As a senior member of the team, Emma will contribute to the investment strategy decision making process across all portfolios, conduct research for the investment team and contribute to the generation of active interest rate strategies that help achieve investment performance objectives.

Emma brings more than 25 years’ experience as a financial markets’ macroeconomist and strategist across investment management, investment banking and government sectors. She was most recently at Treasury Corporation of Victoria where she was responsible for providing views and analysis on the global and Australian economy to a large range of clients. Prior to this Emma held roles across National Australia Bank, Morgan Stanley and Merrill Lynch where she largely focused on combined macroeconomics and currency investment strategies roles. Emma has a Masters in Economics from the University of Adelaide.

Jay Sivapalan, Head of Australia Fixed Interest at Janus Henderson Investors said:

“Emma’s hire was a result of a thoughtful, patient and extensive search. Every member of the Australian Fixed Interest team was involved in her appointment and reached a unanimous agreement on her selection. We are delighted to welcome such a well-established, seasoned and high calibre economist. I know every member of our team is looking forward to working with her to deliver exceptional investment outcomes for our clients”.

Emma’s appointment enables the planned and phased retirement of Frank Uhlenbruch, who has decided to retire from the from the funds management industry after a long-standing career spanning over 39 years, including 28 years at Janus Henderson. Frank is due to retire in the second half of 2023 and will work closely with Emma to ensure a smooth transition and handover of responsibilities before his departure.

Jay Sivapalan, continues: “Whilst Frank will be with us for some time yet in order to ensure a smooth transition, I want to express that it has been a real privilege and pleasure to work alongside him. He has been a valued member of the investment team and has tirelessly put the needs of our clients first over the journey.  His experience and friendship will be missed. We look forward to keeping in close contact with him as he embarks on the next chapter and wish him well for the future.”

Matt Gaden, Head of Australia at Janus Henderson Investors said: “Emma’s appointment and smooth transition will ensure that clients and their investment outcomes driven by a long-standing repeatable process that has been in place for over two decades will be seamless.”

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Frank Uhlenbruch

Market review

Stubborn inflation and hawkish central banks led to higher yields as markets moved to discount further monetary tightening. Risk appetite waned, with both equity and credit markets softening. Against this backdrop, the Australian bond market, as measured by the Bloomberg AusBond Composite 0+ Yr Index, fell 1.32% after gaining 2.76% the previous month.

While February’s 0.25% lift in the cash rate to 3.35% was widely anticipated, subsequent hawkish messaging from the Reserve Bank of Australia (RBA), including that they considered a 0.5% move, led markets to reassess the likely peak in the cash rate. Three and 10-year government bond yields ended the month 42 basis points (bps) and 30bps higher at 3.60% and 3.85%.

Activity based measures indicated that the economy looked to have gained some momentum early in the new year. Labour market conditions continued to ease slightly from extremely tight levels, with employment falling modestly for the second month in a row and the unemployment rate lifting to 3.7%. The Wage Price Index for the December Quarter came in at 0.8%, slightly lower than the RBA’s and market’s estimate. Despite tighter monetary conditions, private capital expenditure intentions remain strong.

Short-term money markets remained volatile as monetary tightening expectations pivoted on RBA signalling. Three- and six-month bank bill yields ended 19bps and 21bps higher at 3.56% and 3.93%. In terms of the tightening cycle, markets are now looking for the cash rate to peak around 4.25% during the second half of the year.

In credit markets, investors re-evaluated the implications of a ‘higher for longer’ interest rate regime for economic growth, margins, earnings and cashflows.

Concurrently, a number of corporate treasurers utilised a window of opportunity to access the global primary debt markets in order to get ahead of further anticipated rises in the cost of debt. The new supply was relatively easily absorbed by investors eager to deploy elevated cash holdings into assets with attractive outright yields.

In the domestic credit market, Westpac followed on from CBA a month earlier, issuing $4.25 billion of senior unsecured bonds across three- and five-year tenors in both floating and fixed rate formats. Similarly meeting solid demand (~$7.5 billion order book), these bonds priced at credit spreads of +78bps and +95bps, and fixed rate coupons of 4.6% and 4.8% respectively.

Two other notable transactions were both undertaken by rival Big Four bank, ANZ. The first was a $1 billion fixed rate Tier 2 bond callable in 10 years, with an attractive credit spread of +280bps / yield of 6.736%. This was closely followed by a $1.5 billion ASX-listed Capital Notes 8 transaction sitting lower down in ANZ’s capital structure, at an almost equivalent credit spread of +275bps, callable in seven years. This pricing disconnect reflects differences in demand between institutional and retail investor buyer bases for these complex bank capital instruments.

The Australian iTraxx Index closed 5bps wider at 87bps, while the Australian fixed and floating credit indices returned -0.62% and +0.43% respectively.

Market outlook

A hawkish RBA, clearly anxious about the inflation outlook and indicating that work still needs to be done, has led us to factor in a 4.1% peak in the cash rate by mid-year.

While monetary policy is a blunt instrument and operates with long and variable lags, it seems the slowdown in activity late last year hasn’t carried over into early 2023. Despite low levels of consumer sentiment and cost of living pressures, the January NAB Business Survey recorded improving business conditions, forward orders and capacity utilisation. Labour and purchase costs continued to lift at a fast pace.

This resilience was also evident offshore, particularly in the US, where markets shifted from looking through the tightening cycle to building in more tightening. Central banks, including the RBA, look set to continue their strategy of providing a dose of concentrated tightening, risking recession, to stop higher inflation from becoming entrenched.

We still think the most likely scenario is for a growth slowdown that sees demand fall to below trend and allows inflation to fall back into the top of the RBA target band. In their latest forecasts, which used a cash rate peak of around 3.75%, the RBA had core inflation falling to 2.9% by mid-2025. If the cash rate peaks higher, as we and the market expect, then the prospect of inflation falling into the top of the target band increases.

Nevertheless, with the cash rate expected to peak at 4.1% mid-year, the biggest and fastest tightening in the inflation targeting era, the risks of a hard landing from mid this year onwards have increased, but not enough to be our base case. We do not see the conditions in place for monetary easing until mid-2024.

Given the change to our cash rates forecasts, we currently see yields as broadly fairly valued. We remain on the lookout for opportunities to add duration on spikes in yields as we enter the more mature phase of the tightening cycle.

Investors should remain focused on improved compensation for risk as monetary policy tightens further. We continue to observe that the repricing across different pockets of credit and risk premia remains uneven, providing outperformance opportunities through active rotation.

Attractive yields on high quality credit spreads have seen demand return from defensive income investors. In our view, the more illiquid, structured, and levered sectors of the market are yet to adequately reprice. We believe this is a process that will occur in due course as earnings outlooks weaken.

We anticipate that as conditions tighten further, global spreads will suffer decompression. This is where high quality liquid credit outperforms lower quality as compensation for default risk and illiquidity needs to increase. We continue to favour being positioned up in quality and seniority in capital structures, leaving powder dry for when compensation for investors escalates.

By Frank Uhlenbruch, Investment Strategist

The post Australian economic view – March 2023 appeared first on AdviserVoice.

Frank Uhlenbruch

Frank Uhlenbruch, Investment Strategist in the Australian Fixed Interest team, discusses the key events of 2021 and what to expect in the year ahead.

Did the Australian economy present any surprises over 2021?

The year began well with the economy re-opening and in ‘catch up’ mode following the lifting of earlier national and Victorian lockdowns. Economic growth was strong, and the labour market boomed with strong jobs gains and a sharp fall in the unemployment rate to 4.5%.

If there was a surprise for the global and domestic economy, it wasn’t from geo-political developments, but rather from the more transmissible Delta COVID-19 variant. From just after mid-year, localised offshore and domestic lockdowns took the wind out of the recovery’s sails.

In Australia’s case, lockdowns in New South Wales, Victoria and the ACT led to a sharp contraction in economic activity in the September quarter. Rising vaccination rates paved the way for a gradual re-opening of Australia’s Southeast mainland, allowing the economy to finish the year on a stronger footing.

There was also another surprise in store for investors and policy makers and that came from inflationary pressures which proved to be more persistent than expected. Strained supply chains, labour market turnover, energy shortages and higher energy prices have all added to higher headline and underlying inflation prints.

What’s in store for 2022?

A less bumpy ride as state-wide lockdown risk diminishes

As vaccination rates rise to 80% and above, the pace of recovery over 2022 should be less volatile than for 2021 given that New South Wales and Victoria have ended their state-wide lockdowns. That said, the recent emergence of the Omicron variant of COVID-19 has resulted in growing uncertainty as the year comes to a close. The threat from this new variant and its potential to affect the economic outlook remains to be seen. The high vaccination rates in NSW and Victoria mean they are not yet considering further lockdowns (at the time of writing), which should dampen the impact of this new virus strain on the economy.

After falling around 3% in the September quarter, we look for a rebound in the December quarter to deliver economic growth of around 1.75% over 2021. For 2022, we expect the economy to reach mid-2021 levels by around mid-year and grow by 5.25% over 2022. Growth is expected to ease back to 2.75% over 2023.

As the economy goes back into catch-up mode from late 2021, labour market conditions should rapidly improve. Labour supply is poised to improve as international borders gradually open up, but employers still face challenges in meeting the expectations of a post-pandemic workforce with its greater preference for offsite working.

Inflationary pressures should be most acute earlier in the year, but gradually ease as supply chains catch up to pent up goods demand. Nevertheless, the risk of cyclical price pressures finding their way into higher core inflation is higher than it has been for many years.

Monetary tightening coming, but unlikely in 2022

Towards the end of 2021 the Reserve Bank of Australia (RBA) abandoned its three-year government bond yield curve control target of 0.10% following an earlier than expected pick-up in the pace of underlying inflation. The move essentially re-linked cash rate moves back to developments in economic data, as was the case before the pandemic.

The barrier to near-term tightening remains high, with the RBA indicating that it expected no change to the 0.10% cash rate over 2022. Markets remained unconvinced, factoring in four tightenings or a cash rate just above 1% at one stage.

For the RBA to move, the following three hurdles will have to be cleared:

• the unemployment rate will have to fall close to 4%;
• wages growth will have to lift to at least 3%; and,
• actual inflation will need to be around 2.5% on a sustainable basis.

Our view is that these hurdles will not be cleared until mid-2023 when we expect the RBA to commence a tightening cycle that takes monetary conditions from a highly accommodative to a more neutral stance.

The post The Australian economy in 2022 appeared first on AdviserVoice.

Frank Uhlenbruch

Frank Uhlenbruch, Investment Strategist in the Janus Henderson Australian Fixed Interest team, provides his Australian economic analysis and market outlook.

Market review

A downward revision to the growth outlook following ‘Delta’ strain outbreaks led to sharp falls in domestic yields and a flattening in the yield curve. A strong offshore earnings season helped support risk appetite, with the domestic equity market firmer. After a strong run, credit markets softened, with a modest widening in spreads. Inflation expectations edged slightly lower. The Australian bond market, as measured by the Bloomberg AusBond Composite 0+ Yr Index, performed strongly, climbing by 1.76% over July and has since clawed back all of February’s 3.58% fall.

Following a period of rolling lockdowns, and with New South Wales set to run for longer, markets began to push back both the start date of the next tightening cycle and the amount of likely tightening. These expectation shifts were behind the 17 basis point (bps) fall in the three-year government bond yield, which ended the month at 0.24%.

The fall in yields was more pronounced at the longer end of the curve despite higher offshore and domestic inflation readings, which were seen as temporary. The 10-year government bond yield ended 34bps lower at 1.18%, while the 30-year government bond ended 24bps lower at 2.04%. Inflation expectations edged lower, with the 10-year breakeven inflation rate falling 6bps to 2.00%.

Partial demand indicators suggest that the economy had considerable momentum before hitting the latest air pocket caused by rolling lockdowns. Business surveys point to another quarter of strong growth in the June quarter with activity, forward orders and labour demand at high levels. Strong labour demand was reflected in June labour force data, where employment rose by 29,100 and the unemployment rate fell to 4.9%.

However, there were early signs of the lockdown impact showing up in falling levels of business confidence, weekly payrolls and hours worked. On the prices side of the economy, higher fuel and fruit and vegetable prices pushed the headline inflation rate up by 0.8% over the June quarter, with base effects contributing to the 3.8% yearly rate. Core measures were more muted, with the average of the Reserve Bank of Australia (RBA) statistical measures up 0.5% for a 1.7% yearly rate.

Short-term money market rates remained very low given the 0.10% official cash rate and the deterioration in the near-term growth outlook. Three-month bank bills ended the month 1bps lower at 2bps, while six-month bank bills ended 1.5bps lower at 5bps. Further out, markets pushed back the timing of the first tightening from late 2022 into early 2023.

Renewed lockdowns weighed on investor sentiment in credit markets, which had been buoyed by the rebound in growth and an improving outlook for corporate earnings. The Australian iTraxx Index ended the month 5bps wider, while Australian fixed and floating rate credit indices closed flat and 3bps tighter respectively.

While COVID-impacted sectors such as airports, REITs and the universities faced elevated volatility, investors have significantly more confidence today relative to 12-18 months ago, armed with clear evidence of demand coming back strongly as vaccines get rolled out and lockdowns are lifted. This allowed issuers such as Dexus Wholesale Property Fund and Edith Cowan University to come to market with attractively priced (from a “through the cycle” perspective) deals. The airport sector was boosted by potential M&A for Sydney Airport, demonstrating strong demand for essential infrastructure assets.

A muted corporate primary market ahead of full-year reporting was trumped by a very active primary securitisation market, with investors attracted to solid housing market fundamentals. A stand-out was Macquarie Bank closing its most recent PUMA transaction at $3.75 billion, meeting strong investor demand for high quality AAA rated bank RMBS at 55bps over one-month bank bill swap rates. Another notable item was Zip Master Trust achieving credit rating upgrades to Aaa for the senior notes in its three outstanding public securitisation transactions.

Market outlook

After a vigorous first half of economic and employment growth, rolling ‘Delta’ lockdowns mean that the economy will hit a significant air pocket. With the Sydney outbreak proving more persistent, we look for the economy to contract by between 1%-1.5% over the September quarter.

As has been the case in other periods of lockdowns, post-lockdown rebounds are vigorous as the economy shifts into ‘catch up’ mode. As vaccination rates rise, the pace of recovery over 2022 should be less volatile than for 2021. Even after allowing for a negative September quarter, we still look for the economy to grow by around 3.75%-4% over 2021 (this was 4.75% pre lockdowns). For 2022 we expect the economy to grow by around 3.5% and for the unemployment rate to fall to around 4.5%.

The RBA Governor recently indicated that monetary policy decisions would be ‘data’, not ‘date’ driven. Since those comments were made in early July, the near-term outlook has worsened and we expect that deterioration to be acknowledged at the upcoming August RBA Board meeting via dovish signalling and a less urgent wind-down of quantitative policies. We also expect the RBA to look through the June quarter spike in the yearly headline inflation rate to 3.8%.

Our base case still has the first tightening in a cycle that takes monetary conditions from accommodative to neutral starting in H1 2024. By then we expect that the tightening trifecta conditions of: i) an unemployment rate close to 4%; ii) wages growth of at least 3%; and iii) actual inflation at 2% or above on a sustainable basis, will have been met.

We regard the market pushing back the commencement of the tightening cycle to early 2023 as still being on the optimistic side. Nevertheless, the rally in the three-year government bond yield down to 0.24% at the time of writing has released any built-up value and taken valuations to mildly expensive. At the longer end of the curve, the fall in the 10-year government bond to 1.17% has taken them to outright expensive levels in our view and vulnerable to a lift in growth and inflation expectations as vaccination rates progress.

Spread sectors are likely to remain well-supported, with corporates in particular, benefiting from the tail winds of a cyclical recovery and persistent accommodative policy settings. Nevertheless, with the spread cushion for investors within pockets of credit having narrowed substantially, we remain very active and selective in this environment. While the market searches for any yield advantage, we remain discriminate, avoiding lower quality borrowers. The need for inflation protection has diminished somewhat, with breakeven inflation rates moving back into the lower end of the RBA’s 2% to 3% target band.

Views as at 31 July 2021.

The post Australian economic view – August 2021 appeared first on AdviserVoice.

Frank Uhlenbruch

Market review

A dovish monetary policy shift by the US Federal Reserve (Fed), with an elevated focus on full employment and shift towards a 2% average inflation target, buoyed risk appetite. Equity markets were firmer, while credit markets continued to perform as investors searched for yield. Increasing supply of government debt and a loosening in the Fed’s inflation objective led to a sharp lift in longer-dated yields and was a drag on sector returns. Inflation expectations also rose as observed through a lift in breakeven inflation rates. The Australian bond market, as measured by the Bloomberg AusBond Composite 0+Yr Index, ended August 0.42% lower.

“The role played by Government fiscal support via Jobseeker and Jobkeeper payments, as well as early access to Super, was evident in the 20% rebound in retail sales between April and June.”
Yields at the shorter end of the Australian government yield curve remained anchored by the Reserve Bank of Australia’s (RBA) forward guidance and yield curve control measures. After trading in a relatively narrow band, the three-year government bond yield ended the month 1 basis point (bps) lower at 0.26%.

There was significant movement further out along the yield curve as increasing government debt supply and the shift to an inflation averaging target by the Fed raised term compensation for inflation risk. The 10-year government bond yield ended 17bps higher at 0.98%, while the 30-year government bond yield ended 26bps higher at 1.91%.

Economic readings show that the national recovery, fuelled by easier fiscal policy, lost some momentum following the re-introduction of progressively tighter lockdown measures in Victoria. The Greater Melbourne area moved to a six-week period of Stage 4 lockdown in early August, whilst various state borders were also closed.

The role played by Government fiscal support via Jobseeker and Jobkeeper payments, as well as early access to Super, was evident in the 20% rebound in retail sales between April and June. While real retail sales fell 3.4% over the June quarter, this outcome was better than initial estimates for a much larger fall.

Labour market outcomes continued to improve, with the number of jobs lifting by 114,700, although the unemployment rate edged up to 7.5% in July. The underemployment rate of 18.7% was indicative of significant labour market slack. Wages growth was weak, rising by 0.2% over the June quarter and 1.8% over a year ago.

While government and central bank support has cushioned the fall in economic activity in the June quarter, partial demand indicators still point to an historically large drop in output in the upcoming release of the national accounts.

Against this backdrop, money market rates were steady to slightly lower. The RBA left the official cash rate target at 0.25% and the interbank overnight cash rate ended the month unchanged at 13bps. Three-month bank bills ended the month 1bps lower at 9bps, while the six-month bank bill ended 3bps lower at 14.5bps. Cash rate expectations remained consistent with RBA forward guidance for no change in the cash rate until the labour market and inflation outlook improved.

Credit markets continued to recover following the COVID-19 shock that occurred in March, with the iTraxx Index ending the month 11bps tighter at 65bps. Despite the setbacks regarding the second lockdown in Victoria and the impact this will have on the credit profiles of corporate Australia, credit investors generally looked through this weakness.

Companies announced their full year results in August and this was dominated by COVID-19 related impacts and the uncertainty regarding FY21 profit guidance. Not all sectors were impacted equally. The spectrum ranged from some COVID-19 winners, such as non-discretionary retailers, to some where the impact was yet to fully play out (such as the major banks) to others where the current operating conditions are stretching financial profiles (such as airports). Despite most companies being generally well-funded, the announcement of financial results provided the window for companies to access primary markets. Issuance was dominated by insurance companies with IAG, QBE and Suncorp all issuing subordinated bonds to raise capital. Another point of interest was that ANZ raised the first Australian dollar bank bond where the proceeds were to be used to meet part of the United Nations’ Sustainable Development Goals.

Market outlook

We look for the economy to contract by up to 7% in the June quarter and fall again in the September quarter before rebounding as Victorian lockdown measures are eased. For 2020 we look for GDP to fall by 5.75% before lifting by 5.50% in 2021. The economy is expected to take until Q1 2022 to recapture end of 2019 levels.

This implies a massive build up in slack that will take years to absorb and will exert downward pressure on wages and inflation. The RBA have the unemployment rate peaking at 10% at the end of this year and falling to 7% by end 2022. That level remains well above the 4.5% estimate for the neutral unemployment rate and will require an extended period of highly accommodative policy settings to drive that rate lower.

While the RBA has signalled that it is comfortable with its current portfolio of strategies and advocates that fiscal policy is best positioned to boost aggregate demand, the RBA Governor has signalled that the RBA would be prepared to provide further support if they felt any additional measures would gain traction.

With the Governor again noting that negative interest rates remain “extraordinarily unlikely”, additional initiatives are most likely to come in the form of measures that support the smooth functioning of markets and lower borrowing costs across the economy, be it for banks, corporates, individuals or state governments. Further steps could include extending forward guidance, yield curve control and Term Funding Facility measures.

We see the lift in longer-dated government bond yields, following the Fed’s dovish policy shift, as reducing fiscal space and inconsistent with the RBA’s accommodative policy objective. We see scope for them to use their balance sheet to purchase government bonds out to 10 years.

We remain attracted to spread sectors, but have shifted from accumulating holdings following the widening in spreads over March, to becoming more selective about the names and tenors we are adding. Despite ever-present solvency risks, we expect spread sectors to be shored up by the outlook for an extended period of low yields on government securities and unprecedented levels of central bank support for both sovereign and non-sovereign debt markets.

We remain mindful that massive fiscal easing, burgeoning money supplies, geo-strategic supply chain reconfigurations and the blurring between monetary and fiscal policy in some jurisdictions raises medium to longer term inflation risks. Add to that the Fed’s shift to an inflation averaging target where it stated that it will tolerate a period of inflation over 2%. Against this mix of cyclical and structural factors we think it remains prudent to hold a core exposure to inflation-protected securities while inflation protection remains cheap.

By Frank Uhlenbruch, Investment Strategist

The post Australian economy expected to take until Q1 2022 to recapture end of 2019 levels appeared first on AdviserVoice.

Frank Uhlenbruch

Australian government bond yields continued to rally over January as weaker domestic economic readings led markets to become more confident that the next move in the cash rate would be down. Longer-dated yields benefitted from flight-to-quality flows when concerns over trade, Brexit and the US government shutdown were most elevated. Risk appetite recovered, with equity markets performing strongly and there was some narrowing in credit spreads. Overall, the Australian bond market, as measured by the Bloomberg AusBond Composite 0+ Yr Index, gained 0.64% over January and follows December’s strong gain of 1.5%.

The domestic economy looks to have lost some momentum towards the end of 2018 and confidence measures, which had held up through an earlier period of falling house prices and equity markets, fell sharply in December. On the activity side, there was a sharp fall in the business conditions index in the NAB survey from well above, to well below long run levels. While most likely reflecting some seasonal volatility, given that other PMI measures remained in expansion territory and capacity utilisation rates in the NAB survey were elevated, future moves in this series bear close monitoring. Building approvals declined a greater than expected 9.1% over November, to be down 33% from the peak levels of a year ago.

Labour market conditions remained solid, with the unemployment rate falling back to 5% in December and total jobs lifting by 21,600. The composition of jobs gains was on the softer side, with full time jobs falling by 3,000 while part time jobs rose by 24,600. The participation rate slipped from 65.7% to 65.6%, but still remains close to cyclical highs. Forward labour market indicators were mixed with DEWR skilled vacancies lifting 0.7% in December, while the NAB employment index pointed to a fall in near term jobs growth from around a 22,000 per month pace to an 18,000 per month pace.

The rate of credit growth continued to slow in December, reflecting a combination of demand and supply side factors with the slowdown most evident in personal and investor lending. On the prices side, headline inflation rose a stronger than expected 0.5% over the December quarter for a yearly rate of 1.8%. Core inflation remains contained, with the average of the Reserve Bank of Australia (RBA) statistical measures lifting by 0.4% for a 1.8% year rate. The income side of the economy should receive a boost from a jump in the terms of trade, with the export price index lifting by 4.4% over the December quarter against a 0.5% lift in the import price index.

Against this back drop, three and 10 year government bond yields ended the month 10 basis points (bps) and 8bps lower at 1.75% and 2.24%. Australian government yields outperformed those in the US, where the US two and 10 year treasury ended the month 3bps and 5bps lower, at 2.46% and 2.63%, following the eventual reopening of the US government and the US Federal Reserve (Fed) signalling that monetary policy was on hold.

In money markets there was a modest easing in the tightening of liquidity conditions experienced at the end of last year. Three and six month bank bills ended the month 2bps and 4bps lower at 2.07% and 2.19%. Markets became more convinced that the next move in the cash rate would be down, moving from pricing in a 36% to around 50% chance of an easing by the end of the year. For May 2020, the market shifted from pricing a 40% to a 70% chance of a rate cut.

Credit markets strengthened as risk appetite recovered, with the iTraxx Index tightening 18bps to close at 77bps. After an extremely quiet December, primary markets re-opened and this was led by the major banks. Between CBA, ANZ and Westpac, they raised just under $12.5bn from domestic investors over the month. Given the impending release of the Royal Commission findings, this was a strong result for the banks. The domestic company reporting season occurs in February and this will provide investors with an update as to how companies are managing their credit profiles.

Market outlook

Despite comments from an RBA board member that the next move in the cash rate was eventually up, the gap between the RBA’s expectation for the path of the cash rate and market pricing continued to widen in January.

Given recent choppiness in domestic data, unresolved trade tensions and a slowing in the global economy, we expect that the RBA will signal in upcoming communications that leaving the cash rate unchanged at current accommodative levels will help it meet its mandated objectives.

Rather than cut the cash rate once and tighten again later as the market has factored in, we think the RBA would rather keep the cash rate unchanged at the current accommodative level for a longer period before gradually winding back the amount of policy accommodation from 2020 onwards.

Such a strategy preserves scarce monetary policy ammunition for a real shock and allows time for house prices to find their level after a tightening in lending standards designed to reduce financial stability risks. Furthermore, waiting also allows time for any election-related fiscal easing to become visible and time for offshore policy makers to support their economies.

The Fed has already signalled that it has moved from tightening to patience mode and signalled greater balance sheet flexibility. The recent rebound in risk appetite and lower government bond yields should see some unwinding of the tightening in financial conditions evident late last year and help extend the duration of the current global expansion. Chinese policy makers have announced and are likely to announce further measures to support their economy while minimising financial stability risks.

While we see near-term risk as tilted to the downside, three and 10 year government bonds yielding 1.73% and 2.20% (at the time of writing) look expensive in our view and are fully discounting significant downside risks and a very low terminal cash rate.

Frank Uhlenbruch is an Investment Strategist in the Australian Fixed Interest team

Views as at 31 January 2019.

The post Market review – February 2019 appeared first on AdviserVoice.

Frank Uhlenbruch

While weather events created some volatility in the data, it appears as though the Australian economy is poised to expand by around 2.50% to 2.75% over 2017. Monetary policy settings remained accommodative with the Reserve Bank of Australia (RBA) leaving the cash rate unchanged at 1.50%. Central banks’ concerns about medium-term financial stability were somewhat allayed by macro-prudential measures designed to tighten lending standards and limit growth in riskier types of lending.

The main positive surprise on the macro side was the strong rebound in the labour market after a lacklustre period over 2016 and early 2017. Over the 12 months to September 2017, employment was up 3.1%, with full time jobs growth accounting for most of the gain. The rebound in the labour market helped close the gap between persistently elevated levels of business conditions and subdued levels of consumer confidence.

Given the strength in jobs growth, some fall in the unemployment rate could have been expected over the year. Instead the unemployment rate has largely tracked sideways as labour market strength enticed workers back into the labour force, resulting in a lift in the participation rate. Going into the end of 2017, historically low rates of wages growth and elevated levels of underemployment suggest that the labour market still has some slack in it.

What’s in store for 2018?

Trend to above trend growth: against the backdrop of solid major trading partner growth and with public infrastructure work yet to be done at around 6% of nominal GDP, the economy is reasonably well-placed to manage the end of the most recent housing boom. Consumption is expected to grow at a moderate pace and net exports are set to benefit from further expansions in LNG export capacity. Business investment is poised to become a source of growth as the drag from falls in mining investments finally ends. Overall, we see economic growth lifting to around 3%.

Gradual lift in inflation: we look for the underlying inflation rate to gradually lift to 2% by the end of 2018. Upward pressure comes from the direct and indirect flow-on effects of higher utilities prices. Some further tightening in labour conditions and the flow-on effects from the 3.3% lift in the minimum wage in mid-2017 should exert upward pressure on inflation in the non-tradeable sector. Working in the opposite direction is limited rent inflation given recent increases in dwelling supply and heightened completion in a range of sectors from new and prospective new entrants.

RBA tightening on the horizon: while some offshore central banks have begun to remove high levels of policy accommodation, the pace of tightening is expected to be very gradual given low wages and inflation outcomes. Given that many offshore economies had to ease monetary conditions by much more than Australia, the RBA has suggested that initial rises in offshore rates have no automatic implication for domestic settings.

While the RBA appears to be in a patient mind-set, its expectation is that the next move in the cash rate will be up. We suspect that as we head towards the end of 2018, the growth and inflation outlook will allow the RBA to commence winding back the level of monetary accommodation towards a more neutral stance.

By Frank Uhlenbruch, Investment Strategist in the Australian Fixed Interest team

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