News

Today’s release of the RBA’s Statement on Monetary Policy (SoMP) had very little effect on markets and, according to Westpac, it “did not alter market perceptions around RBA policy.” Most forecasts from May’s SoMP remained intact, with the exceptions of underlying inflation for the year to June 2017, which was increased by 0.5% to 1.5%-2.5% and GDP for the year to June 2018 was bumped up by 0.5% to 3.0%-4.0%.

June quarter inflation was pretty much as the RBA had expected and while a weakening currency is pushing the price of imports (“tradables”) higher, consumer inflation is not expected as low wages growth and competition in retail markets keep a lid on price increases. “The large exchange rate depreciation since early 2013 is likely to continue boosting the prices of tradable items as increases in import prices are gradually passed through to the prices paid by consumers. However, domestic factors, such as heightened competitive pressure in retail markets and low wage growth, have put downward pressure on retail inflation over recent years and are expected to persist for some time.”

The RBA seems to be sending more time on the underemployment issue, something it referred to in its interest rate announcement earlier in the week. “…to the extent that gains in employment continue to be mostly in part-time employment and among workers who would like more hours, there could be more spare capacity in the labour market than implied by the forecast for the unemployment rate.”

AMP Capital’s Shane Oliver described the tone of the statement as “dovish”; that is, the statement implies an inclination for the RBA to cut rates further. He also noted the RBA’s expectation of inflation remaining below 2%, their view of growth rates below limits, a diminished housing bubble risk and mixed employment indicators which “implies [the] RBA retains an easing bias”.  ANZ and Westpac shared his sentiments. ANZ Research said, “We view this, in combination with the RBA worrying about more risks to the outlook, as a strong easing bias.” Westpac’s  chief economist Bill Evans said, “Our current forecast is that having responded to the ‘inflation scare’ in May with two rate cuts, the Bank will be inclined to now seek a period of stability on the policy front. However the sentiment in this statement indicates that the Bank is more open to further near term stimulus than we thought would have been the case.”

The Bank of England has cut its official interest rate by 25bps to 0.25%, a historic 322 year low. Markets had already priced in the reduction as well as an increase in the asset purchase programme but what was actually delivered by BoE chief Mark Carney was well in excess of expectations. What’s more, the statement accompanying the decision indicated “a majority of members expect to support a further cut in Bank Rate to its effective lower bound at one of the MPC’s forthcoming meetings during the course of the year.  The MPC currently judges this bound to be close to, but a little above, zero.”

Markets had expected the Bank to purchase another £50+ billion ($80 billion) of UK government bonds but instead the UK central bank announced a £60 billion programme which will take the total stock of gilts owned by the BoE to £435bn, corporate bond purchases worth £10 billion over 18 months and a “term funding scheme” (TFS) which will provide finance to banks and buildings societies at close to the Bank Rate (ed: akin to our official cash rate). In response, UK 2 year bond yields fell 8bps to 0.12%, the yield on 10 year bonds fell 16bps to 0.64% and the pound fell against other major currencies.

NAB’s David de Garis said the combination of the rate cut, the bond purchase programme and the TFS were tantamount to using almost everything at the BoE’s disposal. “While the moves were not totally unexpected, the concerted dual move from the BoE – as close as we could have expected to an “all guns blazing” approach or in the words of BoE Chief Economist Andy Haldane, a “muscular” approach.”

The BoE’s rationale behind the introduction of the TFS is to provide finance at close to the Bank Rate to institutions which are likely to be reluctant to reduce deposit rates further as official rates push towards zero. The TFS will provide financing to these institutions as an alternative to deposit financing and thus allow banks to reduce lending rates without cutting margins. “This monetary policy action should help reinforce the transmission of the reduction in Bank Rate to the real economy to ensure that households and firms benefit from the MPC’s actions.” As well as the carrot of cheap financing, there is a stick. Fees for using the TFS will rise if an institution’s net lending falls so the message from the BoE is to go forth and lend.

Seven Group announced their annual profit results and at the same time announced an on-market buy-back of up to 10% of the hybrid TELYS4 (ASX code: SVWPA) on issue. Richard Richards, Seven’s chief financial officer said the company would buy the preference shares if the price fell below a level it thought was reasonable. “Today we announce the extension of recent capital management initiatives with the buy-back of up to 10 per cent of the TELYS4 shares on issue, allowing value to be captured should its price fall below what we believe to be its intrinsic value.” Interestingly they didn’t say what that intrinsic value was so investors might well assume in the absence of any buying that the firm thinks the TELYS4 are overvalued.

TELYS3 (ASX code: SEVPC) were first issued in 2005 at $100 and the securities paid a fully franked floating rate dividend where the grossed up an amount equal to BBSW + 250bps. In 2010 when Seven Network and Kerry Stokes’ Westrac Holdings businesses were put together, holders of the TELYS3 were offered replacement securities in the form of TELYS4. The floating rate dividend was “stepped-up” by 225bps so holders would receive the equivalent to BBSW + 475bps.

The price of the securities has plunged in recent times, sending the gross running yield well above 15%. Being a perpetual security there is little to anchor the price to or near the securities’ $100 face value but Seven’s buy-back announcement has since triggered investor interest and the price has partially recovered. Even so, the yield is still substantially in double-digit territory. Another possible attraction is the potential for Seven to establish a quasi-floor price through their on-market purchases. Any on-market purchases will need to be reported to the ASX, giving investors some idea of the price Seven is prepared to pay.

Moody’s Investors Service has downgraded the credit rating of the Northern Territory Treasury Corporation, the financing authority of the Northern Territory Government. The ratings agency dropped the NTTC’s credit rating one notch from Aa2 from Aa1 and changed the outlook to stable from negative.

Moody’s said larger deficits are expected to add to the Northern Territory’s debt levels as revenue from taxation, grants and duties weaken and outgoings fall at a slower rate, held up mostly through healthcare and other social services costs. The NT’s Power and Water Corporation also gets a special mention for its financial “weakness”.

It’s not all bad news, however. Moody’s noted the level of Federal Government support for the territory, its “solid economic prospects related to large resource investments” and the NT Government’s acknowledgement of a need to rectify its budget in the medium term.

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On Tuesday 2 August the RBA cut official cash rate 25bps to 1.50%, the lowest cash rate in Australian history. However there was a predictable outcry from the tabloid press and talkback radio as Australian banks failed to pass on the full rate cut to their mortgage holders.

What the big four banks did do though was very interesting. As well as only cutting variable mortgage rates by between 10bps and 14bps they increased the rates paid to term deposit holders. CBA was first to move and raised 1, 2 and 3 year deposits by between 50 and 55bps. Westpac followed with increases over the same terms by between 45bps and 55bps. ANZ is said to be scheduling an increase of 60bps in its 31-day notice term deposits and NAB is thought to be increasing 8 month TDs by 85bps.

The move has been cynically seen as a way of offsetting the predictable disenchantment with the lower than 25bps reduction on mortgages. With continuing discussions around a Royal Commission into the banking sector, the banks need to manage perceptions around their behaviour. The optics of the decision to cut mortgage rates and increase term deposit rates certainly look good.  Savers, and retirees in particular, have borne the brunt of relentless cuts to interest rates. So giving something back to depositors has a good look to it but the reality of the banks’ munificence may be somewhat different. One analyst said yesterday CBA only has $9 billion of term deposits but $400 billion of housing loans. The result being that they will most likely increase their returns on equity from the changes.

The other side of the coin that doesn’t get much airtime is that banks are in a battle to maintain even greater liquidity levels via the Net Stable Funding Ratio. With new APRA rules set to be implemented by January 2018, banks will rely more and more on increasing their deposit bases. They can’t afford to lose depositors and the latest rate moves could be seen as a defensive move to stop the leakage of term deposits into other yielding products such as hybrid securities or housing. Notwithstanding the reasons for the moves, they are a welcome relief for deposit holders.

Morgans, the Brisbane-based wealth management form, is recommending investors buy ANZ CPS 2 (ASX code: ANZPA) as an alternative to a term deposit. Morgans’ fixed income analyst James Lawrence made the recommendation in a note to clients recently, saying the ANZ preference shares have yield to conversion of 5.39% and absolute expected return of 2.50%. ANZPAs will convert to $101.01 worth of ANZ ordinary shares in December 2016 subject to ANZ’s ordinary share price being not under $12.20 at the time. Alternatively, ANZ may elect to arrange the sale to a third party just prior to the exchange date for $100 plus accrued dividend.

While noting the ANZ preference shares were a higher risk than term deposits, he said the return was higher than four month deposit rates. “This return compares to similar duration term deposits with absolute returns of less than 1.50%.” Another attraction in his opinion is the likelihood of ANZ issuing a replacement security in December. “Additionally, holders of ANZPA may be offered the opportunity to reinvest the redemption proceeds in a new Tier 1 security ahead of the December 2016 Conversion Date. Our expectation would be that ANZ undertakes a new security issue and uses the proceeds to redeem ANZPA for $100.00 per security, a move we have seen from other financial issuers recently.” Trading margins of hybrid securities recently issued by the major banks are in the range of 4.50% to 4.90% above BBSW, which translates to a grossed-up dividend yield of 6.30% to 6.70%.

Australian financial markets has spent much of July waiting for two events; June quarter CPI figures in Australia and the July meeting of the FOMC. CPI figures came in as expected and now the FOMC meeting has been held and the federal funds rate has been kept steady, pretty much as most observers expected. Prior to the meeting, Federal funds futures implied no chance of a rate rise in July but a 19.5% chance of a September move. Post the meeting, not much changed.

Westpac’s Richard Franulovich summed up the local reaction when he said, “Today’s FOMC statement contained no great surprises.” However, he went on to say, “Overall the statement reads like a central bank that is inching closer to pulling the trigger on rates but it lacks the heavy “nudge, nudge, wink, wink” signals that were in their October 2015 statement that all but signalled a hike at the following 15 December meeting was coming.” Most economists focussed on parts of the statement such as “near-term risks to the economic outlook have diminished”, “the labor (sic) market strengthened” and “household spending has been growing strongly” but noted the committee’s acknowledgement of below-trend inflation.

NAB’s David de Garis reminded us of the Fed’s focus on data. “The Fed in the end will be data dependent; the statement noted that near-term risks to the economic outlook “have diminished” while also tweaking the statement to recognise the strong pick up in jobs in, strong household spending, but also that business investment has been soft.”

Both Westpac and ANZ noted puzzling reactions in the bond and foreign exchange markets; yields fell and the greenback fell against other currencies, typical of a “lower future interest rates” scenario, although another explanation is simply the “buy on rumour, sell on fact” behaviour of some traders. St George’s senior economist Janu Chan said yields had been dropping prior to the meeting because of weaker-than-expected data (durable goods and pending home sales) and this continued after temporarily halting when the Fed decision was published. US 2year yields finished down 3bps at 0.73% while US 10 year yields dropped 5bps at 1.52%.

One of the traps for hybrids investors can fall into with any high yielding security which is past its call date is to buy it at more than its face value, only to have the issuer call it. Earlier this year Evans & Partners highlighted this issue. Using Ramsay Healthcare “CARES” (ASX code: RHCPA) as an example, E & P pointed out the way to avoid potentially-disappointing returns is to wait until the price is below the sum of the face value and the accrued income and that way if the securities are called the investor will not take a loss on the capital side.

It has been a little under six months since E &P last mentioned this issue but recently they decided to revisit this topic and once again, using the Ramsay Healthcare “CARES” as an example, they warn of this type of pitfall. From the chart above, readers will see the gap between the price of the CARES and the sum of the face value and accrued income has blown out (the orange line represents face value ($100) plus income plus franking credits while the grey line does not include franking credits). Readers will also notice how this is not unusual and, if not mindful of one’s timing, it would be all too easy to invest at a time which puts the investor at risk. That’s not to say there is a reason to expect the CARES to be called any time soon, it is just a risk investors should know about and seek to minimise, perhaps more so now as the gap has widened in recent times.

The Japanese government of Shinzo Abe announced a new round of economic stimulus on Wednesday 27 July that would inject up to ¥28 trillion (AUD$354 billion) into the economy. The government has also urged the Bank of Japan to take action in a coordinated action to boost the so-called ‘Abenomics’ stimulus package that has been waning of late. While the markets had been expecting a new round of stimulus, the size of the package was clearly at the upper end of expectations.

The planned package will go to a party meeting parliament on 2 August and be voted on during a parliamentary session in September according to a government report.

Japanese bonds rallied strongly on the news with 2 year bonds dropping to -0.37% and 5 year bonds falling to -0.38%.

Many economists are expecting an August rate cut subject to this week’s June CPI figures being in line with market expectations. Westpac’s Bill Evans was representative of most of his peers when he said prior to the release of the June quarter CPI figures, “I think it is therefore reasonable to conclude that a 0.5% print for underlying inflation, although representing a sharp jump from March’s 0.2% print would be consistent with a follow up rate cut at the August meeting.”

The numbers have now been published and they were basically as expected and the lowest since 1998. The headline consumer inflation rate was 0.4% for the quarter and 1.0% for the year (1.1% expected). The biggest contributors to inflation were higher health, fuel and housing-related costs. The core measure of inflation, which strips out volatile components such as fuel, fruit and vegetables, rose 0.3% for the quarter and 1.6% for the year.

Cash market futures contracts reduced the probability of an August cut from 57% to 51%, suggesting markets are not as confident as economists of a rate cut at the next RBA meeting (on 2 August), but still view the chances of a cut as just as likely as not. Local bond yields moved a tad higher while the response in currency market was to bid up the price of the local currency to 75.60 US cents before it quickly settled back, indicating financial markets viewed the numbers as supportive of higher interest rates, at least initially.

*Average of trimmed mean, weighted median and ex-volatiles 2002 to present. CPI ex-volatiles pre-2002

Here’s what the economists thought:

Michael Blythe, Commonwealth Bank

“Inflation is low whichever way you cut the numbers. Headline inflation is running at the slowest pace since mid-1999.  Underlying inflation is running at a record low.  Inflation in the first half of 2016 ran at 1.25% (annualised) or well below the RBA’s 2%‑3% target band. While the RBA will probably cut in August, taking the cash rate to a new record low of 1.5%, we suspect that they will do so through gritted teeth. It is arguable that the domestic economy is in need of any additional stimulus at this point. There is a respectable line of argument that further rate cuts may not help.  And that cuts may just add fuel to the housing market.”

Scott Haslem, UBS

“On balance, we believe today’s CPI is enough to get the RBA across the line for a (final) cut in August, but the lack of downward surprise today and better recent data, makes this a closer call.”

Annette Beacher, TD Securities

“Recall the May minutes revealed that some members saw a case for waiting to cut: they could ‘see cases both for moving at this meeting or at the subsequent meeting’. With a lack of a shock in either inflation or key activity indicators, there really isn’t a clear trigger for a cut next week.”

 David De Garis, NAB

“The revelation that the underlying CPI was not another repeat of the first quarter when growth was an anaemic 0.2% but pushed up this quarter to 0.5% had the market rethinking and repricing whether the RBA was indeed more likely than not to cut rates again next week. NAB’s assessment is that the CPI was right in line with RBA May SoMP forecasts and likely sufficient to see them remain on hold next week.”

Josh Williamson, Citigroup

“The yearly underlying CPI result of 1.5% is directly in line with the RBA’s forecast from the May Statement on Monetary Policy. We had previously said that it would take a downside surprise from this forecast to get the RBA cutting the cash rate next month. We now push our forecast for a 25bp cut out to the November RBA meeting.”

Craig James, CommSec

“The only way that the Reserve Bank can seek to lift the inflation rate to the target band is by running the economy at a faster rate and that means cutting interest rates. So a rate cut will be on the agenda at the Reserve Bank Board meeting next Tuesday. Will a rate cut actually boost growth? It is far from certain, but the Reserve Bank has to try. But the Reserve Bank won’t continue to cut rates if it’s clear that interest rates at super-l low levels have become ineffective in boosting demand.”

ANZ Research

“Wages growth is still soft and tradables prices are weighed down by competitive pressures and margin compression, which will likely see inflation remain soft over the next 12-18 months. Combined with softening labour and housing markets and a relatively high AUD, we are likely to see the RBA cut the cash rate next week.