Australian Bond Exchange

ABE Weekly 19/05/2021

Market Update  


“You must be the change you wish to see in the world” Gandhi 


Despite record levels of debt in Australia, the cost of servicing the debt is forecast to hold at 0.7% of GDP due to the low interest rate environment. An early use of policies to reduce debt would have been at the expense of allowing the economy to operate at its potential. As with other countries debt ratios are unlikely to return to pre COVID levels. Despite employment levels now being above pre-COVID-19 levels and GDP expected to grow rapidly this year, the government is clearly going all in to “secure the recovery” and drive the unemployment rate down faster. The government defines full employment as 4.5 per cent, although that level is not forecast to be reached until mid-2024. Westpac believe the Reserve Bank sees it as 4 per cent or even a little lower. 

Cashed up consumers are set to drive the economy this year, buoyed by the strong housing market, jobs market and the national border remaining shut (in 2019 Australians spent around $55bn on holidays overseas, well above the $25bn foreign tourists spent in Australia). The rapid recovery in the economy which is reflected in the dramatic improvement in the budget bottom line is still challenged by risks around the virus (India for example) and the global economy. 

The greatest risk to economic policy and recovery going forward will be inflationary concerns. For now, inflation seems to be contained withing acceptable levels, minimising any threat to monetary policy changes which in turn would have an impact on interest rates going forward. Slightly higher US inflation numbers recently released signalled CPI had climbed its highest level since 2009 which in turn had a massive impact on stocks. Inflation data going forward will play a key role in how markets behave.  

The chart below illustrates tongue in cheek the crossroads we are at when it comes to asset allocation. With increased funds chasing risk assets like equities, valuations are becoming even more stretched. This suggests a reallocation of assets towards safer securities like bonds will or at least should start to gather momentum in the near term but investors are inherently reluctant to step outside their comfort zone even if it means forgoing income. 

Australian monetary policy is very much dependent on what’s happening in the US and for now Federal Reserve Vice Chair Richard Clarida said the recent weaker-than-expected U.S. jobs report showed the economy had not yet reached the threshold to warrant scaling back the central bank’s massive bond purchases. Employers added 266,000 new jobs last month, which was dramatically fewer than the 1 million forecasts by economists surveyed by Bloomberg, while unemployment rose to 6.1%. The Fed has pinned interest rates near zero to help the economy recover from the pandemic and vowed to maintain a $120 billion monthly pace of asset purchases until the U.S. has made substantial further progress on employment and inflation. 

The bottom line Is that fixed income is still massively underrepresented in almost every retail portfolio. Yet at the same time we have record levels of cash tied up in term deposits earning almost insignificant returns. We acknowledge that with greater return comes a little more risk, but we qualify every investment to make sure it meets not only ours but independent quality control. 

We look forward to your company next week! 


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