Mutual Daily Mutterings
Quote of the day…
“The more I live, the more convinced am I that this planet is used by other planets as a lunative asylum”.…George Bernard Shaw
Chart du jour: US vs AU 10 Year Yields..
“The Drought Is Gawn…”
Overview…”here we go again…”
- Risk off. Stocks were belted from pillar to post last night with no index spared the rod, while bond yields continued to trend higher as US debt ceiling concerns build. Oil came off the boil after being on a tear for a week, down -1.2% on the day, but still up 5.7% on the week. Even credit for once came under some pressure, with offshore spreads moving out of neutral, into first gear (wider). Surging energy prices in Europe and China reporting power outages has also impacted sentiment.
- The US government debt ceiling be thy new catalyst…well, not quite new, more a recycled catalyst. We’ve been here before, many times in the past with varying degrees of market volatility…100 times since WWII to be exact. Sentiment fragility given the various prevailing uncertainties, combined with frothy valuations, means that markets are taking more note this time around.
- US Treasury Secretary Yellen warned that her department will effectively run out of cash around October 18 unless legislative action is taken to suspend or increase the debt limit. For those not familiar, the debt ceiling sets the limit on the amount that the US treasury can borrow to pay government commitments already approved by Congress, including government benefits and employee salaries.
- Once the ceiling is reached, US lawmakers must either increase the limit or suspend it – which is what Trump did in 2018. That suspension expired August 1st this year. Once a routine affair, adjusting the debt limit is now often used as a political tool by Republicans to extract concessions on Federal spending. The stand-off which has brought the US to the brink of default in the past has always been resolved.
- Talking heads…“we would expect a deal to get done, but it appears as though both sides are a bit more entrenched compared to previous periods….a government shutdown is a risk factor that we’ll be watching in the coming days and weeks.” And this…”the downside risk is so great that conventional wisdom suggests that Congress will not impose this self-inflicted wound on the US economy, especially in the middle of a pandemic.
- Offshore Stocks – starting with talking heads…”it feels like the movie we’ve all seen before and it is getting pretty old…this is something we see every two years and people are catching on that this is showmanship and political posturing”…be that as it may, the uncertainty presented by the debt ceiling impasse, at a time when sentiment was already fragile, has put a shot across the bow of markets with a meaningful overnight route. Around nine out of every ten stocks retreated and only one sector was able to advance, Energy (+0.5%), despite oil prices dropping on the day. Tech S&P 500 is back near its 100-day moving average and RSI’s are at 38. The worst of the worst sectors was headed up by Tech (-3.0%), followed by Telcos (-2.8%) and Discretionary (-2.0%). Month to date the S&P 500 is down -3.8%, and is on track to be the worst month of the year, by a long way, and only the second negative month – January (-1.1%) being the other.
- Local stocks – the ASX 200 stumbled again yesterday with a broad sell-off. Just under 80% of stocks in the index retreated, as did nine of the main sectors. Only Energy (+4.3%) put up any real fight, with a best supporting nod from Utilities (+0.7%). Beyond these two it was a sea of crimson as far as the eye could see. Healthcare (-3.6%), Tech (-2.9%) and REITS (-2.4%) took the podium for line honours here, and as is often the case, Materials (-2.3%) did a lot of the damage. The ASX 200 remains below its 100-day moving average and continuing to look directionless. Futures are pointing to another tough day in the trenches, down -1.1% at the moment. Month to date the index is down -3.4%, the first negative month since this time last year (-4.0%).
- Offshore Credit – eight borrowers priced over US$10bn of fresh supply overnight despite the weaker market tone, taking the two-day total to US$17.55bn. Syndicate desks had called for as much as $20 billion for the week. In secondary, the weaker tone from stocks filtered through with spreads drifting a basis point or two wider across US and EU markets. EU primary was also active with a handful of deals printing €6.8bn with modestly constructive deal metrics – book cover at 1.9x and spread compression of -13 bps from launch to final pricing…a bit behind YTD and prior year averages.
- Local Credit – a little bit more action yesterday…traders…”secondary credit markets marginalised by the ongoing sell off in rates and primary issuance from Woolworths. This is an awkward time of year as we approach FYE and we anticipate a frustrating few days ahead and we endeavour to keep the book lean and clean”…the last bit no doubt reflected across three of the majors. Interesting with the Woolworths deal, last I saw the book was just shy of $3bn for a $700m print. Just shows, there is still demand for credit out there. In the financials space, “we close the curve a basis point wider and for reference we have incorporated our indicative curve as it stood prior to APRA’s CLF announcement (chart below). As you can see the widening and steepening has been felt most from the 3yr point. We expect this to persist, though accept that the capacity of the majors to issue offshore with likely temper this trend”.
(Source: ANZ, Mutual Limited)
- Bonds & Rates – another day of meaningful increases in bond yields with the ACGB 10-year bonds at 1.53%, which is where consensus had pegged their expectations for year end. Offshore we saw US treasury yields continue to rise, 10’s + 6 bps to 1.55%, despite the risk off tone. Not surprising when the source of that risk off tone was the prospect of the US government defaulting on its debt. Whether it’s a real risk remains to be seen, but we’ve been here many times before and a deal has always been done in the end. Having said that, the US government has had to shut down in the past because the debt limit has been reached – ever since a 1980 interpretation of the 1884 Antideficiency Act, a “lapse of appropriation” due to a political impasse on proposed appropriation bills requires that the US federal government curtail agency activities and services, close down non-essential operations, furlough non-essential workers, and only retain essential employees in departments covering the safety of human life or protection of property (Wikipedia, sorry). As far as I can tell, since 1980, the US government has had to shut down for as short as one day and for as long as 35 days (2018-19). While the debt ceiling debate ‘rages’, upward pressure on yields will persist.
- Local Macro – retail sales out yesterday, paraphrasing some NAB commentary here….”retail sales fell -1.7% MoM in August against -2.5% MoM expected. The decline was alongside clear lockdown impacts. NSW retail sales fell a further -3.5% MoM to be -13.9% below pre-lockdown May 2021 levels. Victoria, which re-joined NSW in lockdown on 5 August, fell -3.0% MoM from levels already weighed by earlier lockdowns. QLD fell -0.9% MoM, weighed by a snap lockdown mid-month. Retail sales in the ACT plummeted -19.9% MoM after their lockdown from August 12 heavily restricted retail sales. Elsewhere, sales remained robust. Western Australia, which has not been impacted by lockdowns to the same extent as the rest of Australia suggests households are still spending strongly. Retail sales rose a further +2.8% MoM to be +21.2% above pre-pandemic levels”.
- Offshore Macro – US consumer confidence dropped in September for a third straight month, suggesting concerns over the Delta variant and higher prices continue to be a downer on sentiment. Nevertheless, home prices surged +19.7% in July – once again posting the biggest jump in more than 30 years. While rising house prices of this scale in Australia don’t concern me (in a crash potential sense), they do in the US given the vastly different dynamics of the US housing market vs our own.
- Going off on a tangent here, but when at CBA I would travel annually to the US, UK, Europe and Asia spruiking the Australian economy, credit markets and issuers. Without fail, the first 20 minutes to half an hour of each meeting in the US would be taken up discussing Australian house prices. Why? Everyone is familiar with the ‘widow maker’ trade, where US hedge funds come to Australia spruiking a local housing bubble and shorting the banks. Inevitably they go home with their tails between their legs, chastised by the local market. Why do supposedly smart people keep making the same mistake? Somewhat arrogantly (or is it ignorance?) they view the Australian housing market through the prism of US housing market dynamics. The main differences between the two markets revolve around tax and lending recourse. In the US, interest on your prime residence is tax deductible and any profit on the sale of your house is taxable. Accordingly, there is an incentive to run high LVR’s, which reduces owner’s equity and buffers for dealing with valuation weakness. Obviously, we’re different. No tax deductibility and no tax on profits (primary residence), accordingly we’re incentivised to pay down our mortgages as quickly as possible. The other difference, recourse, is also starkly different. In the US a bank only has recourse to the house, not the borrower’s other assets. So, if a borrower’s equity in their house turns negative, there is an incentive just to hand the keys over to the bank and walk away – thus the term ‘jingle mail’. In Australia, we sign a personal guarantee in addition to the mortgage, which effectively gives banks the power to take your car, first born, and or kidney to recoup any lost capital.
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Scott Rundell, Chief Investment Officer
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