.94% while the 6-month rate was unchanged at 2.14%. The Australian dollar remained unchanged for the month at USD 0.72.

During the month, the Reserve Bank of Australia (RBA) maintained the cash rate at 1.50%. The RBA continues to maintain its view on the economy with global growth continuing and global inflation remaining low.

Domestic economic data releases were mixed in September. GDP growth in the June quarter was ahead of expectations, recording growth of 0.9%. The annual rate was up 3.4%, the fastest annual expansion rate since Q3 2012. Employment rose by 44,000 positions in August (mostly in full-time positions). Meanwhile the unemployment rate remained steady at 5.3%. The NAB Survey of Business Conditions rose to +15 in August, however business confidence fell 3 points to +4, the lowest level since 2016. Retail sales disappointed, with a flat result for July.

Australian Market Outlook

Despite signs of improvement in key global economies, we remain cautious given ongoing geopolitical risks and shifting central bank policy settings. The US Federal Reserve raised the federal funds rate by 25 bps and the European Central Bank continues to reduce the pace of their QE tapering, with the program set to end in December. Concerns remain around the fragility of Europe with the UK’s Brexit plan again being rejected by the European Union. The US instigated trade war remains ongoing, as the US continues to impose new tariffs, and targeted countries continue to retaliate.

The Australian economy continues to grow and has officially completed 26 years of uninterrupted expansion. We expect the monetary policy easing that took place in 2016 to continue to support a slow but robust growth environment.

Over the past six months the consumer has struggled despite a strong business and employment outlook. Corporate profits are robust and business confidence is high, however historically low retail sales and poor consumer confidence driven by very low wages growth makes the outlook for growth quite mixed.

We expect the RBA to continue to keep rates on hold into 2020. In the bond market, we expect Australian bond yields to follow global yields higher. Provided there is no sharp sell-off in risk assets we would expect credit spreads and swap spreads to remain well supported.

Credit Commentary

Credit was slightly volatile over the month as sentiment waxed and waned on the impact of the potential trade wars. However, spreads in most markets finished relatively close to the levels where they began at the start of the month.

Australian physical spreads widened 1-2 bps on average and the Australian iTraxx was 1.3 bps wider. In offshore markets, US CDX was wider by 0.5 bps and the European iTraxx tighter by 1 bp.

In credit news, banks continued to provide headlines with ANZ, Commonwealth Bank and Suncorp following Westpac’s lead in raising their standard variable mortgage rates. NAB decided not to follow the others and held its rates fixed, as an attempt to “build trust”.

Westpac was fined AUD 35 million by ASIC after admitting to wrongly assessing people’s ability to repay mortgages. ASIC also launched proceedings against ANZ for allegedly breaching its continuous disclosure responsibilities during its 2015 share sale. The Commonwealth Bank has signalled an exit from Self-Managed Super Fund lending.

Moody’s released its report on the Australian banking system and maintained a stable outlook due to the favourable economic environment although acknowledging risks from potential slowing credit growth, increasing profitability and rising funding and operating costs.

On last working day of the month, Commissioner Hayne’s interim report of the results of the Banking Royal Commission was released: while heavily critical of many financial institutions and of the regulators, it stopped short of recommending substantially more regulation suggesting rather better enforcement of existing regulations.
Outside the financial sector, Telstra’s fixed line services are being reviewed by the ACCC with the risk of changes to the conditions that they operate under. Transurban’s agreement to buy 51% of the WestConnex toll road has been priced at AUD 9.3 billion of which AUD 4.2 billion is funded by a rights issue. Standard & Poor’s and Moody’s both signalled that it would not impact ratings. Oxford Properties has entered the chase for Investa Office Fund (IOF), competing with Blackstone, with an initial bid of AUD 5.50 raised to AUD 5.60 after a counter offer was made. IOF management is still recommending the Blackstone offer.

Credit issuance for the month was AUD 8.1 billion down from AUD 12.9 billion the previous month though still at the high end of monthly issuance. Non-financial issuance (AUD 1.675 billion) included Paccar, GPT and AT&T while financial issuance came from Suncorp, AMP, MUFG Bank, Westpac, NAB, Toronto Dominion, Svenska Handelsbanken and Liberty Financial. In the securitised market there was AUD 2.7 billion of issuance from Commonwealth Bank’s Medallion Trust, Liberty and RedZed. The Medallion Trust deal was AUD 1.63 billion, out of which the senior AUD 1.5 billion tranche was privately placed. The deal had a three year revolving period resulting in the senior tranche have a 6.5 year weighted average life (WAL) and a 9.2 year WAL for the other tranches.

Credit Outlook

Credit spreads seem to have settled wider than the tight levels at the start of year and are now closer to their post-financial crisis historical average levels across most jurisdictions and sectors, although still on the tighter side. At these spreads, any global or economic uncertainty will create increased widening pressure and recent uncertainty is putting pressure on spreads. Underweighting credit for any sustained period of time has become more expensive as spreads widen.

Despite a two month hiatus in June and July, supply in Australia has been very strong both in the financial and non-financial sectors, though this seems to have been met by demand and spread widening has been constrained to this point. Future domestic non-financial supply is, however, always uncertain given many Australian investment-grade issuers tend to be lowly geared and so require less debt. In addition, the bank loan market remains attractive for shorter maturities and offshore markets offer competitive pricing for sizable long-term debt issues. Many issuers have also taken advantage of low rates to refinance much of their maturities and the short-term corporate pipeline is thin.

Offshore, supply in the US market has remained strong despite a relatively quiet July and offshore markets, are in general, not as exposed to the lack of supply of non-financials as the Australian market.

Given the relative tightness of spreads, caution needs to be applied especially when investing in lower-rated credits. Despite the differing performance in terms of ratings, high-yield spreads are reasonably tight and the extent of compensation for taking exposure to lower-rated credit is less compelling.
Our preferred sectors remain domestic or select Asian banks, RMBS and the stronger utilities. Select offshore banks can also provide strong opportunities but caution must be taken due to the difficult operating environments and regulatory uncertainty for banks in many jurisdictions.