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U.S. raises rate, bond holdings to fall this year

15 June 2017

The U.S. Fed’s Open Market Committee (FOMC) was expected to raise the federal funds rate range at its June meeting. It was also anticipated to have something to say about its holdings of Treasury bonds and asset-backed securities. It delivered on both items.

The U. S Fed announced it has raised its target range for the federal funds rate to 1.00%-1.25%. It would also begin to reduce re-investment of proceeds of matured bonds this year. “The Committee currently expects to begin implementing a balance sheet normalization program (sic) this year, provided that the economy evolves broadly as anticipated.”

While the exact timing has been left unstated, the amounts have been disclosed as starting at USD$6 billion (AUD$7.9 billion) Treasury bonds per month and USD$4 billion (AUD$5.3 billion) mortgage securities per month. Every 3 months the amounts will increase until they hit USD$30 billion and USD$20 billion respectively. To put his into perspective, the U.S Fed’s last quantitative easing programme, referred to as “QE3”, bought an additional USD$45 billion mortgage securities per month. Westpac estimate the run-down in holdings will take place over at least four years.

Unemployment surprises, drops to 5.5%

15 June 2017

The growth in employment numbers forecast by various leading indicators seems to have finally appeared. Australia’s unemployment rate dropped in May and it was not because of a drop in the number of people counted in the labour force. The ABS released employment estimates which indicated Australia’s unemployment rate fell from 5.7% to 5.5% while the participation rate rose from 64.8% to 64.9%. The total number of people employed in Australia in either full-time or part-time work rose by 42,000 during the month, in contrast with the market’s expectation of +10,000. Total hours worked in May were 1.9% higher than April and 2.3% higher than a year ago.

For some years there have been concerns regarding the effect of the sampling process on labour force figures and these concerns are still present. According to NAB economist Tapas Strickland, “82% of [the] employment gains came from changes to the sample…” and he wonders whether there may be some reversal in next month’s figures. “[T]his could represent genuine improvement, but it also suggests some statistical payback is likely next month.”

Westpac economist Justin Smirk described the figures as a “solid” and he was impressed by some aspects of the report. “Further signs of the overall strength of this report was the 1.9% (over May) jump in hours worked taking the annual pace to 2.3% per year. This lift in hours worked was driven by a lift in both total employment and hours worked per person, 2.0% and 1.6% respectively.

However, he was surprised by the drop in the unemployment rate. “We had been looking for the unemployment rate to fall over the next few months but had not expected it to get to 5.5% so soon.” A glass half full approach would be to welcome the employment growth which produced such a result. A glass half empty approach would be to doubt the result. UBS economist George Tharenou was definitely in favour of the former approach. “Overall, employment remains very strong and clearly improved in recent months, with 2% year on year growth the best in over 2 years and now more consistent with the positive leading indicators. The unemployment rate has also surprisingly dropped to a cycle low of 5.5%. This supports the RBA’s positive outlook…and keeps rates on hold.”

Petrol prices drive U.S. CPI lower

15 June 2017

Petrol prices drive U.S. CPI lowerA 6.4% fall in petrol prices had driven the overall U.S. consumer inflation lower in May. Consumer price index (CPI) figures released by the Bureau of Labor Statistics indicated prices fell by 0.1% for the month, missing market expectations of a flat (0%) result. On a 12-month basis the CPI growth rate dropped back to 1.9% from April’s comparable figure of 2.2%.

Core prices, a measure of prices which strips out food and energy price changes, rose by 0.1% for a second month in a row. Annualised core inflation dropped again for a third month in a row to 1.7% (seasonally adjusted) from April’s 1.9%. The figures were under market expectations of a 0.2% rise; prices fell in the clothing and new/used vehicles segments and certain non-food and non-energy commodity prices fell.

Petrol prices drive U.S. CPI lower

The CPI numbers were released on a busy day for economic reports and announcements. U.S. May retail sales data were released and the U.S. FOMC announced its new higher target range for the federal funds. On the day, U.S 2 year yields fell 4bps to 1.33%, U.S 10 year yields fell 8bps to 2.12% while the U.S. dollar was steady against the euro and sterling but weaker against the yen.

Queensland Government cuts back on bonds

14 June 2017

The Queensland Government has released it 2017-18 budget and as a result Queensland Treasury Corporation (QTC) estimates it will borrow $6.8 billion in 2017-2018 which is about $2.7 billion less than forecast in QTC’s mid-year statement. QTC’s gross issuance was around $10.8 billion in 2016-2017.

Most of the borrowing will be done to finance existing debt worth $9.4 billion which will mature during the year. $600 million is expected to be needed for “other entities” such as universities, schools and water utilities. $3.2 billion has already been borrowed, either in 2016-2017 or earlier years which leaves a net $6.8 billion.

QTC’s benchmark series will form the bulk of the bonds which will be issued but QTC also flagged the potential for green bonds, bond with maturities as long as 30 years and other types of debt securities.

Households more pessimistic: Westpac-M.I. survey

14 June 2017

Conditions may be good in the business sector but there does not seem to be evidence of Australian households feeling the same way. The Westpac-Melbourne Institute consumer sentiment index fell for a third month in a row in May to record a drop from 98.0 to 96.2. Any reading below 100 indicates the number of consumers who are pessimistic is more than the number of consumers who are optimistic. Westpac senior economist Andrew Hanlon said, “The index is now back in firmly pessimistic territory with the June reading the weakest since the RBA’s 2016 rate cuts. Although confidence is not overly weak it has shown a clear downtrend since mid-2016.”Australian Households more pessimistic: Westpac-M.I. survey

Confidence around the wider economy fell sharply in early June and survey respondents were slightly more pessimistic about keeping their jobs. However, they also expect their own finances to improve in the next 12 months. AMP Capital’s Shane Oliver put the results down to multiple factors. “The combination of poor wages growth, high levels of underemployment, bank rate hikes, higher electricity prices, talk of an increase in the Medicare levy et cetera, are likely all depressing consumer confidence.”

103 quarters without recession

13 June 2017

Australia has matched the Netherlands’ record of the most quarters without a recession. While Australia has had the odd quarter of negative GDP since 1991, it has not suffered two such consecutive quarters which is what would be required to fit the widely-acknowledged definition of a recession.

The latest figures released by the ABS indicated first quarter GDP grew by 0.3%, taking the year-on-year figure down to 1.7%. This was in line with the median forecasts and well above some of the more pessimistic forecasts made by some respected economists.


The quarterly figures were driven by business restocking, government and household expenditure while net exports and government investment held the total growth figure back. Private investment was essentially flat.

ANZ senior economist Felicity Emmett said the figures were not exactly encouraging. “Annual growth at an eight year low, with little prospect of any improvement in Q2, suggests that the economy is not running strongly enough to eat into spare capacity. This will clearly have implications for the trajectory of the unemployment rate and hence the outlook for wages.”

However, there were some positives in the figures (aside from the obvious one of avoiding going backwards). Consumer spending was not as weak as retail sales data had suggested and, to some degree, Cyclone Debbie held back export volumes. It also appears if the investment contraction is nearing an end.

Markets seemed to have seen the best in the figures as currency markets immediately sent the AUD around 0.5 US cents higher to 75.50 US cents and bond yields rose. 3 year bond yields finished 5bps higher at 1.73% and 10 year yields were 2bps higher at 2.41%. Yields in U.S. bond markets had dropped moderately overnight so movements in Australian markets may have been somewhat subdued as a result.

Business confidence dips but conditions still good

13 June 2017

The Australia business sector is apparently still doing well despite mediocre consumer confidence. According to NAB’s latest monthly business survey of 400 firms in late May, its Business Conditions Index fell 1 point to 12 from a revised reading of 13 in April, while its Business Confidence Index reversed April’s 6 point rise and came back to 7, 1 point above its long term average.

The capacity utilisation rate, generally accepted as an indicator of future investment expenditure, increased from 81.4 to 82.4 and according to NAB, “utilisation rates are currently above long-run averages for most industries, which is encouraging for the investment…Only transport and mining sit below their long-run averages.” However, the fall in the Business Confidence Index suggests there are some concerns present.

Business confidence dips but conditions still good

Trading conditions held steady at elevated levels but profitability and employment conditions slipped back, albeit from elevated levels. Alan Oster, NAB’s chief economist said, “All three components of business conditions are looking quite solid, while the strength has also been relatively broad-based across industries, suggesting the recovery in conditions has become well entrenched.”


More income ETFs debut on ASX

09 June 2017

The continued growth in the popularity of ETFs as a low cost investment amongst investors has seen a flurry of listing activity in recent weeks, particularly in the income space.

This week saw three more funds listed on the ASX with the listing of the BetaShares Australian Bank Senior Floating Rate Bond ETF (ASX: QPON), and Blackrock’s iShares Core Cash ETF (ASX: BILL) and iShares Enhanced Cash ETF (ASX: ISEC).

BetaShares’ Australian Bank Senior Floating Rate Bond ETF is the first ETF in Australia to offer exposure to a diversified portfolio of floating rate bonds issued by banks. The fund aims to provide income paid monthly. QPON invests at least 80% of its assets in floating rate bonds issued by the big four Australian banks and up to 20% in bonds issued by the six ‘regional’ banks, including Macquarie Bank. The fund will hold a maximum of 14 securities from up to 10 issuers.

Commenting on the launch of the fund, BetaShares Managing Director, Alex Vynokur, said: “In the current environment of historically low interest rates, we believe the case for investing in floating rate bonds is very compelling. In the US, the Federal Reserve has raised interest rates twice in the past six months in the effort to return monetary policy to a more normal footing. In Australia, the last increase in the cash rate by the Reserve Bank was in November 2010, while the current cash rate is at historic lows.”

The fund’s investment objective is to provide an investment return that aims to track the performance of the Solactive Australian Bank Senior Floating Rate Bond Index, before taking into account fees and expenses. The fund will have an ongoing management cost of 0.22% p.a. and distributions will be made monthly.

Meanwhile, BlackRock has launched two income focused ETFs which will be benchmarked to the S&P/ASX Bank Bill Index.

The iShares Core Cash ETF will invest in cash deposits and negotiable certificates of deposit (NCDs), with the majority with the four major Australian banks. The fund can also invest in treasury notes and commercial paper issued by the Australian Government and other semi-government entities.

The iShares Enhanced Cash ETF will have a slightly riskier investment profile. It can invest in cash deposits and NCDs, with the majority being with the four major Australian banks. The fund can also invest in treasury notes and commercial paper issued by the Australian Government and other semi-government entities, corporate issued commercial paper and corporate issued fixed or floating rate notes. The fund can invest up to a maximum of 20% in FRNs and limits are placed on any individual security exposure, credit rating exposure and maturity (maximum FRN maturity of 5 years).

Both iShares funds will not invest in any deposits that have issuer-imposed repayment restrictions (e.g. term deposits). The ongoing management cost of the iShares Core Cash ETF is 0.07% p.a., while the cost of the iShares Enhanced Cash ETF is 0.12% p.a. For both funds distributions will be made monthly.

The index for both iShares funds consists of synthetic “securities” that cannot be purchased and sold. The constituents of the index are a series of 13 hypothetical weekly bills, ranging from one week to 91 days in maturity that are interpolated using the 24 hour cash rate and the 30 day, 60 day and 90 day bank bill swap rates (BBSW). Given the synthetic nature of the index, a full replication (or optimisation) passive investment strategy is not possible. Instead, BlackRock will construct a portfolio with consideration to the liquidity, average maturity, credit and interest rate characteristics of the index.

You can find a full list of ASX listed cash and fixed interest ETFs here.

SAFA completes 2017 funding

07 June 2017

South Australia has left it late in the year to complete its 2016/2017 funding programme but now it is out of the way. SAFA sold $750 million September 2027s via a syndicated placement for the second transaction for this line. Total final bids were around $1.15 billion.

The bonds were issued at ACGB + 58bps which is the equivalent of 61.5bps over the 10 year futures contract. When these bonds were first issued in early March, they were issued at ACGB + 54.25bps but this time it cost ACGB + 58bps or 51bps over the 10 year futures contract.

63% of the purchasers were domestic, slightly more than was the case in the March transaction. This time central banks doubled their purchases from 9% to 18% and bank trading desks and hedge funds greatly increased their allocations.

This transaction has completed SAFA’s $3.75 billion of term funding for the 2016/2017 financial year. $250 million of the $750 million raised represents pre-funding for 2017/2018. South Australia’s budget will be released on 22 June 2017 and SAFA said it will provide its 2017/2018 funding requirements shortly afterwards.

SAFA funding

Nothing to see here, move along: RBA

06 June 2017

The June RBA meeting is not one of the four months of the year in which most rate changes have been historically made and for that reason alone no one expected anything to happen. Aside from this historical observation, the RBA has made it quite clear is concerned by the build-up of household debt. Even if it thought the economy was weak and need of monetary stimulus, interest rates are historically very low and a cut would be unlikely to aid business or household sectors much at all.

One of the main points to come from the statement which followed the meeting was the RBA Board still viewed housing market conditions as a concern. Another was the weakness in the first quarter is likely to prove temporary. Both of these issues is a tick for a higher interest rate. On the other hand, some economists think economic conditions may weaken in 2018 as consumer spending growth is constrained by low wage growth, which is a tick for lower interest rates.

nothing to see here

Here’s what a few economists had to say.

Matthew Hassan, Westpac

“The structure of the statement is also worth noting. The most important concluding paragraph is completely unchanged, stating policy was unchanged and giving no forward guidance. The penultimate paragraph discusses housing market conditions, a key area of concern for the Bank according to its most recent minutes and the focus of its latest macro-prudential policy measures.

All up, we see no reason to change our current view that the official cash rate will remain on hold throughout 2017 and 2018.”

David Plank, ANZ  thought the RBA may be wrong when it comes to first quarter weakness proving to be temporary. “We think there are good reasons to believe that the pace of economic growth may have stepped down in a sustained fashion.” If weakness in the first quarter continues he thinks core inflation will be unlikely to rise. “In which case, the Bank’s policy settings may be challenged.” In other words, there may be an incentive for the official rate to be lowered.  Not yet, however. “On balance, we continue to see the RBA on hold for the foreseeable future. We do, however, think the Bank is underplaying the likely weakness in economic activity in the first half of 2017.”

Daniel Blake, Morgan Stanley

“We have the benefit of incorporating the most recent data and policy developments, with the next round of RBA forecasts not published until August 4th. But even still, we question whether policymakers are too optimistic on the quality of employment growth and the leverage that Australia has to improved global growth, while not factoring the risk that reported business conditions to soften alongside already weakening revenue/earnings trends…As a result, we hold our forecast for the RBA to leave the cash rate at 1.5% into 2019, although the risk of another round of cuts has increased and we would expect the Bank to respond quickly to any emerging recessionary labour market dynamics.”

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