Mutual Daily Mutterings
Quote of the day…
“Think of how stupid the average person is, and realize half of them are stupider than that.”” – George Carlin
“The Old Normal…”
“The Price Of Incompetence…”
Overview…”And, they’re off…”
- Moves: optically a risk on session… stocks ↑, bond yields ↑, curve ↓, credit spreads ↔, volatility ↑ and oil ↓….
- Ahead of tonight’s FOMC pow-wow US stocks edged higher overnight, although it was a volatile session, key indices ebbed and flowed intra-day. Yields rose at the front of the curve, but did little out the back end – bear flattener. The big ‘what-if’ is whether the Fed can orchestrate a soft landing for the US economy that manages inflation lower, but without cutting the red wire (instead of the green) and triggering a recession. Credit mixed across cash and synthetics, movements were modest in either direction.
- “Markets have whipsawed amid concerns about persistent inflationary spirals and risks to global growth from rising yields. Fed Chair Jerome Powell and his colleagues are expected to raise rates by +50 bps tonight and signal they’re on track to lift them to around 2.50% by the end of the year. It’s not clear, though, if that’ll be enough to tame inflation, which is running above the central bank’s target.” (Bloomberg). There is also the expectation the Powell will unveil the Fed’s plan on how to normalise the US$9 trillion balance sheet.
- Talking heads…”clearly there’s just a great deal of volatility, ….the biggest risk possibly really going on into next year is this question of: ‘Does the Fed tighten at the same time as other forces are causing the economy to weaken, and does that lead to a recession?”’. And…”because the market has priced in a +50-bp rate hike at the May meeting, the focus will immediately shift to just how many half-point hikes the Fed expects to initiate over the balance of 2022. Powell’s greatest folly would be to insist that the economy is very strong in the face of overwhelming evidence that it is slowing and slowing fast.”
- Closer to home, obviously yesterday was a red-letter day for local rate markets with the first rate hike in almost 12 years. While ‘a’ rate hike was expected, no one predicted it would be +25 bps (from 0.10% to 0.35%). In addition to the hike, the statement took on a decidedly more hawkish tone. The street is now pondering a +40 bps hike in June, taking cash rates to 0.75%. Local yields were smashed.
The Long Story….
- Offshore Stocks – a sea of uncertain green across the screens this morning, with both US and EU market advancing. In both instances, intra-day was choppy. In the US the DOW gained +0.2%, the S&P 500 +0.5% and the NASDAQ +0.2%. Within the S&P 500 some 72% of stocks advanced, and only two sectors dithered – Discretionary (-0.3%) and Staples (+0.2%). Getting on with life, we saw Energy (+2.9%) at the top of the heap, followed by Financials (+1.3%) and REITS (+1.2%). Materials (+1.1%) did well also. Direction from here, over the near term, will be dependent to a large degree by what is said and done by the Fed tonight. If Powell can convince markets the US economy is robust and they have a handle on inflation, then we might get a rebound…but it’s a big sell. You can only put so much lipstick on a pig….
- Local Stocks – a relatively dour day in local stocks with the ASX 200 giving up ground, down -0.4% with 64% of stocks retreating. Only three sectors put up a fight, as insipid as it was, Tech (+0.9%), Healthcare (+0.4%) and Industrials (+0.1%). REITS (-1.3%) was worst performer on the day, followed by Materials (+1.0%) and Utilities (+0.5%). The RBA rate hike had a modest impact at the time. The index was marginally down leading into the statement, then dropped -0.5% immediately (within 20 minutes) after the rate hike was announced. Most of that drop was clawed back as markets digested what was said, closing +0.2% off intra-day lows. Futures are up +0.6%.
- ASX 200 Relative Strength Indicators…
- Offshore credit – normally on the eve of a FOMC primary markets would be quiet, which they generally were, except for two deals that saw US$3.7bn price, which push weekly supply to US$8bn. Many other issuers lining up to launch decided to put their respective cues back in the rack until they have some clarity around monetary policies. Primary will be muted tonight as the FOMC statement is digest. In secondary, spreads ebbed and flowed, some drifted wider, some tightened a snifter, all up muted on the day.
- Local Credit – all eyes on the RBA announcement, which seemed to keep credit managers away from their trading books…traders on senior financials…”spreads unchanged with flows very light. FRNs remain challenged with a number of traditional buyers absent. Hard to believe NAB printed a 5yr benchmark transaction at +41 back in August 2021, we close the 1yr point at +42 bps today. We await bank results in the coming days with the prospect of supply to follow. Not unreasonable to expect a senior domestic benchmark, though we favour the chances of A$ T2, noting the warm reception given to the most recent T2 deal despite the challenging market conditions.” No change in the curve, 5Y at +90 bps and 3Y at +70 bps, within expect range of long run averages.
- Traders on tier 2…”closing spreads unchanged, though favour they should be wider. No inquiry of note and with the prospect of imminent supply we would not expect clients to be active in the coming days. Doubtless, the pressure imparted on the senior curve will be weighing on T2 spreads, but would not rule out a sensibly sized and priced deal playing well with potential investors.” CBA’s last deal, and the last major bank deal, an Apr-27 call, is at +202 bps.
- ANZ released interim results this morning…some very high-level details and first thoughts: cash earnings from continuing ops came in at $3.1bn, +4.1% YoY and ahead of street estimates (A$2.9bn). Net income rose +20% YoY to A$3.5bn. CET1 dropped, down to 11.5% vs 12.4% in the pcp…still ‘unquestionably strong’. Net interest margins were crunched, 1.58% vs 1.63% in the pcp. Efficiency ratio was 53.9% after an 8% growth in expenses. Net lending rose +3.8% vs Sep-2021, but housing lending was flat. Deposit growth was solid at +3.4%. Asset quality remains robust, but only a modest volume of prior credit impairment provisioning was released, which is prudent. Of most interest, to me at least, is ANZ announcing it will be applying to establish a non-operating holding company and create distinct banking and non-banking groups within the organisation. APRA has voiced no in-principle objections to this structure. Should the proposed restructure proceed, a new listed parent holding company will be created with two wholly owned distinct groups of entities sitting directly beneath it. All up, credit neutral results on the surface, but looking under the hood and the bank has lost some momentum. Nothing terminal, but not as robust as the headlines suggest…not enough to move spreads.
- Local vs Global Spreads – YTD Cumulative Change…
- Bonds & Rates – smoked, puked, smashed, etc, with the RBA blindsiding markets and unloading an unexpected +25 bps rate hike instead of the +15 bp consensus call, yields were belted from pillar to post. More hawkish commentary added fuel to the fire. By day’s end ACGB 3-year yields were +20 bps higher at 3.02%, above 3.00% for the first time since April 2010. ACGB 10-year yields were +14 bps higher, at 3.40%. More in line with expectations was the decision around QT, with the RBA opting for passive tightening here, letting their bond holdings roll off, but without any active selling. Also of note, the RBA lifted the deposit rate on ES balances from 0 bps to 25 bps, and keeping the bottom of the corridor at a 10bp discount to the cash target. The call for June is a +40 bp hike, taking the cash rate to 0.75%, back to its normal ‘multiple of 0.25%’ range, which will make those symmetry freaks feel better about the world. Policy settings will remain extremely supportive. Inflation and economic forecasts will be updated in the Statement on Monetary Policy (SMP) published on Friday. The 1Q Wages Price Index is out on 18 May. All of the majors have announced they will pass the full hike onto borrowers.
- Some thoughts from the street…”reading between the lines, the RBA has simply been caught off guard by the strength of the Q1 22 CPI data (note, in his post statement conference the Governor described the Q1 22 CPI data as ‘a shock’). As such, the Board decided that it could no longer afford to wait to raise the cash rate. In the grand scheme of things waiting one more month to raise the cash rate would not have changed the economic outlook. But clearly the inflation data last week put the RBA in an uncomfortable place, which is why they delivered a rate hike today.” (CBA).
- From the RBA press conference…”Lowe stated that “liaison shows strong upward pressure on labour costs” suggesting the slow gains for WPI data may not prevent a hike in June. The RBA board “is not on a pre-set path” and will base further decisions on data. By the June meeting, the Bank will count with a 1Q wages, 1Q GDP and labour force data for April. Lowe: over time it is not unreasonable for rates to return to 2.5%, although forecasts assume cash rate at 1.5% – 1.75% by year’s end.” (BAML)
- Prior to yesterday’s hike, the peak terminal rate forecast across the universe of professional procrastinators and pontificators I saw was around the 1.5% – 2.5% range. Markets on the other hand are higher at around 3.5% by mid-2023. There have been four main hiking cycles over the past 30-plus years. The first, in 1994 saw cash rates averaging 6.5% through the cycle. Next was the 1999 – 2000 cycle, with an average of 5.7%. For the 2002 – 2006 cycle the average was 5.9%, and then for the last cycle, post the GFC in 2009 – 2010, the average rate was lower again at 4.0%. If the futures curve accurately reflects the path of cash rate hikes, the average cash rate through this cycle will be lower again, at around 2.70%, give or take. The RBA Guvna on the other hand indicates that its “plausible” that neutral is around 2.50%, “but there is a large degree of uncertainty about the reaction function of a leveraged household sector and underlying productivity growth in the economy.”
- Where to for yields here? Momentum will carry yields higher for a while as markets grapple with how bad inflation really is and how hard the RBA will have to hike rates to reign it in. Looking at historical circumstances, in the first (1994) and second (1999-00) rate hike cycles, ACGB 10-year yields peaked within two months of the first rate hike at +595 bps and +255 bps higher respectively. The third cycle (2002-08) is useless, it took 3 years for bond yields to peak. The four cycle (2009-10) saw 10-year yields peak +286 bps higher from hike date within 140 days of the first rate hike. So, nothing really of use there…waste of time really. Historically, 10-year yields have traded at an average spread to the cash rate of ~90 bps. So, if you think terminal cash rate is 2.5% this cycle, that suggests a 10-year yields will average around 3.40% (current levels). Admittedly a very simple approach.
- With the RBA signalling more hikes to come, bank bills shot up also, 0.81% (+11 bps) now in the 90-day bills, which provides a nice income kicker for FRN funds. Note, through March BBSW 3M ranged between 0.10% and 0.20%, whereas as at the end of April the rate had reached 0.70%, and then today it’s at 0.81%. So, any FRN resetting in coming days and weeks will be running with a coupon that is +60 -70 bps higher than a month ago. This improving income trend will only continue with 90-day BBSW expected to move north of 2.5% – 3.0% by year end. Nice!
- The Bloomberg AusBond ACGB index is now down -1.62% on the month…and it’s only the first week! YTD losses are approaching double figures, -9.17%. Semi’s are down -1.49% MTD and fixed credit is down -0.96%. Floating credit is down a measly -0.02%
- RBA Cash Rate Pricing vs pre-meeting pricing…
Source: Bloomberg, Mutual Limited
- Macro – RBA rate decision yesterday…drop the mic, again. While the RBA rate hike itself was exciting, the central bank boffins also teased revised economic forecasts, which will be formally tabled on Friday when the Statement on Monetary Policy is released. A taste of what to expect….“the Bank has materially revised up its inflation profile with underlying inflation forecast to reach 4.75% this year and moderating to just 3.0% by mid-2024. These forecasts are based on a technical assumption that the cash rate is 1.50% – 1.75% at year end and 2.50% by end 2023, based on an average of market pricing and economists’ forecasts.” (Barronjoey).
- In offshore markets…”US employers saw record levels of job openings and workers quitting in March, pointing to intensifying labour-market tightness that will keep pushing wages higher at a rapid clip. The data come ahead of Friday’s payrolls report, which is currently forecast to show the U.S. added 390,000 jobs in April.” (Bloomberg)
Source: Bloomberg, Mutual Limited
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907