News

Consumer inflation continues to rise in the US, albeit at a slower pace than in January. Although the consumer price index (CPI) is not the US Fed’s preferred measure of inflation, rises and falls in the rate of CPI inflation add to the overall picture of the US economy’s price level.  February CPI figures released by the Bureau of Labor Statistics indicate consumer prices rose by just 0.1% for the month, well down on January’s comparable figure of 0.6% but above the consensus market forecast of 0%.

On a year-on-year basis, the CPI increased by 2.8%, well up on January’s comparable figure of 2.5%. Core prices, the measure of prices which strips out food and energy price changes, rose 0.2% for the month and in line with expectations. Over the last 12 months, core inflation has slipped down to 2.2% from January’s 2.3% (seasonally adjusted).

Australia’s unemployment rate rose in February as part-time jobs fell in greater numbers than a rise in full time employment. The Australian Bureau of Statistics has released February employment estimates which indicated Australia’s unemployment rate rose from 5.7% to 5.9%. The total number of people employed in Australia in either full-time or part-time work fell by 6,400 during the month, in contrast with the market’s expectation of +20,000. The participation rate remained steady at 64.6% but total hours worked fell by 1.2% over the month and they are 0.5% lower than the comparable number from February 2016.

Bond yields were already headed south after large falls overnight in US bond markets and the employment figures just added to the downward pressure on yields. 3 year bond yields fell 9bps to finish the day at 2.06% while 10 year yields fell 11bps to finish at 2.86% and the Aussie slipped back under 77 US cents.

It was hard to put a positive spin on the numbers although some economists thought the rise in full-time positions was encouraging. ANZ economist Felicity Emmett said the report was disappointing but the “detail was slightly more positive than the headline with full-time jobs rebounding after the previous month’s sharp fall. The weakness in the report is at odds with still solid business conditions and ongoing gains in ANZ job ads, and in our view some improvement is likely over coming months.”

Markets around the world were essentially on hold in the lead up to the Federal Open Markets Committee (FOMC) March meeting. A 25bps rise was expected to provide only the third such rise since 2009. It would also provide confirmation the rate-raising part of the cycle markets had well and truly begun.

The FOMC has since announced it has raised the target range for its official rate, known as the federal funds rate, from 0.50%-0.75% to 0.75%-1.00%. Until two weeks ago, markets had not placed much weight on a rate rise at the March meeting of the FOMC. However, a string of speeches and interviews by Fed Reserve officials, including chief Janet Yellen, quickly convinced markets such a rise was indeed likely.

Australian households are concerned about their finances as weak wages and salary growth lead to a juggling act between spending and saving or reducing household debt. The Westpac-Melbourne Institute consumer sentiment index barely rose in February, recording a 0.1 increase to 99.7. Any reading below 100 indicates the number of consumers who are pessimistic is more than the number of consumers who are optimistic.

Westpac chief economist Bill Evans was concerned by the results. He found a “disturbing lift in risk aversion amongst Australian households. Compounding this result is a sharp fall in how respondents assess their own finances. Our research highlights a direct link between these factors and consumer spending.” Consumption accounts for around two-thirds of GDP and is thus the largest component. Any change in consumption patterns tends to have noticeable effects on the overall economy. He also thinks the households will carry their worries into 2018. “This concern is unlikely to fade in 2018 appropriately constraining household spending and discouraging investment.”

In the olden days…

Back on 7 March Kiwibank announced it had priced $175 million 10 year bonds. It was to be Kiwibank first transaction in the Kangaroo market where issuers incorporated offshore issue bonds denominated in Australian dollars, since 2009.

The timing could have been a bit better. Only a week earlier, all three credit ratings agencies had downgraded Kiwibank’s debt to A/A1/AA-. Kiwibank’s major shareholder is New Zealand Post, which removed a guarantee on Kiwibank’s payment obligations at the end of February. That led to a credit downgrade which in turn would have added to the cost of any subsequent bond issue.

Everyone was aware of the downgrade and there was nothing untoward about it in connection with the intended bond issue. Kiwibank had gone through the usual series of investor presentations which are designed to gauge investor interest at the same time as informing investors of the securities’ investment merits. Then came the pricing stage, where a yield which is acceptable to both the seller and the buyers was decided. In this case, the yield to redemption was set at 4.575% or 162bps over Swap.

It is rare for a planned bond issue to get past the investor briefings and the pricing stage only for the issuer to pull the issue. However, this is exactly what Kiwibank has done. One week after the bond pricing announcement, Kiwibank announced it would not proceed with settlement. Apparently the RBNZ has notified Kiwibank its tier 2 convertible bonds and additional tier 1 perpetual bonds do not comply with certain requirements in the RBNZ’s capital adequacy framework and Kiwibank felt this enough reason to pull the issue. ”While the issues continue to be discussed, Kiwibank has decided not to proceed with the settlement of a proposed AUD175 million bond issue that was scheduled to settle on 15 March 2017.” Kiwibank said it was pretty much business as usual and the “RBNZ preliminary decision does not in any way impact the growth opportunities of the bank…” It makes one wonder why the bank is working “urgently” to resolve the issues.

Australian businesses are still quite happy with conditions they currently face, as well as with the immediate outlook, despite some slippage during February. According to NAB’s latest monthly business survey of 400 firms, its Business Conditions Index fell 7 points to 9 while its Business Confidence Index fell 3 points to 7. The latest figures are still at elevated levels, even after they have dropped back.

Bond and cash market yields were higher by the end of the day. 3 year and 10 year bond yields were both 1bp lower at 2.14% and 2.96% respectively as markets paid little attention, being focussed on the FOMC decision coming later in the week.

The US unemployment rate is well under 5% after six years of continuous employment growth. The latest figures for February continue this admirable performance and according to the US Bureau of Labor Statistics, 235,000 jobs were created in the non-farm sector in February against expectations of 200,000. After revisions to previous months’ figures, the unemployment rate fell from 4.8% to 4.7% as the participation rate rose 0.1% to 63.0%. The US has not had a negative employment growth figure since September 2010 or for 77 months.

ANZ Research said markets had already factored the risk of higher-than-expected numbers and US bond yields eased back, as did the US dollar. However, the main interest in the employment report was its status as the final hurdle which needed to be cleared for the US Fed to raise rates at its mid-March meeting. As ANZ put it, “To be fair, the US jobs report would have had to have been an absolute shocker to derail prospects for a Fed rate hike this week. It wasn’t, in fact it was pretty good across the board and so serves as the final green light for the Fed to lift rates once again.” Westpac agreed, saying “Overall, this is a strong report for the labour market which is consistent with previous tight jobless claims readings, the ADP report, and consumer and small business sentiment. It should remove any doubt the Fed will hike on 15 March, with the main question now being the pace of tightening thereafter.”

Challenger has announced the margin on its latest Challenger Capital Notes 2 (ASX code: CGFPB) offering and, as expected, it was at the bottom of the 4.40%-4.60% indicative range. When this margin is added to the current 3 month bank bill swap rate (BBSW) of 1.78%, investors can expect around 6.18% annualised, inclusive of franking credits, for the first quarter and thereafter if BBSW rates do not alter materially. BBSW is typically close to the RBA’s official cash rate which is currently 1.50%.

The chart below shows the trading margins of existing hybrids which are already listed on the ASX. In very simplified terms, a security’s trading margin is the sum of its annualised distributions as percentage of its price less BBSW. (In practice, unrealised annual capital gains/losses and accrued distributions are also taken into account.)

Challenger said it had allocated $430 million on a firm basis and an additional $20 million is expected to be allocated under its Securityholder offer, which closes on 31 March 2017. The new capital notes are expected to begin trading on the ASX on 10 April 2017 and the first distribution date will be on 22 August 2017.

For readers interested in the historical movements of 3 month BBSW, here is a chart which shows its relationship to the RBA cash rate.

When the RBA’s Governor Phillip Lowe appeared before the Standing Committee on Economics in late February, he made it clear the RBA was concerned by house prices and the amount of household debt which is primarily in the form of mortgage debt. “With household debt as a share of household income already at a record high, is it really in the national interest to get a little bit more employment growth in the short run at the expense of creating vulnerabilities which could become quite dangerous in the medium term?”

With this in mind it would have been hard for the RBA to turn around and cut the official rate at its March meeting after its chief made this statement. The RBA chief and his staff would be aware of the history of housing market busts; ten years ago the GFC came out of a collapse in the US housing market and Australia’s 1990/91 recession followed a price bubble in the housing market here. The RBA’s decision to hold the cash rate steady at 1.50% therefore should come as no surprise. It may have also convinced a few more economists who expect another rate cut to reassess their positions.

There was little in the way of change in the statement which accompanied the decision. Some economists pointed to the addition of the sentence “Most measures of business and consumer confidence are at or above average” and noted the RBA’s favourable mention of the global economy and higher prices for Australia’s commodity exports. However, by and large, these changes did not signify any real change in the statement’s tone or outlook.

Accordingly, reactions in bond and currency markets were subdued. The Aussie was fractionally higher by the end of the day at around 75.9 US cents, while the 3 year bond yield rose 2bps to 2.07% and the 10 year bond yield increased from 2.835% to 2.85%. Prices in the cash market barely moved for 2017 contracts and the 1.50% cash rate is still expected to last through 2017. However, the probability of a February 2018 rate rise increased from 32% to 46%.

Here’s what some economists thought about the decision:

Kristina Clifton, Commonwealth Bank

Today’s RBA commentary confirms our view that the cash rate will remain on hold in 2017. There is little in the way of wage and inflationary pressures and underlying inflation is expected to remain below target until end 2018. However over the past few months Governor Lowe has expressed some discomfort with the prospect of household debt rising further. He has also acknowledged that conditions are strong in the housing markets in Sydney and Melbourne. These factors mean the cash rate is unlikely to move any lower.

Bill Evans, Westpac

On the less encouraging side, he refers to the insipid growth in household incomes and linked to that effect the observation that employment growth has been concentrated in part time jobs. Those considerable headwinds for the economy have been known for some time but, recently, he has not chosen to highlight them….We do not expect that the Australian economy will be sufficiently robust in 2018 to justify a return to a tightening cycle and continue to forecast rates on hold in 2017 and 2018.

Annette Beacher, TD Securities

To shift the RBA into a more hawkish stance we need to see a noticeable improvement in full-time hours worked. The February employment report is released March 16, and we did spot signs of life in the January report.  We see the next move being up for the cash rate due to rising financial stability risks, strong national income growth, and inflation swiftly returning to the target band.

Ivan Colhoun, NAB

The bank is thus prioritising its concerns about household balance sheets at this point…It’s likely that the RBA will leave interest rates unchanged at least for the next six months. NAB’s forecasts for economic growth in 2018 are weaker than those of the RBA, largely because we expect a drag from lower commodity prices and a downturn in the housing construction cycle. This could see the RBA again considering a further cut to interest rates late this year.