Australian Budget
Last week we pointed out that the assumptions on which the budget is based are more important than most realise. The Federal Budget assumption of steady unemployment, steady inflation, steady economic growth over the forward years may be convenient but, in all likelihood, will be wrong. There is a base assumption in the budget that Business Investment will increase over the forward years and that this will lift labour productivity growth to 1.2%pa. Most of the budget outcomes forecast are predicated on this assumption being realised. We cannot see any chance of business investment increasing under the current policy settings of the Federal Government and in fact we expect it to decline and in doing so, further undermine labour productivity that is currently negative 1.2%pa.
The chart below shows an increase in business investment comm encing in 2021 when small business investment decisions, post the pandemic lockdowns, drove both an increase in business investment and a sharp increase in labour productivity. This reflected the policy decisions taken by the Morrison government that supported all businesses through the lockdowns and the fact that these stimulatory measures remained in place well after the lockdowns were lifted due to the timing of the 2022 Budget & Federal Election. Since 2022 the increase in business investment reflects mostly a growth of investment in the health and education sectors that is unlikely to be maintained given its reliance on government subsidies and its failure to produce an increase in labour productivity.
The centre piece of the Budget was the tiny further reduction in the income tax rate that applies to employees’ earnings between $18,201 & $45,000 pa. Together with the tax cuts announced last year the tax rate on this portion of earnings will have fallen from 19% to 14% by the end of the 2027 financial year. Given the fact that last year’s tax cuts had minimal impact on household consumption activity we do not expect this added reduction to have any impact, at all, at an aggregate level, however, it may encourage part time workers that still accept welfare to increase their working hours. If this reduces our nations dependency on welfare then we are all winners, but no one should hold their breath waiting for this outcome.
The real problem we have with the extra tax cuts is that they are increasing the mortgage on our children’s future. The government is borrowing from the future to fund it staying in government today. Is this a price worth paying? All Australians should be questioning how efficiently all government spending is being allocated (wasted) if it means borrowing from our future. Surely, the $300m wasted on ‘The Voice’ campaign and the billions being wasted on the not commercially viable Green Hydrogen Mirage would have been better spent on things like our nation’s defence?
There was a lot written about the Federal Budget last week. Here are some of the articles we thought are worth reading:
- Budget 2025: Tax cuts – everything you need to know about Jim Chalmers’ new income tax measures
- Budget 2025: Why Labor’s tax cuts are so trivial
- Budget 2025: There is no plan to pay for tax cuts and spending
The must-read opinion piece from the AFR Editor points out that the Budget fails to address 3 issues:
- The NDIS is still out of control.
- Tobacco taxes are going up in smoke.
- The spending assumption are not credible.
Budget 2025: Three problems bigger than the puny tax cuts
US Economy
The US PCE prices index data released on Friday night was a further confirmation that inflation is embedded in the US economy well above the Federal Reserve’s target of the core PCE price index at 2%. Last week we warned that this was the case.
“The reporting of Federal Governor Powell’s speech and the interpretations were disappointing. Many leapt on the use of the word ‘Transitory’ to conclude that the Fed will look through the impact on inflation of the tariffs. Talk about short term memories! The last time the Fed claimed that price increases would be transitory it was very wrong. Not a little wrong, but very wrong and still wrong today given the inconvenient truth that inflation is no longer declining and is still well above the Federal Reserve core PCE price index target of 2%.“
The monthly core PCE price index showed a gain of 0.4% to lift the yearly rate to 2.8%. The markets were expecting a monthly reading of 0.3% for an annual rate of 2.7%. On its own this price index is not significant, but the market may be looking forward to higher import prices feeding into inflation readings. There are several factors at work here:
- Durables Good orders are strong ahead of tariffs. Last week’s Feb durable goods orders release saw an 0.9% increase when a negative 1.2% was expected.
- Imports increasing ahead of the tariffs.
- Impending Whitehouse actions against shipping companies involved in Russian oil trade.
- US based manufacturers pricing finished production with an assumption that some of the inputs would be impacted by tariffs. As an example, most of the luxury brands of cars have their electronic car keys made in Wuhan China.
Interest Rates
The sharp 12bp fall in US 10-year yields on Friday night was a panicked flight out of equities driven by poor economic data, more uncertainty over tariffs and a higher PCE data print than expected. The US 10 year closed at 4.239% and the key 5-year yield also fell 12 bps 3.98%. It is worth noting that the 9bp fall in the 2-year yield to 3.91% suggests that the fall in yields was not driven by macroeconomics but merely the market uncertainty around the Tariffs being imposed from April 2. We see the US 10- and 5-year bonds trading in a tight range from 4.20-4.40% until there is more certainty around the US tariff policy.
The comm. gov. 10-year yield finished the week at 4.41% but this will fall given the US bond rally on Friday night. The 2-year bond yield finished the week at 3.71% after Goldman Sachs came out very publicly with a forecast of the RBA cutting rates at the April meeting this week. Seems they are running early – a Reuters poll of 39 economists unanimously expect no cut next week, however 75% expect a rate cut at the next RBA meeting in May. Perhaps GS are doing the ALP’s rate pushing, just as journalists and ex-Labor pollies did prior to the RBA Feb rate cut.
Major Credit Markets
US investment grade (IG) spreads continue to widen with tariff uncertainly, driven home by the 25% tariff on imported cars, impacting the big auto names in the US and that seemingly no one in Corporate America will be untouched as the tariff rollout continues. Overall high-grade corporate average credit spreads are wider by 9bp YTD according to BofA.
The Australian market showed early signs of exhaustion last week under the weight of several corporate (non-bank) issues. Scentre issued at 30NC 6.5-year T2 at +200bp, Coles $300m 7.5-year fixed at +145bp and then Worley cancelled its 7-year bond due to a lack of demand. There were also a number of issues done offshore with Brambles, QBE, and Woolworths bond issues all well bid. This week we are likely to see the banking sector return with senior and T2 offers in Australia. This will pressure Bank senior and T2 margins wider.
High Yield Markets
US high yield (HY) spreads got another whack late in the week with the average HY spread moving higher by 0.43% to 3.13%. Spreads hit 3% in mid-March and are thus volatile as shown in the chart. Monies continue to move out of HY funds. A volatile equity market is always negative for HY spreads.
Hybrids continued to firm after the AN3PH redemption funds hit accounts on March 20. The average major bank hybrid margin fell by 0.07% again over the week to now be 1.85%. Volumes were still above average however the focus different from previous weeks, with Macquarie hybrids getting strong buying attention, as well as longer dated ANZ and Westpac issues. The Dec 2031 maturing MQGPG topped turnover with nearly $10m traded.
The smaller listed semi-annual bonds and hybrids will have their bi-annual focus in the sun next week with RHCPA, AYUHD, AYUHE and NFNG all ex-distribution. Often these securities track sideways in price until ex-distribution week.
Listed Hybrid Market
Hybrids continue to rally.
Hybrids rallied last week as mentioned above, with the average major bank hybrid margin falling by 0.07% for the second week in a row and quite out of synch with credit markets, which have been weak. This level is close to 4-year lows as shown below and has been driven by the AN3PH $930m redemption being reinvested, as well as the improved risk profile for hybrids since the APRA decision to halt hybrid issuance. The chart below shows the overall average margin as well as the average margin for longer dated issues alone. The gap between the two is the hybrid yield curve, which as shown, is now quite tight. This indicates investors have a preference for longer dated hybrids and not short dated, a logical move to stay invested in the sector given the APRA decision to halt bank hybrid issuance. As time proceeds, the APRA decision looks more and more confused contradictory. Not only is it against the global trend, but market participants are now questioning the rationale of removing a risk buffer and the resultant transition of this stress to sub ordinated notes. All in the name of reducing hybrid investor risk. Careful what you wish for APRA. Don’t say we didn’t warn you!
Forward Interest Indicators
Australian rates
Swap-rates fall in line with bond rates.
Swap rates:
10-year swap 4.24%
7-year swap 4.06%
5-year swap 3.90%
1-month BBSW 4.10%
