Fed Hikes

The Fed Hikes

ABEWeekly 18-03-22

“A problem is a chance for you to do your best.”

  • Edward “Duke” Ellington

Key Points

  • The U.S. Federal Reserve has now clearly signalled its determination to get on top of the inflationary outbreak. However, central banks also remain keenly aware of the importance of not over-reacting and damaging the recovery from the pandemic.
  • The ongoing uncertainties and volatility in investment markets reinforce the need to ensure that investment portfolios are spread across multiple asset classes to protect and build wealth.
  • Investment in carefully selected corporate bonds from leading global companies in sectors which are under-represented locally provides such a diversification opportunity, as well as offering regular and reliable higher income than many alternatives.
  • We’re holding a webinar on Tuesday 22 March launching our next offering, a bond linked to a Fortune 500 company. Register here (advisers/brokers) and here (investors).

Australia

The reopening of the economy and borders, substantial accumulated household and corporate savings, positive labour market dynamics, and a significant construction activity pipeline all translate into low credit risk for Australian corporates.

National Australia Bank’s most recent monthly business conditions survey showed that despite pressures from increased business input costs, including higher international shipping rates, Australian businesses are in good condition and remain broadly positive in their outlook.

Higher prices for Australia’s coal and base metals are boosting our terms of trade and national income. In conjunction with market anticipation of higher interest rates, this is likely to provide ongoing support for a higher Australian dollar.

Homeowners have also benefitted from the ‘wealth effect’ of rising house prices – Australian Bureau of Statistics numbers released this week also showed that residential property prices surged 23.7% last year.

Consumers are however beginning to feel the pinch from elevated petrol prices, while the Queensland and New South Wales floods are likely to result in higher prices for fruit and vegetables in the coming months. The election year federal budget on 29 March will almost certainly include measures to alleviate these cost of living pressures.

Addressing the Australian Financial Review Business Summit on 9 March, Reserve Bank of Australia Governor Philip Lowe pointedly reiterated that Australian inflation at 3.5% is less than half the rate in the United States.

Surges in the prices of many goods in the U.S. during the pandemic, supply dislocations, and worker shortages had translated into significant price increases. This phenomenon had been less pronounced here.

Wages growth in the United States and United Kingdom had increased significantly, while in Australia, wages have only been rising at a similar rate to before the pandemic, Lowe noted.

The Bank has consistently stated that it wants to see evidence that inflation will be sustained in the 2-3% target range – not just be forecast to do so – before increasing its policy cash rate.

On these grounds, Lowe stated, “we can take the time to assess the incoming information and review how the uncertainties are resolved. Given the outlook, though, it is plausible that the cash rate will be increased later this year.”

The bond market continues to expect the first increase in the Bank’s policy cash rate in July.

Westpac’s economists believe however that the Reserve Bank’s first upwards move will be in August, followed by October: “The spectre of significant risk and lower global growth, particularly in Europe, should see the RBA remaining patient over the next few months.”

Global

Global uncertainties remain heightened, particularly over any protracted negotiations over Russian sovereign debt defaults.

Chinese authorities have introduced stringent curbs on activity and lockdowns in key cities including Shanghai and Shenzhen in response to a resurgence of COVID-19. This raises the potential for further disruption to global supply chains and uncertainty about China’s contribution to the continuing post-pandemic global economic recovery.

Oil prices have pulled back over the past week from their immediate post-invasion highs. The international community is making concerted efforts to increase production. Iran, Venezuela, and the United Arab Emirates in particular are likely to be able to increase supply, although there will be a time-lag.

As we have discussed previously, central banks have to balance three thorny issues to try and avoid stagflation.

The first is managing monetary policies to avoid damaging the post-pandemic economic recovery. The second is responding to the existing inflationary surges, now intensified by the third, the effects of the war between Russia and Ukraine.

Inflation in many advanced economies was already at its highest rates for decades. This has been exacerbated by the increases in energy prices following the onset of the conflict in eastern Europe.

February U.S. consumer price index data released at the end of last week showed another significant jump in inflation, up 7.9% year-on-year, the highest rate in 40 years.

As widely anticipated, the U.S. Federal Open Market Committee raised its policy cash rate by 0.25% this week, the first increase in three years.

The Federal Reserve said it expected to keep increasing rates until they reach 1.75 – 2.00% by the end of this year, given the bank’s expectation that inflation would remain significantly above the 2% target for the rest of the year and beyond.

Federal Reserve Chairman Jerome Powell stated: “Inflation is likely to take longer to return to our price stability goal than previously expected”. The FOMC described the implications of the Ukraine war for the U.S. economy as “highly uncertain”, but “likely to create additional upward pressure on inflation and weigh on economic activity”.

The Bank of England is also poised to lift its policy rate again later this week.

Central banks are however keenly aware of the importance of not over-reacting and damaging the recovery from the pandemic. Higher interest rates will act as a drag on business and consumer activity and confidence at a time when these are already affected by existing increases in prices and business input costs.

The European Central Bank also recently made an unexpectedly hawkish move by accelerating the winding down of its monetary stimulus. ECB President Christine Lagarde made it clear, however, that the bank would provide the necessary support for eurozone economic activity should there be any meaningful deterioration in growth prospects.

As always, these ongoing uncertainties and the volatility in investment markets reinforce the need to ensure that investment portfolios are not over-dependent on any asset class, region, or sector to protect and build wealth.

Investment in carefully selected corporate bonds from leading global companies in sectors which are under-represented locally provides such a diversification opportunity, as well as offering regular and reliable higher income than many alternatives.

Current Investment Opportunities

We’re holding a webinar on Tuesday 22 March launching our next offering, a bond linked to a Fortune 500 company. Register here (advisers/brokers) and here (investors).

This builds on our track record of providing high-quality investments in Australian dollars, eliminating currency risk.

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.

Pallas Capital

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

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

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