No Lack of Interest

ABEWeekly 14-04-22

“Act as if what you do makes a difference. It does.”

  • William James

Key Points

  • As the Federal Election gets underway, markets still expect the next increase in the Reserve Bank of Australia’s cash rate to take place after the election, irrespective of which political party wins, in either June or August.
  • Persistently high inflation figures out of the U.S. this week further bolster the case for more aggressive hikes by the U.S. Federal Reserve.
  • Higher U.S. interest rates coupled with increased cost pressures will over time flow through into lower corporate earnings. When valuations for many companies are already arguably overheated, this should progressively take some of the buoyancy out of the U.S. sharemarket.
  • Continuing investment market uncertainties and volatility reinforce the need to ensure that investment portfolios are not over-dependent on any asset class to protect and build wealth.
  • Investment in carefully selected corporate bonds can offer both regular and reliable higher income than many alternatives, as well as the potential for increased portfolio diversification. This is beneficial given arguably extreme valuations in a number of asset classes.
  • Our latest offering is a bond linked to Fortune 500 company Goodyear Tire & Rubber. Full documentation is available here, and you can watch a recording of a recent webinar here. You can also invest in bonds linked to FHIM Trade Logistics, Xerox, and Jaguar Land Rover.

Australia

As the Federal Election campaign gets underway, the latest indicators of the state of the Australian economy show it remains healthy.

National Australia Bank’s Monthly Business Survey released this week showed that business trading conditions, profitability, and confidence rose markedly in March, particularly in the retail, finance, business and property, and recreation and personal services sectors.

This was despite increases in costs of business inputs and labour. As the NAB survey noted, many businesses seem to have been able to pass on at least some of these cost pressures to their customers in the form of higher prices.

The labour market also continues to outperform expectations. Stronger job vacancies also point to a further tightening of the labour market in the months ahead.

Irrespective of which party wins the Federal Election on 21 May, interest rates are going up. The key questions are around the pace and rate of increases.

In its most recent statement last Tuesday, the Reserve Bank stated that it wanted to see “actual evidence” that inflation is sustainably in the 2-3% target range before moving.

The Bank also said that it would be assessing “important additional evidence” in coming months on inflation and the evolution of labour costs, having described wages growth as being “below rates that are likely to be consistent with inflation being sustainably at target”.

As well as this week’s employment data, the release of consumer price index data for the March quarter (27 April) and wage price index data for the March quarter (18 May) will give the Reserve Bank more up-to-date readings on these key indicators of the state of the economy.

Markets still expect the next increase in the cash rate to take place in either June or August (after the Federal Election).

Westpac’s economists are now expecting consecutive rate hikes in June (15 basis points), July (25 basis points), and August (25 basis points), followed by a pause in September, and then further hikes in October and November, bringing the cash rate to 1.25% by year-end.

Hot Property

In the aftermath of the Reserve Bank’s most recent monetary policy statement, some more excitable market participants have been canvassing a cash rate looking out up to two years in the order of 3.0 – 3.5%.

Such a 3% increase in interest rates would effectively double 2021 level mortgage repayments for many borrowers. The cohort of fixed rate borrowers which took out home loans during the pandemic is set to roll over to mortgage rates more than double their original rate over the next two years.

Given that Australia has among the most heavily indebted mortgage borrowers in the world, and mostly variable interest rates, mortgage rate increases at this level would have significant implications for the property market, small businesses, households, and consumer spending. The Reserve Bank reiterated this as a key risk in its Financial Stability Review published last week.

Laminar Capital’s Stephen Roberts also pointed this week to the anomaly that market players locally are pricing in more tightening by the Reserve Bank of Australia over the next 18 months, in response to a lower rate of inflation, than markets are expecting from the U.S. Federal Reserve battling a much stronger inflationary surge.

Global

As the conflict in eastern Europe grinds on, holders of Russian bonds got another unpleasant surprise last week when the U.S. blocked Russian attempts to use reserves held in U.S. banks to make scheduled interest payments.

Developments in energy markets remain critical for world economic activity.

The COVID-19-driven lockdowns of several Chinese cities, in particular Shanghai, have affected Chinese demand for oil, and the prospect of Guangzhou also going into lockdown would exacerbate this further.

The European Commission is reportedly preparing proposals for an EU embargo on Russian oil, although several countries – in particular, Germany – are objecting to an all-out ban.

International Energy Agency member nations have agreed to release 60 million barrels of oil from storage over the coming six months. This will complement last week’s announcement that the U.S. will be releasing over a million barrels of oil a day from its Strategic Petroleum Reserve for six months from May. These and similar initiatives should continue to put downwards pressure on oil prices.

The major U.S. banks also release their first quarter earnings at the end of this week. This will provide an initial indicator of the state of U.S. corporate profitability during a period of heightened geopolitical instability and sustained high inflation.

As we discussed last week, recent inversions in the yield curve have indicated that bond market investors have been more pessimistic than sharemarket investors about the potential for a U.S. recession.

However, higher interest rates coupled with increased cost pressures will over time flow through into lower corporate earnings. When valuations for many companies are already arguably overheated, this should progressively take some of the buoyancy out of the U.S. sharemarket.

Inflation On the Up

U.S. inflation data released this week showed that the U.S. consumer price index rose by 8.5% at an annual rate in March, up from 7.9% for the year to February. The increase in prices was slightly less strong than some forecasters had anticipated.

This comes on the back of strong job creation in March and a further fall in the unemployment rate from 3.8 to 3.6%. While average hourly earnings increased by 5.6% over the 12 months to March, this was some way below the rate of the general increase in prices.

The strong inflation reading further bolsters the case for more aggressive rate hikes from the U.S. Federal Reserve.

Minutes from the Fed’s March meeting and subsequent public statements by Fed Board members indicate that the Bank is toughening its stance, to forestall inflation from becoming entrenched in consumer and business thinking and decision-making.

Bond markets are still expecting the U.S. federal funds rate to be 50 basis points higher at the next meeting in May. Morgan Stanley expects the Federal Reserve to lift its policy rate by 50 basis points at meetings in May and June, and then in 25 basis point increments throughout the rest of the year.

The European Central Bank’s next meeting will be Thursday European time. Inflation in the Euro area is running at a recent record high of 7.5%.

The ECB will have to continue to balance whether to raise its policy rate to attempt to choke this off, against ongoing uncertainties about the effects of the war between Russia and Ukraine on Eurozone area economic activity.

A number of commentators are expecting the Eurozone cash rate to be left unchanged, but for a shift in tone to begin to manage expectations of future rate rises.

As always, market volatility and uncertainties reinforce the need to ensure that investment portfolios are not over-dependent on any asset class or sector to protect and build wealth. This is particularly the case given some of the arguably extreme valuations in other asset classes.

Investment in carefully selected corporate bonds can offer both regular and reliable higher income than many alternatives, as well as the potential for increased portfolio diversification.

Corporate bonds are not term deposits, and come with additional risks.

Current Investment Opportunities

Goodyear Tire & Rubber

Our new Goodyear bond is a fixed coupon credit-linked note yielding 4.5% per annum and maturing in March 2027.

The bond is issued in Australian dollars, eliminating foreign currency risk.

We held a webinar recently launching the offering. You can watch it here, and full documentation for the offer is available here.

NASDAQ-listed Goodyear develops, manufactures, and sells tires for cars, trucks, buses, aircraft, and earthmoving and mining and industrial equipment in 48 facilities in 21 countries.

The company earned $US17.5 billion in revenue in 2021, more than leading Australian companies such as Commonwealth Bank of Australia and National Australia Bank.

Goodyear is a leading global consumer discretionary company. This bond can help you introduce sector diversification to your investment portfolio.

FHIM Trade Logistics

This Australian dollar-denominated note is linked to a shipping and trade finance fund from TradeFlow Capital Management.

TradeFlow is a fintech-powered commodity investment strategy and business which enables physical commodity trading, using a proprietary digital trade services platform to manage and monitor cargoes globally.

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 suitable for sophisticated/wholesale investors. You can read full documentation 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. You can read full documentation here.

Jaguar Land Rover

You can still invest in an Australian dollar fixed coupon credit-linked note over Jaguar Land Rover, a senior unsecured 5-year note offering a 4.50% per annum fixed rate with coupons paid half-yearly. You can read full documentation here.

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

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