News

The federal election was held over the weekend resulting in a shock swing away from the sitting Liberal party led by Malcom Turnbull. So close is the election result that it will not be known for a few days. The likely outcomes are either a narrow Turnbull victory or a hung parliament.

A hung parliament is one where neither of the major parties hold a majority and must rely on the smaller parties or independent members to form government. This was the situation most recently with the Labor government of Julia Gillard.

Should the Turnbull-led Liberal Party be able to form a government it is unlikely to be able to pass legislation on the majority of its platform including reforming industrial relations, increase taxes on retirement savings and cutting taxes for small business. A previously legislated ‘short term’ tax on higher earners due to be removed on 1 July 2017 is also likely not to be passed by the parliament.

In short, it’s a mess and likely to lead to lower growth, higher taxes, greater spending and pressure on Australia’s AAA rating. Australia’s budget, last in surplus in 2007 when the Liberal government was ousted by Labor’s Kevin Rudd, looks likely to see spending at record levels of GDP. This will increase pressure on Australia’s credit rating as both gross and net debt continue to grow.

Total job advertisements rose for the second month in a row in June, according to ANZ’s monthly jobs ads survey.  Month on month, they rose by 0.5% or 8.0% compared to June 2015.  After revisions to past data, May’s comparable figures were 2.2% and 9.1% respectively.

The survey’s results produce what economists call a “leading indicator”, or a statistic which gives a strong hint as to the direction and strength of parts of the economy. In the case of ANZ’s job ads survey, it provides a preview of conditions in the employment market, especially with regards to employer demand for labour. More advertisements generally means more hirings and thus lower unemployment rates.

ANZ’s Felicity Emmett said the figures indicated recent employer demand was a reflection of a solid economy. “…the strength in labour demand over the past two months is consistent with robust business conditions and solid momentum in the domestic economy.” She did, however, express concern for employment figures later in the year. “Unfortunately, uncertainties around the economy are mounting – both offshore from the Brexit vote and domestically from the unresolved federal election outcome – and that may pose some downside risks to the employment outlook later in the year.”

TransGrid, the power generator business the NSW Government leased last year to investors for 99 years, has been busy in the US bond market. In what was its inaugural US private placement, it has priced $1 billion worth of bonds in four tranches through its financing arm, NSW Electricity Networks Finance. The bonds will be issued in September and are in three USD tranches and one AUD tranche; USD$200 million (AUD$267 million) September 2026s, USD$250 million (AUD$333 million) March 2029s, USD$250 million (AUD$333 million) September 2031s and AUD$75 million September 2033s. TransGrid said it immediately swapped US dollar proceeds in AUD and the bond sales will allow it to repay a $1 billion debt facility which had been due to expire in December 2017.

Since the granting of the lease in late 2015, the TransGrid business has been controlled by a consortium of investors comprising Spark Infrastructure, Hastings Funds Management, Canada’s CDPQ, Kuwait’s Wren House Infrastructure and Abu Dhabi’s Tawreed Investments.

The US Fed takes into consideration several price indices when evaluating the rate of inflation. It says it does so because “various indexes (sic) can send diverse signals about inflation”. One of its favoured measures of inflation is the core personal consumption expenditure. The core version of consumer spending strips out energy and food components, which are volatile from month to month, in an attempt to identify the prevailing trend. It’s not the only measure of inflation used; the Fed also tracks the Consumer Price Index (CPI) and Producer Price Index (PPI) from the Department of Labor. Its view of inflation is important as it forms the basis for the FOMC’s interest rate settings.

The latest core PCE figures have been published by the Bureau of Economic Analysis as part of May figures for personal income and expenditures. At 0.2% for the month and 1.6% year on year, they came in as expected. Even though the data was in line with expectations, ANZ Research viewed the numbers as more on the positive side. “Overall, the data suggest the US consumer remains in a healthy position. Rising incomes, coupled with elevated consumer confidence….bode well for spending in the second half of the year – as long as Brexit fears continue to fade.”  Other views were more neutral. St George senior economist Janu Chan said, “We would need to see a further pickup to give the Fed greater confidence that inflation is moving towards their 2% target.” AMP Capital’s Shane Oliver viewed the data as giving the Fed “plenty of flexibility to keep delaying on rates“.

According to US cash futures markets there no chance of a rate rise in July and perhaps remarkably, a small chance of a rate cut. US 2 year bond yields finished the day 3bps higher at 0.64% while 10 year bonds yields finished 5bps higher at 1.52%.

US consumers became more optimistic in the May/June period as employment prospects picked up. The US Conference Board survey revealed a sharp rise in its consumer confidence index to 98, which is well up on the May reading of 92.4 and back above the pre-2008 average. The result was considerably higher than the median expectation of 93.7, although the survey period does not include the week of the UK’s EU vote and next month’s reading is likely to be affected.  The higher figures were released on the same day as final revisions were made to US first quarter GDP numbers which showed the US economy grew more than previously thought.

Lynn Franco, Director of Economic Indicators at the Conference Board said, “Expectations regarding business and labor (sic) market conditions, as well as personal income prospects, improved moderately. Overall, consumers remain cautiously optimistic about economic growth in the short-term.”

How confident consumers feel about the stability and durability of their finances affects their spending and saving patterns. Consumer confidence surveys are therefore viewed as one of the key leading indicators of an economy’s growth rate, especially for Western countries where an estimated 60-70% of economic activity, or GDP, is in the form of private sector consumption.

Third estimate GDP data indicates US first quarter GDP grew at a faster rate than previously thought. Q1 growth figure have been revised up from annualised 0.8% to 1.1% as a result of higher US exports and non-residential investment, although consumer spending was pared back in the latest figures.

US GDP numbers are published in a manner which is different to most other countries; quarterly figures are multiplied by four to give an annualised figure. In countries such as Australia and the UK, an annual figure is calculated by taking the latest number and comparing it with a figure from a year ago. The diagram below shows US GDP once it has been expressed in the normal manner.

According to cash futures prices, the new data is unlikely to have any effect on the voting intentions of FOMC members at the July meeting. Prices implied a zero chance of a rate rise and a 7% chance of a rate cut, a possibility which has arisen amongst the UK Brexit vote. The US bond market took a slightly different view and sent US 10 year yields 4bps higher to 1.47%.

Fallout from the UK vote to leave the European Union has already begun only days after the vote was taken. Standard & Poor’s has cut the UK credit rating two notches from AAA to AA with a negative outlook. The ratings agency, now known as S&P Global Ratings, said the UK will lose the advantage of EU membership when it comes to attracting capital and skilled labour. Not being part of the EU would also deter investment, decrease demand for sterling and put the country’s financial services sector at a disadvantage.

S&P is the last of the three rating agencies to remove the UK’s AAA rating. Both Moody’s and Fitch downgraded the UK’s rating in 2013; Moody’s dropped the rating to Aa1 while Fitch moved to AA+. Moody’s has also just announced the UK is now on negative credit watch negative and Fitch has also cut the UK ‘s rating one notch farther to AA (negative outlook).

The European Union has also had its credit rating cut from AA+ to AA by S&P.

A description of Brexit by Westpac seemed to sum up the mood of markets: “The unimaginable has happened and the UK has voted for Brexit. The referendum result will cast a long shadow over global markets and traders are more likely than not to extend the burst of risk aversion in coming days.” Well it may have been unimaginable for some but the vote counting has finished and “Brexit” will become a reality. While the actual implementation of the British disengagement from the European Union will take some time (Article 50 of the Lisbon Treaty has to be triggered and the UK then has 2 years to leave; there is no time limit for the UK  to trigger Article 50), financial market fallout has been immediate. In Australia, the effects are being felt through the bond and cash markets, the equities market and the foreign exchange markets.

It is important to note that markets did not expect this result and hence were positioned collectively the wrong way. This resulted in additional volatility. The sterling/greenback exchange rate seemed to be the most popular indicator for observers. As the early votes came in the currency pair see-sawed depending on which vote was in front. When the “leave” vote was in front, the sterling fell against the dollar. When the “remain” vote was in front the sterling rose (although to put it in perspective at the end of the day the exchange rate was marginally below where it was in February 2016). The AUD stayed relatively steady until 9am and then fell as investors sold it along with sterling and euros to buy the USD. US denominated assets are typically the beneficiaries of safe-haven buying. US 10 year Treasurys fell 28bps. Even in 2008 and 2009, when the investors were faced with the prospect of massive US mortgage losses, they perversely bought US dollars and USD assets in preference to those of other currencies in the belief the US was still the safest place to be.

Another beneficiary of this “flight to safety” strategy has been Australian 3 and 10 year bonds. Yields on 10 year bonds plummeted back below 2.00% (down 25bps), which marks today as only the second day since Federation for a sub 2.00% yield. 3 year bond yields hit their record low today, going below 1.50% for the first time on record.

Fortescue has been making the most of the rise in iron ore prices above $50 per tonne to repay substantial amounts of debt this year. In May it repaid USD$577 worth of 8.25% 2019 bonds and prior to this, the company has made several early debt repayments during 2015. In 2013 the company had gross debt of USD$13 billion and as at June of last year gross debt was $9.5 billion.

Fortescue has now announced it will repay another USD$500 million (AUD$665 million) a little later this month, with the payment to be made from existing cash reserves. On this occasion the debt reduction will be made to its term loan facility and the balance will be reduced from around USD$4.2 billion to USD$3.7 billion. Fortescue chief financial officer, Stephen Pearce said this latest repayment brings total debt repayments made during the 2016 financial year to USD$2.9 billion.

Leading indicators of the Australian economy have been providing mixed messages recently and the latest one, the Westpac-Melbourne Institute leading index, is no different. The index rose from -1.51% in March to -1.08% in April and given the index suggests the likely pace of economic activity 3-9 months in the future, this latest reading implies the Australian economy is likely to grow at less than the trend rate over 2016. Trend growth was once taken to mean around 3% but recently the RBA and private sector economists have been suggesting it may mean a lower figure.

Westpac chief economist, Bill Evans said, “With trend growth generally assessed as 2.75% for Australia the index is sending a more negative signal than both Westpac and official forecasts.” Westpac is currently expecting another rate cut from the RBA but not until the August meeting because the June quarter CPI report will not be available until July. “We expect that further action will be required at the August meeting once more information about the inflation outlook is available following the release of the June quarter Inflation Report.”