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Mutual Daily Mutterings

 

Quote of the day…

“No amount of evidence will ever persuade an idiot”– Mark Twain

 

 

Dashboard

 

 

“Flop Gun…”


Source: www.hedgeye.com

 

 

“Keeping the Top Gun theme going…”


Source: www.heraldsun.com.au

 

 

Overview…”RBA meeting, +25 bps or +40 bps, choose your poison…”

  • Moves: risk on… stocks , bond yields , curve , credit spreads , volatility and oil ….
  • It was a choppy session in offshore stocks, with an initial rally underpinned by Chinese headlines around moves to ease COVID restrictions.  In the end, stocks held on to portions of their early gains, while bond yields punched higher as markets continue to digest data and speculate on how aggressive the Fed will need to be on hiking rates in coming months. Rising energy costs (oil) and tight labour markets continue to underpin bets in the market that the Fed may need to be more aggressive in its attempts to rein in inflation. No data of note out overnight, but US CPI and consumer confidence data is scheduled for Friday.
  • Talking heads…”this year’s decline has not priced-in much of the slowdown in economic growth that we’re going to get this year…the decline so far has only worked off the overvaluation that existed at the beginning of the year.”  True dat!
  • Fed speak…not quite Fed speakers, but some thoughts on the Fed…”a strong consumer that keeps inflation too high for the Fed for too long is a significant risk.  This week’s CPI report will help determine if price gains are slowing enough to give the Fed comfort or if more aggressive rate hikes/rhetoric will be needed to slow growth. Investors are much more focused on CPI than payroll or other data points.
  • US inflation…”is closer to its 1980 peak than previously thought, according to a paper by economists including Larry Summers, suggesting the Fed has an even tougher job on its hands. Their historical analysis shows that core CPI hit an estimated 9.1% in June 1980 — versus the reported high of 13.6%.
  • Still in central bank land, “the European Central Bank is set to announce an end to bond purchases this week and formally begin the countdown to an increase in borrowing costs in July, joining global peers tightening monetary policy in the face of hot inflation. The ECB is planning to strengthen its support of vulnerable euro-area debt markets if they are hit by a selloff.” (Financial Times)
  • Talking heads…”let the speculation begin. In the absence of both significant economic data and Fed-speak over the next several days, financial markets will be free to indulge their imaginations and debate the great topics of the day without the necessity of conjuring verifiable proof…” (Cameron Crise, Bloomberg).
  • Main event for local markets is the RBA rate decision at 2:3pm.  The bulk of rate callers are pinning their reputations on a +25 bp hike, just over half, while the rest are calling a +40 bp hike.

 

The Long Story….

  • Offshore Stocks – the S&P 500 was up over +1.0% at one stage during the overnight session, mainly on the back of hope China was easing it’s COVID restrictions, which have been a source of disruption for supply chains and in turn inflationary pressures.  But, then bond yields shot up with US 10-year yields breaching the 3.0% level on inflation concerns, raising concerns around stock valuations.  By day’s end the S&P 500 had gained +0.3% with 62% of stocks advancing.  More sectors gained than not, eight vs three, led by Telcos (+1.0%), Materials (+1.0%), and Discretionary (+0.7%).   At the other end of the table, we had REITS (-0.3%) and Energy (-0.1%).  Healthcare was flat.
  • Local Stocks – lower a smidge yesterday, but with slightly positive leads today.  Yesterday the ASX 200 lost -0.5% with three-quarters of the index retreating.  Only three sectors gained ground, Energy (+2.1%), Utilities (+0.7%) and Healthcare (+0.2%).  At the shallow end of the performance pool we had Tech (-1.6%), Telcos (-1.1%) and Industrials (-1.0%).  Materials (-0.9%) and Financials (-0.6%) did most of the damage.  Despite the positive leads, albeit modest, futures are slightly in the red (-0.1%).  All eyes on the RBA today – post the prior meeting, markets sold off a touch, very minor, and are down -1.5% since said meeting.

 

  • ASX 200 relative strength indicators


Source: Bloomberg

 

  • Offshore credit – a busy day of issuance in US primary markets despite underlying bund yields spiking higher.  Twelve borrowers priced US$15bn of new IG paper with a relatively constructive tone across the market.  Deal execution has been reported as orderly across pricing, although issuers did pay slightly higher new issue concessions (on average) of 13 bps vs 11 bps YTD averages.  Order books were 2.8x oversubscribed, which is in line with YTD averages.  Despite the heavy issuance, cash spreads drifted lower by a couple of basis points.  CDS spreads flat in CDX, while MAIN is -2 bps lower.

 

  • Offshore credit indices vs A$ spreads…note, A$ spreads are much less volatile than offshore markets…


Source: Bloomberg, Mutual Limited

 

  • Local Credit – not a lot to report yesterday on the senior front, spreads largely unchanged with 5-year major bank spreads around +100 bps, -5 bps vs the previous print, which was WBC’s May-27 about two weeks ago (May 20th).  Flow was muted as investors no doubt waiting for today’s RBA decision.  In the tier 2 space, some buying noted, although reportedly its just one buyer rather than broad based.  Nevertheless, against historical averages tier 2 spreads are attractive.  CBA’s Apr-27 callable line – most recently issued tier 2 line – is quoted at +226 bps on trader’s EOD notes, however Bloomberg has spreads quoted at +211 bps.
  • Markets have priced in a +25 bps with BBSW1M at 0.585% this morning, while BBSW3M is at +1.235% suggesting several more +25 bp hikes are priced in.  In the last meeting minute’s the RBA signalled that they expected the cash rate to be around 1.75% by the end of 2022 (option pricing suggests 2.60%) and 2.50% by the end of 2023 (options at 3.50% area).  Should the RBA go +40 bps, that will send the signal that they need to get a wriggle on and will likely see BBSW push higher, which is positive for floating rate note funds given coupons reset regularly – our own income fund has just under half of its holdings reset through June, with BBSW3M at 1.235% vs their last reset of anywhere between 0.08% and 0.23%, so over +1.00% more in running yields by month’s end vs three months ago.

 

  • Major bank 5-year vs the major bank RMBS…


Source: Bloomberg, Mutual Limited

 

  • Bonds & Rates – minimal action in local bonds yesterday ahead of today’s RBA policy meeting.  No material changes to expectations with the weight of consensus at +25 bps (to 0.60%), but also a handful of notable market commentators at +40 bps (to 0.75%).  The arguments set out for each scenario are plausible and admittedly I have been oscillating between the two.  I re-read the last meeting’s minutes this morning and have come away with the view that the +25 bp hike has a better fit with reality for me.  Better-than-expected GDP data, which was underpinned by resilient consumer spending and continued draw-down of savings rates might give the RBA confidence to go harder here and now, but rather given the language of the minutes, I suspect they want to assess the reaction of the first hike before they go too hard.  So, I’m off the +40 bp hike and onto team +25 bp hike…now watch the RBA surprise me and go with my initial gut reaction.
  • Notwithstanding the above pontificating, we have seen a couple of market pundits call a +65 bp rate hike, which would take the cash rate to 1.00%.  I like the boldness of the call and one or two people within ‘Team Mutual’ have empathy for the call, but I suspect it’s too bold for the RBA, maybe the RBNZ, but not the RBA.  To further rationalise my change of heart on the size of the hike, my reading of the RBA’s minutes gives me the sense the RBA wants to see how a couple of ‘normal’ rate hikes are digested before they get too aggressive.  Specifically, I note the following comment from the last minutes…”there is no contemporary experience as to how labour costs and prices in Australia would behave at an unemployment rate below four per cent.”   The current cycle vs past cycles is materially different because the financial system plumbing has changed.   It’s been bastardised from what it once was through the development of financial engineering (evolution of derivatives), bank regulation, and monetary policy intervention (QE…and QT).  All this warrants caution
  • Another consideration for the RBA and its call is cost of bank wholesale funding, which has risen since the last meeting and must be a consideration as it represents a source of system tightening.  Since the last meeting BBSW 3M has risen +54 bps and spreads have widened some +12 – 15 bps.  At the last meeting the RBA note that “bank’s overall funding costs and lending rates had remained low.”  In a spread sense, bank funding costs are at or near post GFC highs (pandemic spike aside).
  • Overall, global themes noted in the prior meeting’s minutes remain in place.  Supply-chain disruptions, resilient consumer demand, tight labour markets, elevated commodity prices and geopolitical uncertainties have not materially changed.  Locally, we’ve had better than expected GDP data, which supports the idea that the economy can withstand higher rates.  Wages data came out post the RBA’s May meeting, which was flat to the prior quarter (+0.7% QoQ), but below consensus estimates – annual data was a touch ahead at +2.4% YoY (vs +2.3% YoY in Q4’21).  Still sluggish in the context of CPI north of +5.1% YoY (and forecast to hit 6.0% by year end).  Credit growth continues to run hot, albeit data pre-dates the RBA hike, and unemployment remains very low by historical standards.  No new readings on CPI have been released since the last meeting.  Most of this suggests the RBA could go down the +40 bp rate hike path, and the symmetry of it all is appealing (taking the cash rate to a multiple of 0.25%).
  • Market reaction to a +25 bp hike is likely to be muted in isolation, however offshore leads are very hawkish with US 2-year treasury yields +7 bps and 10-year yields +11 bps overnight.  A +40 bp hike would put the cat amongst the pigeons, likely turbo-charging any sell-off (yields higher) on the back of offshore leads.  As for the +65 bp rate hike outliers, that would be truly disruptive, which is why I would assign a very low probability to the outcome.  Bond yields have opened +2 – 4 bps higher this morning.

 

  • RBA rate hike cycle – market expectations…

 


Source: Bloomberg, Mutual Limited

 

  • BBSW 1M vs cash rate vs CPI…


Source: Bloomberg, Mutual Limited

 

  • A$ Fixed Income Markets…


Source: Bloomberg

 

  • Macro – nothing of note, all eyes on the RBA.

 

  • Charts:

 

 

 


Source: Bloomberg, Mutual Limited

 

 

Click here find the full PDF from our Chief Investment Officer’s daily market update.

 

 

 

 

Contact:

Scott Rundell, Chief Investment Officer

T: +61 3 8681 1907

E: Scott.Rundell@mutualltd.com.au

W: www.mutualltd.com.au

Mutual Limited Daily Update

Mutual Funds

MCTDF – Mutual Cash Fund
Gross running yield: 0.78%
MIF – Mutual Income Fund
Gross running yield: 2.07%
Yield to maturity: 1.78%
MCF – Mutual Credit Fund
Gross running yield: 3.34%
Yield to maturity: 2.99%
MHYF – Mutual High Yield Fund
Gross running yield: 6.00%
Yield to maturity: 6.02%