Mutual Daily Mutterings
Quote of the day…
“I’m not crazy about reality, but it’s still the only place to get a decent meal.” – Groucho Marx
“Won’t someone think of the children…and old folk?”
Overview…”the ‘Fed Put’ is kaput…”
- Moves: risk off… stocks ↓, bond yields ↑, curve ↑, credit spreads ↑, volatility ↑ and oil ↑….
- Stocks ended their session offshore in the red as inflation and growth concerns continue to weigh on sentiment as oil surged once more (Brent: +2.7%). Bond yields ticked higher with US 10-years back above 3.0%, while credit spreads drifted wider…but with no urgency. The surge in oil comes after crude inventories in the largest storage hub and gasoline stockpiles dropped. Overall sentiment remains fragile on concerns rising rates will curtail economic growth and the outlook for corporate earnings, problems that realistically will linger for the foreseeable future.
- US CPI data is due out tomorrow evening our time, which will be watched with eagle-eyed interest, bordering on obsessive. Expectations are for an acceleration in CPI through May vs a month earlier (+0.7% MoM vs +0.3% MoM), but slowing from a year earlier. Be that as it may, it is expected to remain north of 8.0% (+8.2% YoY cons. vs +8.3% YoY last).
- Talking heads…”we believe market pricing of recession risk is more likely to increase rather than decrease from here, and still-expensive valuations do not provide adequate compensation for the downside risks to activity and earnings…” A view on stocks, but a plummeting stock market is reflective of risk concerns (obviously), which flows through to credit and bonds to a greater or lesser extent. “In the face of such high inflation, uncertainty in the global macro, fiscal cliff here in the US, I think it will be a stretch to really expect a soft landing. Unfortunately, the Fed put is kaput for now.”
- Global…”the world economy will pay a “hefty price” for the war in Ukraine, the OECD said, slashing its outlook for global growth this year to 3.0% from the 4.5% it saw in December. The inflation outlook was doubled to almost 9.0% for its 38 member states. The US PCE deflator will be at 5.9% this year and 3.5% next.” (Bloomberg)
- ECB speak…”the ECB will end QE and forge a path toward reversing eight years of negative rates at Thursday’s meeting (tonight). Christine Lagarde’s remarks will be parsed for indications that a July hike of as much as +50 bps is in the cards. A hawkish decision could further boost the euro, which hit a five-year low last month against the dollar; European bonds have tumbled as money markets wager on more aggressive tightening. Some good news: First-quarter euro-area GDP rose 0.6%, double the original estimate.” (Bloomberg)
The Long Story….
- Offshore Stocks – oil price rises and inflation concerns continued to weigh on sentiment, and on the day, there wasn’t enough counteracting forces to prevent stocks falling. European markets performed better, marginally better than US markets, but still down. The DOW lost -0.8%, the S&P 500 -1.1%, and the NASDAQ -0.7%. It was pretty much all one-way traffic with 90% of the S&P 500 losing ground and only one sector able to advance – Energy (+0.2%). Worst of the worst was REITS (-2.4%), followed by Materials (-2.1%) and Utilities (-2.0%). The broader market is stuck in a relatively tight trading range with continued conflicting signals around how bad things could get. US reporting season (Q2) is around 5 – 6 weeks away. Apart from tomorrow night’s CPI data, and FOMC meeting next week, this is one thing to keep an eye on, specifically management outlook statements. This could present another downside risk for markets broadly.
- Local Stocks – modest gains yesterday, ASX 200 advanced +0.4% with 69% of stocks contributing and only one sector dragged the chain, Financials (-2.9%). Materials contributed much of the upside, +1.9%, and if not for the drag from Financials, the market would have been up over +1.0%. Energy (+4.2%) was the leader of the pack, followed by Utilities (+3.2%), and Industrials (+2.0%). Futures are signalling a down day, -0.8%.
- Within Financials, Banks were down -4.3% with BEN (-7.2%), WBC (-6.1%), and CBA (-4.3%) the top three trouble makers, despite most banks passing on the +50 bps RBA hike on. And that’s the rub. Markets are expecting slowing lending growth (probably) and impairment costs to rise (eventually, but off a very low base), both representing headwinds for earnings. No argument there is a risk, but I think the move has been a little over the top, and no doubt we’ll see more pain given offshore leads.
- Offshore credit – seven borrowers navigated a weaker market tone to price US$10.7bn overnight, pushing weekly volume to US$33.65bn, comfortably through the US$25bn-$30bn projected range. After concessions shrank Tuesday, issuers relinquished pricing leverage overnight as spread compressions receded, concessions jumped (+22 bps vs +11 bps YTD average) and order books were just modestly oversubscribed (2.6x vs 2.8x YTD average).
- Some handy commentary and charts from my man Coops over at WBC yesterday, comparing the A$ major bank funding curve with their US$ curve, swapped back into A$. Coops quite rightly highlights the flatness of the curve, with the 2s5s at just +25 bps vs say ‘normal’ curves which should be +35 – 45 bps (rough & dirty). He notes “demand for recent 5yr benchmarks remains firm at the expense of deals priced prior to the TFF that have suffered as investors sell shorter dates to retain cash. At current spreads, investors can pick up close to ¾ of the 5yr Major bank spread through the 2yr part of the curve.” Coops also notes the US$ curve is trading well inside the A$ curved (swapped back) out to late 2025 maturities, thereafter A$ is expensive to US$ from an investor’s perspective.
- Brendon, that be ‘Coops’, notes that “US curves, conversely, have remained well anchored at the front end as new issuance has not been met with significant switch interest and high demand remains in place for defensive IG product. The technical picture also remains robust in US Money markets which will substitute more readily at the front end of US$ curves that have a greater proportion of fixed bonds outstanding.” So, how does this pan out, do the curves hover around where they are, or do the slopes align somewhat, and if so, how? For mine, the front of the A$ curve is more likely to tighten toward US$ levels than the other way around. You could argue given this line of thinking that the back half of the A$ curve will widen toward US$ spreads, but I don’t think that’ll happen. Home bias should keep the back half of the A$ curve somewhat inside US$ spreads.
- Major Bank US$ vs A$ spreads……
Source: Bloomberg, Mutual Limited
- Local Credit – a bit of focus in primary yesterday with Singaporean bank, DBS, pricing a $500m 3-year at +85 bps, which I suspect was a touch inside where NAB’s recent 3-year is pricing…nope, just checked, NAB’s 3-year line is pricing around +83 bps. DBS is rated the same as the four majors, AA-, so pricing is fair, although it was a chunky book, I think it hit $1.8bn at one stage. Elsewhere within our sand-box, not a lot happening in spreads. WBC’s May-27 senior line, the most recent major bank senior line is steady at +99 bps (vs +105 bps at launch), while in tier 2, CBA’s Apr-27 call is at +210 bps (vs +190 bps at launch), also reasonably steady.
- Since the RBA rate hike, major bank (and regional) shares have come under immense selling pressure on the belief rising interest rates will slow credit growth (impact the revenue line) and accelerate arrears (impact cost line and balance sheet). Both fair concerns, which I touched on above. The ASX 200 Bank index has fallen -6.6% since the RBA met on Tuesday, whereas the broader ASX 200 index is down only -1.6%. This concern has not translated into credit markets, yet. Cash spreads have been stable in the senior space, while tier 2 drifted a couple of basis points on the day of the hike, but nothing since. CDS levels jumped a bit leading into the decision, but are ~7 – 8 bps below pre-rate hike peaks. All told, a muted reaction, and rightly so. While higher rates do pose the above stated risks, they are very much risks to earnings around the edges, and in turn dividends. This is more an equity focus than credit, unless it becomes structural. The risk, here and now, is not material enough to impact credit ratings or spreads performance. For now, technicals carry more weight on how spreads will behave, and for now, they’re looking ok.
- Major bank 5-year vs Bloomberg AusBond Credit FRN Index…
Source: Bloomberg, Mutual Limited
- Bonds & Rates – local bond yields retreated a few basis points as expected following leads out of the US treasuries market. Curves bull steepened, where the front end rallied faster than the back end. There was no data of note, rather just a day of digesting the RBA’s Tuesday rate hike and follow up analysis from professional market watchers. General consensus is the RBA has taken the gloves off and we’ll see another +50 bp rate hike in July and possibly another in August, taking the cash rate to 1.85%. The +50 bp rate hike in July is where the cool kids are hanging out, while the same again in August is attracting less of a crowd, a few are calling +25 bps in August.
- CBA are calling the double +50 bp hike, but are also calling for the RBA to begin cutting rates again in the second half of 2023. Either way, by year end 2022, most pundits expect the cash rate to be somewhere around 2.00% – 2.35%, which is on or around neutral. I’m not game enough to forecast into 2023 yet, but do expect the cash rate at 2.00% by year end, which would see BBSW also up around the 2.00% – 2.50% range, which is good for our floating rate note funds…yep, talking the book. Market implied terminal cash rates eased back a notch yesterday, with cash option pricing peaking at 3.79% vs almost 4.00% on Tuesday. Regardless of the implied terminal rate easing back, markets are still calling bull@#$% on the RBA’s confidence that they can manage inflation within prevailing expectations, and their expectation that the peak of the cycle will be 2.00% – 3.00%. With all due respect to members of the RBA board, past, present and emerging, they have been behind the curve more often than not. So, at this stage, the risk of an overshoot in cash rates (bs RBA guidance) cannot be discounted or ignored.
- The rally in local bonds, as minor as it was, will likely be short lived. Offshore leads are in the opposite direction. Across European bond markets closed +6 – 9 bps higher (yields), while in US treasuries yields popped +5 bps wider to 3.02% in the 10’s. It was a similar move at the front of the curve with 2’s +5 bps higher to 2.77%. Accelerating oil prices on the day and related inflation pressures were a key features of the daily narrative. Oil will remain an inflationary headwind for the foreseeable future with no apparent let up. Even if Russia tucks tail and heads home from Ukraine, it’s unlikely they’ll be allowed to hoc their oil into open markets willy-nilly…there will be consequences. Or, given the damage high oil prices are doing to global macro conditions, do they get a tusk-tusk, you old scallywag, ruffle the hair a small kick up the bum, off you go? Hard to say, maybe oil sells off on the headline. Either way, it’s not happening anytime soon, and the other OPEC countries are both unwilling and incapable of pumping more….so, hign prices are here to stay for a while…get use to it
- Long run A$ bond rates vs CPI…
Source: Bloomberg, Mutual Limited
- ACGB 10-year yields vs Brent Crude…
Source: Bloomberg, Mutual Limited
- A$ Fixed Income Markets…
- Macro – and so it has started…doom and gloom over house prices “CRASHING” in the coming year or so. Prices are set to drop 20% – 25% according to those who make a living out of the number of clicks their economic twaddle attracts in the popular press. And, of course readers are creatures of habit, clicking onto alarmist headlines, worrying what it means for their financial future. This in turn gives website algorithms a nitro boost and said articles take pride of place at the top of new pages. Word of caution, don’t take any economic or finance advice from online news services, or paper ones for that matter, especially articles written by people with little credibility…and potentially vested interests.
- Ok, let me just hop of my soap-box. Let’s assume house prices do fall 20% – 25%, which is the largest forecast I’ve seen so far. In isolation it’s a frightful number, especially if you bought a house in the last year or two. But, keep in mind house prices are up over 30% since just before the pandemic (Dec-19), or up just under 20% in the last 12 months…data to Dec-21, so probably a smidge higher. If house prices do drop has forecast, say by the end of next year, then they will only be marginally below the long run trend. Probably a good thing given it’s generally accepted that Australian house prices are cray-cray high. Full disclosure, I sold my place in Sydney late last year, and have yet to buy in down here in Melbourne, so I’m happy with a bit of house price weakness from a purely selfish perspective.
- Former RBA Governor Macfarlane spoke at a function yesterday. While I didn’t attend…my invite must have been lost in the mail…his comments have been widely reported, and are related to my above venting. He agreed with the RBA’s move, citing problematic inflation, which if left unchecked could be a significant problem. And the he expressed some views on housing, borrowers and mortgages…“athird of Australian households own their home outright, another third rent and the other third have a mortgage. Of the borrowers, most loans were taken out some time ago and the average mortgagee is over two years ahead in their repayments.” And, “Australian households, by and large, continue to service mortgages when interest rates go up. The central point that I want to make is that you can’t allow the marginal mortgage borrower to determine the central bank’s ability to raise rates. The central bank can’t be held hostage by the most recent marginal borrower.” Insert round of applause emoji several times here!
- The chart below shows the ABS’ house price index back 20 years along with a trend line. Optically it’s pretty obvious that house prices have overshot thanks to extraordinarily accommodative monetary condition over the past two years. A period of adjustment is necessary and healthy. From this chart, periods where house prices have dipped below trend have occurred around times of systemic upheaval, 2008 – 2009 (financial crisis), 2011 – 2014 (Greece), and then now. The big question is how abrupt the return to trend will be.
- ABS Australian House Price Index…
Source: Bloomberg, Mutual Limited
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Scott Rundell, Chief Investment Officer
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Mutual Limited Daily Update
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%