ABEWeekly 18-02-22

“Our greatest glory is not in never falling, but in rising every time we fall.”

  • Confucius

Australia

Business and household balance sheets remain in reasonable shape.

Healthy corporate balance sheets mean reduced credit risk – a lower likelihood that companies will not be able to meet their debt commitments.

Commonwealth Bank business banking group executive Michael Vacy-Lyle commented this week that the “eye-watering” amount of cash on business balance sheets should cushion the effects of higher interest rates.

National Australia Bank’s most recent business conditions survey also pointed to an improvement in business confidence. This reflected that the Omicron outbreak appeared to have peaked quickly, lockdowns had been avoided, and forward orders had held steady.

Employment numbers out this week also showed a resilient jobs market, with unemployment in January coming in at a steady 4.2%, a near 50-year low.

Reserve Bank Governor Philip Lowe provided further background to the Reserve Bank Board’s recent decision to leave its policy cash rate unchanged at 0.10% in his speech to the House of Representatives Standing Committee on Economics.

Acknowledging expectations of interest rate increases as a result of higher inflation and the strength of the economic recovery, Lowe restated: “it is too early, though, to conclude that inflation is sustainably in the target range [of 2-3%]”, and that “[a]nother couple of CPIs would be good to see.”

The minutes of the Reserve Bank Board’s most recent monetary policy meeting also reiterated the view of uncertainty about how persistent the inflation pick-up would be. The Board also believes it is likely to be some time before the rate of wages growth is consistent with inflation being sustainably in the target.

Bond market futures are currently pricing in the first in a series of rate rises for June 2022.

Commonwealth Bank economists have also moved their expectations for the first rate hike back from August to June, picking a cash rate of 1.0% by the end of this year.

CBA Chief Economist Gareth Aird noted that home loan borrowers will be refinancing at materially higher interest rates over the next two years, which will have a significant impact on household finances. CBA estimates about A$500 billion of fixed rate mortgages will be rolled over, which it said would lead to a “natural tightening” in financial conditions.

CBA is picking a 10% decline in house prices over 2023 as a result of higher interest rates. This along with other factors at work would help alleviate inflationary pressures and reduce the need for further interest rate hikes in 2023. (Westpac Chief Economist Bill Evans is also picking house price declines through to 2024, restoring some measure of affordability.)

Global

U.S. consumer prices jumped 7.5% higher at an annual pace in January, the fastest increase in 40 years. This was driven by a surge in energy costs, particularly at the petrol pump. It prompted President Biden to state that he would “work like the devil” to address the fuel price issue (although as Forbes magazine pointed out, his administration appears to show few signs of understanding the causes). U.S. jobs growth has also been unexpectedly vigorous.

This is ramping up pressure on the U.S. Federal Reserve (and other central banks) to accelerate their pullback from their COVID-19 stimulus by increasing their policy cash rates.

There’s widespread market expectation that the first move in the U.S. federal funds rate will take place in March, with potential for a 50 basis points hike. Goldman Sachs economists are now calling seven consecutive 0.25% hikes this year, from their previous five.

Across the Atlantic, European Central Bank President Christine Lagarde this week signalled that there would be no rush to dial down stimulus in Europe, stating: “Any adjustment to our policy will be gradual… we will take action at the right time.” Lagarde also however recently refused to rule out a hike this year after the emergence of the highest inflation in the Eurozone’s 23-year history.

The challenge for the central banks continues to be to strike the right balance between raising interest rates to tame inflation, while avoiding damaging the economic recovery from COVID-19 by over-reacting to the inflationary surge.

A flattening of the yield curve – a narrowing of the gap between shorter-term and longer-term bond yields – suggests that bond markets may be becoming concerned that the Federal Reserve could be too aggressive and inflict more pain than necessary. This will continue to play out in the coming weeks and months.

For local investors, even though interest rates will almost certainly move up over the next year, they will still remain extremely low by historical standards. By extension, so will the income available from term deposits and other cash products. Carefully selected higher-yielding bonds will therefore remain attractive as a source of income, especially if held to maturity.

Current Investment Opportunities

FHIM Trade Logistics

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

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. The bond is 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.

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).

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