ABEWeekly 04-02-22

“Failure is not fatal, but failure to change might be.”

  • John Wooden

Economic and Bond Market Outlook

The big economic news at home this week was the Reserve Bank of Australia’s decision to maintain its cash rate target at 10 basis points.

The Reserve Bank also announced the end of its ‘quantitative easing’ program of buying several billion dollars of Federal and state government bonds each week. This had been intended to maintain downward pressure on interest rates, lower the cost of finance, and support recovery from the COVID-19 pandemic.

Reserve Bank Governor Phillip Lowe commented that although inflation had been higher than the Bank had expected, and is forecast to increase further in coming quarters, the Bank expects inflation to decline as disruptions stemming from the Omicron variant of the COVID-19 virus are progressively resolved.

The major contributors to higher inflation have been higher automotive fuel prices – as readers who have filled up their tank will recognise – as well as strong increases in the prices of new houses and shortages of building supplies and labour.

The Reserve Bank was broadly positive about the outlook for the economy, citing the generally good shape of household and business balance sheets, an upswing in business investment, the construction work pipeline, and high job vacancy figures suggesting further employment gains to come.

Looking forward, the Bank restated that “it will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range”, arguing that although inflation has picked up, “it is too early to conclude that it is sustainably within the target band”.

The Bank also pays close attention to wages growth. While this has picked it up, it remains at relatively low pre-pandemic rates, and any further increases are expected to be only gradual.

In his address to the National Press Club on 2 February, Governor Lowe noted that in other countries, the decision to end ‘quantitative easing’ had been followed closely by an increase in the central bank cash rate. He cautioned that this would not necessarily be the case in Australia: “Our lower rate of inflation and low wages growth are key reasons we don’t need to move in lock step with others.”

The Governor’s concluding comment – that the Reserve Bank is “prepared to be patient as it monitors the evolution of the various factors affecting inflation in Australia” – suggests that any increase in the cash rate may yet be some way off.

However, in his answers to questions following his Press Club speech, the Governor also stated: “Faster progress towards full employment and inflation consistent with the target does bring forward the timing of the likely increase in interest rates.”

Globally, the big economic news was the U.S. Federal Reserve’s announcement signalling near-term hikes in the U.S. federal funds rate to do battle with inflation.

“Chair [Jerome] Powell’s comments make it clear that the Fed leadership is open to a more aggressive pace of tightening,” Goldman Sachs economists David Mericle and Jan Hatzius stated on 29 January. They forecast five U.S. rate rises this year, starting in March.

Although the news initially convulsed sharemarkets and cryptocurrencies, bond markets have been pricing in the likelihood of rate rises for some time.

Central banks around the world have effectively sold themselves a ‘free option’ when it comes to monetary policy. In most cases, they can just as easily revert to accommodative policy as they can to tapering. Ultimately, rate increases must be timed effectively to avoid significant market disruption.

Current Investment Opportunities

Xerox

You can invest in an Australian dollar fixed coupon credit-linked note over Xerox Holdings Corporation, a 6.5 year note offering a 4.50% per annum fixed rate with coupons paid half-yearly.

This is an opportunity to invest in debt linked to a Fortune 500 corporation which provides digital document products and services in more than 160 countries and pioneered office technology. (Readers with long memories will recall that ‘xeroxing’ used to be synonymous with photocopying.)

You’ll find full documentation for this offering here.

Pallas Capital

You can also still invest in the 7.5% fixed rate senior secured note issued by real estate financier Pallas Capital (wholesale investors only).

FHIM Trade Logistics

Currently in the pipeline is FHIM Trade Logistics. This is a 3.8 year bond which will pay a 5.50% fixed rate paid quarterly. All coupons and any final value will be in Australian dollars, without currency exposure. The note will be added to the IRESS trading platform to improve secondary market liquidity. This bond will be for wholesale/sophisticated investors only.

Full documentation is available here.

Contact us if you have any questions or would like any assistance.

We continue to build a pipeline of new debt issues for 2022. We apply our rigorous product approval process and exacting standards to provide opportunities to invest in higher-yielding fixed income securities.