“If you owe the bank $1m that’s your problem. If you owe the bank $100m, it’s their problem” J. Paul Getty
Bond markets have been relatively stable this past week but still very much focused on economic data out of both the US and Australia. That said there will plenty of attention on what Fed Chairman Jay Powell will say at the next FOMC scheduled for Apr 28. There will be a particular focus on his previous comments regarding the strength of the US economy and the fact that it may be at an “inflection point.” The chart below of US employment illustrates just how fast the US economy has rebounded from its low. The Fed is also paying close attention to very short-term interest rates, which have been sinking since the start of the year as reserves in the financial system have ballooned. The central bank has been clear that it does not want any market interest rates to go negative which is why it has set its main policy rate, the federal funds rate, in a target range of 0-0.25 per cent. Currently, it is hovering close to the lower end of the band, at 0.07 per cent. The key takeaway is that the Australian Bond Exchange is still able to source high yield corporate bonds for our clients which pay yields of between 4-5%.
On the domestic front the data just keeps getting better. Following the recent surge in employment and tumble in the unemployment rate, WBC have recently lowered its forecast unemployment rate by end 2021 from 5.7% to 5.0%. The Reserve Bank which releases its new forecasts on May 7 will also revise down its unemployment profile. The current estimate of 6% by end 2021 is likely to be revised down to 5.25% and the June 2023 forecast (the end of their forecast period) may be revised lower to 4.5% from 5.25%. Wage’s growth however remains an issue, the labour market needs to remain “tight” for some time before the upward pressure builds on wages, something the RBA will take into consideration when forecasting inflation levels and rate hikes. At the same time the RBA is having a tough time holding the 3year Australian Government Bond (AGB) rate at its target of 10bps which is currently trading at 36bps. The market is clearly already starting to factor in rate hikes toward the second half of 2023 which at the same time will have eventually a negative impact on equities valuations. On the back of this we expect to see further switching out of risk assets and into higher yielding bonds.
As mentioned in last week’s weekly, the theme for this week will look at the Volatility Index in the US otherwise known as the VIX – see chart below. The VIX, is a real-time market index representing the market’s expectations for volatility over the coming 30 days. Investors use the VIX to measure the level of risk, fear, or stress in the market when making investment decisions. It is also known as the “fear index” as evidenced by the two spikes below which represent the GFC and COVID. Market convention suggests that at levels between 10 and 20 markets are deemed to be pricing risk accordingly. The index is currently at 17.6 suggesting investors are comfortable with where asset prices are. At levels of 10 and below the market is said to be complacent about risk and above 20 risk begins to trade at a premium.
The Bubble of all Bubble will burst one day – the big question of course on everyone’s mind is WHEN…..