Mutual Daily Mutterings
Quote of the day…
“I called a detox center – just to see how much it would cost: $13,000 for three weeks! My friends, if you can come up with thirteen grand, you don’t have a problem yet.” – Sam Kinison
“Steeper we go, where we stop…someone must know…”
- Overview – before I kick off, a bit of fatherly boasting. My sons played in a Tri-State Water Polo Tournament in Geelong over the weekend. My youngest, in the under 12’s went through undefeated and won the grand final comfortably. My middle son’s team, the under 14’s, went through to the GF, but were squarely beaten by a team of country boys, very big-lads, must be the country air. Either way, a gold and a silver, so a good weekend. On to the markets, bond yields were up again on Friday and the week with the ‘rising bond yield = bad juju’ narrative continuing to gain support (see ‘Steak Knives’ section below for further musings). Nevertheless, a very modest risk on session to close the week, but it was hardly convincing. Oil slipped below $60/bbl as Texas started producing again, while gold rose for the first time in a week. On the vaccine front (the COVID one of course), some good field data out of Israel, who are well progressed in vaccinating their population. The Pfizer vaccine shot “appears to stop the vast majority of recipients becoming infected with COVID”
- Offshore Stocks – a better end to the week for stocks with most marginally up on the day, the S&P 500 being the exception, slipping marginally into the red. On the week however there were more down days than up days as sentiment took a modest roughing up from steepening yield curves. Most notably in bonds has been the sharp move in real yields, signalling the belief the sleeping inflation is readying to awaken (more below). As to the level where bond yields become a drag on the economy, some research by Citi’s equity gurus has nailed their opinion to the mast at 1.7% for the ten-year, so around 36 bps away. Europe closed up on the day, marginally, while across the week it was a little mixed – still not a lot in it. No meaningful change to recent trajectory or themes.
- Local Stocks – the ASX 200 took it in the neck with a rusty fish fork on Friday as US SPX futures slid almost a percent. Over 80% of stocks were down on the day with Energy (-3.6%), Materials (-2.4%), Healthcare (-2.6%), Discretionary (-1.3%) and Financials (-1.0%) all looking bloodied and bruised. Only Tech put up a fight +0.2%, barely, and gave a lot of its early gains back as the day dragged on. On the week it was a modest loss, with just Materials (+1.8%) and Financials (+0.5%) able to keep their noses above water. Dragging their feet were the low beta sectors, with Utilities (-4.1%), Staples (-3.2%) and REITS (-3.0%) all having weeks to forget. Despite the mildly soggy tone, the ASX 200 is less than 2% off its post pandemic highs, and realistically needed to cool its jets a bit, i.e. let the fundamentals catch up and support the very optimistic valuation narrative. Futures are pointing to a modestly weak open, in contrast to modestly firmer starts expected for regional peer indices.
- Offshore Credit – A quiet end to the week with primary missing estimates – no doubt rising yields is causing some potential issuers to pause. In aggregate, the need for debt should be modest given the scale of issuance last year. In secondary, spreads were tighter again in US IG on the week, while in Europe, where issuance activity was a little more-frisky, spreads inched a touch wider.,
- Local Credit – again, local credit markets largely shrugging their shoulders at the rising bond yield narrative, at least no obvious spread moves. Traders are reporting little change to flows, with investors sitting on the sidelines in the fixed space, which is understandable. At some stage higher yields, combined with subdued issuance might entice some buying in secondary, assuming there is a pause in the yield momentum. Major bank senior curves steepened a smidge with the 1-year and 2-year part of the curve tightening a basis point on the week, to +8 bps and +12 bps respectively. In the major bank tier 2 space the tightening was relentless, -4 – 6 bps tighter again on Friday, with spreads -11 – 17 bps tighter on the week. The most recent major bank tier 2 deal, the Westpac Jan-26 calls are in to +125 bps (-15 bps on the week), and the longest line, the NAB Nov-26 calls are at +129 bps (-11 bps on the week). Traders reported on Friday “we have finally found the point of some profit taking! In late trading we saw some profit taking from two domestic real money accounts. Only relatively small amounts”, which allowed them to re-stock the larder somewhat. Didn’t take long for these lines to be lifted, so tone and momentum remains positive, but we may also see some profit taking given how aggressive the tightening as been. I still think we have room to tighten further, but I wouldn’t be chasing it.
- Bonds & Rates – after a day of pause and reflection, ACGB’s steepened again with the 10’s back at 1.40%, meanwhile UST 10’s rose +4 bps to 1.34%, up +37 bps YTD on the combination of vaccinations, stimulus and rising inflation expectations. Real yields have also risen, from -1.1% to -0.9%…still negative, but optically the move higher is sharp relative to recent trading ranges. Whether the rise in yields will in fact be problematic remains a topic of debate amongst wiser and more education propeller heads than me. Regardless, markets are beginning to price it as if it was an issue, albeit early days. It’d be a braver person than I that would go long bonds here, the steepening has momentum behind it, so too soon to try and catch that knife from the long side. If I were to position here and now, I’d tolerate the splinters in my bum and hug the neutral zone. Having said that, I’m increasingly seeing street strategy comments that bonds are around the “fair value” zone. The next thing to worry about is policy error – jumping too soon. Also, markets have proven a particular dislike to tapering or policy tightening in recent years, suggesting that all and sundry are hooked on the good stuff, an abundance of central bank liquidity and monetary policy support. The last time the Fed took the cookie jar away, in 2018 (second half) markets had a bit of a conniption, with a reasonably sharp 20% sell off in equities (S&P 500) and a couple of sharpish +40 bps increases across US treasury yields (10-year). Credit spreads also punched wider. On the matter of policy ‘error’, the jury is increasingly split. New York Fed president John Williams has stated that higher yields were a positive, whereas former Treasury Secretary Larry Summers feels the large, poorly targeted stimulus package has created risk of the Fed tightening this year.
- Macro – the week ahead, and for the sake of Monday morning efficiency, I’ve pilfered borrowed some commentary from NAB here…”in Australia the key data point is the Wage Price Index on Wednesday. GDP partial releases include construction on Wednesday and capex on Thursday. There are several Fed speakers (including Chair Powell’s semi-annual testimony to congress) on Tuesday and Wednesday. Various Fed branches release their manufacturing surveys. ECB President Lagarde gives a speech today. The US Treasury auctions 2Y, 5Y and then 7Y notes on Tuesday, Wednesday and Thursday respectively”.
Steak Knives – steeper yield curves, when does it become a problem….
- Global markets have caught the jitters over the past week or so as bond yields / curves continue to set post pandemic highs / steepness. The growing narrative being that rising bond yields equates to higher borrowing costs, which will potentially derail the recovery. There is precedence here, market reaction wise, where rising bond yields, or expectations thereof, have caused a meaningful risk-off move. Case in point is 2018, which I touched on above. However, the starting point then vis a vis yield level and volume of debt outstanding is substantially different to what we’re facing this time around, as is the broader macro backdrop.
- Debt issuance over the past year has been stratospheric, with US IG debt issuance through 2020 up +50% (to US$1.9 trn) on the prior fiver year average, while in the HY space, issuance was up +68% on the same basis. Not to mention the volume of treasuries issued, +US$4.4 trn, or +19% since March 2020. Cost of corporate borrowing through 2020, rough and dirty, remains almost 40% cheaper than the prior five years, while the cost of government debt has averaged 0.8% (10-year 12-month average yield). Around 90% of US corporate bond issuance, which accounts for ~80% of US corporate debt funding is fixed rate, with an average duration around 10 years. So, the cost of that debt is locked in, for an extended period of time. Much of this debt was raised to buttress balance sheet strength and provide liquidity through the pandemic. And, basically because it was damn cheap. Proxy time, cash per share within the S&P 500 is up 10% vs pre-pandemic averages. At the household level, the majority or mortgages too are fixed, more often than not, out to 30 years. Accordingly rising bond yields will likely slow credit growth, but the income impact or higher yields should be modest.
- In Australia, we’re flipped, the majority of funding, both business and household wise is off floating rate, particularly at the front of the curve. In this regard 3-year yields are trapped around 0.10%, and bank bills are borderline positive at all. The swap curve has steepened, with 3-year swap at 0.21% and 5-year swap at +0.65%, up +20 – 30 bps in the past month or so, but still very accommodative.
- The above all relates to the US market, which is where much of the steepening pressure is coming from – fuelled largely by the abundance of fiscal stimulus expected to come down the pipeline. Higher borrower costs, relative to recent ranges will inevitably slow credit growth. Much of the credit growth we’ve seen has not been deployed into growth initiatives, rather as I alluded to above, it’s been to shore up liquidity and in some instances, just term out existing debt at lower rates (US).
- Just food for thought. Markets are probably right, but are they too far ahead of the curve? Remains to be seen.
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Scott Rundell, Chief Investment Officer
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