ABEWeekly 28072021

Market Update  

“If the plan doesn’t work, change the plan not the goal” – Anonymous 

What a difference a week makes. At one point it looked like we were going to emerge from the current lockdown in NSW relatively unscathed, but case numbers dictated otherwise, and the lockdown has now been extended another 4 weeks. That said, economists are still very upbeat about an imminent bounce back from the current situation. 

It should be emphasised however that Westpac expect this shock to quickly reverse as was the case in 2020, with GDP bouncing strongly in the December quarter (+2.6%, previously +1.3%) once restrictions lift. Supporting this view, fiscal policy is supportive and, as discussed in the above note by Chief Economist Bill Evans, the RBA may choose to adjust their taper timeline in response. Further, while risks around COVID–19 will persist, the likelihood of significant outbreaks requiring harsh restrictions should fall quickly as Australia’s vaccine drive ramps up. 

As we go to print June CPI numbers were released showing Australia’s consumer-price growth surged by the fastest pace since 2008 joining several developed countries in recording a jump as a result of lockdown-induced weakness. Inflation accelerated to 3.8% in the second quarter from a year earlier, compared with a median forecast of 3.7%. From the first three months of the year, the rate was 0.8% versus a forecast 0.7%.  

As we have said before inflation will be a key determinant of monetary policy going forward but despite this most recent jump, Inflation is expected to dissipate as price indexes lose the boost from the comparison with the depths of the pandemic last year, underscoring why policy makers are still running record-low interest rates and bond-buying programs to try to spur economic growth and employment. The chart below says it all. Despite the pop in inflation bond yields barely moves signalling those low rates are here to stay for some time yet. 

The bottom line is that despite talk of imminent rate rises in the next 2-3 years, it seems Central Banks around the world will be treading very carefully so as not to upset the apple cart as far as economic stability. As we have said before a low interest environment coupled with stretched risk asset valuations only strengthens the case for investing in higher yielding fixed income. 

 

It’ll be interesting to see what the language looks like when the Fed meets tonight (July 28 US Time). Of note will be commentary regarding inflation and the strength of the economy. Judging by the continued rallied in US equities a possible change in the outlook for monetary policy is on the cards. There is no question that valuations on US equities and globally are certainly getting pushed to their limit, but it feels like a game of chicken, and no one is prepared to jump first for fear of getting it wrong, something that is totally understandable.  

The chart below illustrates just how resilient the US market has been in the past 12 months, and how relentless the rally, but just how much further can this be sustained? 

This week we look at “duration” in the context of a bond portfolio. Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates. A bond’s duration is easily confused with its term or time to maturity because certain types of duration measurements are also calculated in years. Duration measures a bond’s or fixed income portfolio’s price sensitivity to interest rate changes. Modified duration measures the price change in a bond given a 1% change in interest rates. A fixed income portfolio’s duration is computed as the weighted average of individual bond durations held in the portfolio. What investors need to be aware of is as a bond’s duration rises, its interest rate risk also rises because the impact of a change in the interest rate environment is larger than it would be for a bond with a smaller duration.  

It’s not as though we don’t get enough information on the subject but below are some recent stats on exactly what is happening around the world.