ABEWeekly 04-03-22

“I am not afraid of storms, for I am learning how to sail my ship.”

  • Louisa May Alcott

Key Points

  • Markets remain volatile as they respond to ongoing developments in the Russia/Ukraine conflict. It is however possible to overstate the effects beyond the very short term on broader global economic activity.
  • Central banks will have to continue to walk the tricky tightrope of dealing with the outcomes of the eastern European conflict on top of an existing inflationary surge and COVID-related dislocations, while not clamping down too early or too hard and dousing the recovery.
  • The investment market volatility stemming from the Russia/Ukraine conflict reiterates the importance of ensuring that an investment portfolio is diversified across assets including carefully selected corporate debt securities.

Australia

There is little credit risk for Australian companies. Profit reporting season has shown that overall, their balance sheets are in great shape, and the record amount of cash they’re holding provides a buffer against future interest rate rises.

Business confidence has improved, and the jobs market has remained resilient. Next month’s pre-election federal budget will almost certainly provide a further boost to household income.

The Reserve Bank Board maintained its policy cash rate unchanged this week at 0.10%.

The Board reiterated that while inflation had picked up, “it is too early to conclude that it is sustainably within the [2-3%] target range”, while wages growth “is only around the relatively low rates prevailing before the pandemic”.

The Board also reiterated that it is “prepared to be patient as it monitors how the various factors affecting inflation in Australia evolve”.

The Bank may well discount the energy-related uncertainties stemming from the Russia/Ukraine conflict as a ‘temporary supply shock’, and ‘look through’ this when setting monetary policy.

(‘Shocks’ of this type can go both ways – as a major global exporter of liquefied natural gas and coal, Australia is likely to gain some short-term benefit.)

If not resolved reasonably quickly, however, the uncertainties generated by any extended conflict in eastern Europe could also prompt the Reserve Bank to “sit on its hands” for longer than it might otherwise have done.

The bond market is anticipating the first rate rise in June or July.

By its June board meeting, the Bank will have data on both wages growth and inflation from the March quarter. A higher rate of price increases, combined with further evidence of a tighter labour market, is likely to prompt the Bank to start to move.

As Westpac’s Bill Evans noted last week, central banks generally adopt some form of monetary policy tightening bias before kicking off the tightening process. Expect this signalling in the coming months.

Global

Bond, share, commodity, and cryptocurrency markets remain volatile as a result of the conflict between Russia and Ukraine, and the sanctions and political responses to it.

Gas and coal prices spiked on concerns about potential disruptions to Russian energy supplies to Europe. As is usual in these situations, the price of oil has leaped above $US100 a barrel. Many investors have sought shelter in government bonds and the U.S. dollar.

The situation remains extremely uncertain in the short term as markets and decision-makers absorb the ongoing flow of events.

It is however possible to over-state the effects of the conflict beyond the very short term on broader global economic activity.

Russia is undoubtedly a major player in the energy sector and in key commodities. The Russian state owns a significant stake, for instance, in VSMPO-AVISMA Corporation. This company is responsible for about a third of global titanium production, and is a manufacturer of products used widely in the aerospace, shipbuilding, petrochemicals, and civil engineering industries.

Beyond energy and commodities, however, Russian corporations occupy a limited (legal) role in many global supply chains. There are no Russian equivalents of Microsoft, Amazon, Apple, Alphabet/Google, or Taiwan Semiconductor in the technology sector, for instance.

Realpolitik also means that statements of condemnation from Western politicians will be accompanied – as they have been since the start of the conflict – by continuing purchases of Russian oil, natural gas, nickel, titanium, aluminium, and other commodities and rare metals and earths. These are essential to the functioning of the world economy and should go some way towards reducing the potential economic fallout.

As Bloomberg commentator Javier Blas noted: “The West knows that commodities are a cash cow for Putin, fueling his imperial ambitions thanks, in great part, to ultra-high oil and gas prices, but the allies are also aware of the economic self-harm of cutting imports to zero.

“For its part, the Kremlin may be tempted to weaponize its natural resources – which could trigger blackouts in Europe. But it also knows commodity exports are its own economic lifeline.

“It’s the commodities market version of the Cold War doctrine of mutual assured destruction, or MAD.”

Central banks will have to continue to walk the tricky tightrope of dealing with the outcomes of the eastern European conflict on top of an existing inflationary surge and COVID-related dislocations, while not clamping down too early or too hard and dousing the recovery.

PIMCO asset allocation specialist Geraldine Sundstrom commented recently that: “what is priced in terms of inflation expectations, in terms of central bank tightening, is already pretty serious. The chances are that central banks eventually hike a little less than what is already priced into the market.”

This was borne out this week in comments from U.S. Federal Reserve Chair Jerome Powell that the central bank would begin “carefully” raising the federal funds rate at its meeting later this month.

His stated support for an initial 0.25% increase has effectively addressed market speculation that the high rate of U.S. inflation would justify a larger than normal 0.5% rate rise.

Powell noted that the U.S. jobs market was “extremely tight”, that “demand is strong”, and that the impact of the COVID-19 pandemic on the economy appeared to be easing. He said the Fed would be “nimble in responding to incoming data and the evolving outlook”, and be ready to move more aggressively with larger or more frequent rate rises if inflation does not cool as quickly as expected.

“We will proceed carefully as we learn more about the implications of the Ukraine war on the economy… We have an expectation that inflation will peak and begin to come down this year. To the extent inflation comes in higher or is more persistently high… we would be prepared to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings.”

What the volatility in shares, commodities, cryptocurrencies, and other investments stemming from the Russia/Ukraine conflict has brought clearly into focus is the value of ensuring that an investment portfolio is diversified across assets.

This could include carefully selected corporate debt securities, which as well as providing higher yields and regular and reliable income, can provide an opportunity to reduce the effects of volatility on an overall portfolio.

Current Investment Opportunities

FHIM Trade Logistics

This Australian dollar-denominated note is linked to a shipping and trade finance fund from TradeFlow Capital Management. ABE and investment manager Ferguson Hyams Investment Management created the note.

TradeFlow is a fintech-powered commodity investment strategy and business which enables physical commodity trading for small and medium-sized firms. The company uses a proprietary digital trade services platform to manage and monitor cargoes globally, now possible because of the advent of Internet of Things (IoT) devices, artificial intelligence, and lower technology costs.

This senior unsecured unsubordinated note will pay a 5.50% fixed rate quarterly, maturing in October 2025. All coupons and any final value will be in Australian dollars. The note is available on the IRESS platform to improve secondary market liquidity. It’s suitable for sophisticated/wholesale investors and has an A$10,000 minimum investment.

Full documentation for this offering is available here.

Xerox

You can still 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.

Full documentation for this offering is available 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).

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