Last week’s Australian Labour force data was much stronger than expected but that did not stop some bank economists trying to downplay it by pointing out that a great deal of the employment increase came from government related services (Education, Health and Administration). We view these jobs as a lot more permanent than private sector jobs. This has implications for inflation at two levels:
- It will not enhance labour productivity.
- It will increase aggregate demand at a time when supply is constrained.
The market had expected an increase of only 25k after the stronger than expected numbers in August, however, in September 64k jobs were added with strong momentum indicated by the employment to population ratio reaching a new high of 64.4%. It must also be remembered that labour participation at 67.2% is increasing labour supply with a strong underlying economy (even if it is driven by government hiring with borrowed money from our children’s future) and increased immigration.
The other factor with the September numbers was that it was 51.6k of full-time employment added and only 12.5k of part-time employment.
In August the growth was supported by 48k of part-time employment growth that the market did not see as sustainable as full-time employment in August fell 5.9k.
Japan Inflation and interest rate policy
Perhaps the market should be happy that the Japanese inflation rate came in lower than expected as it takes most of the pressure off the BOJ to increase rates at the November meeting.
- Headline CPI 2.5%
- Core CPI 2.4%
The fall of inflation was expected by the market because the fall in energy prices since June was expected to flow into broad goods prices. Once the food and energy prices were removed from the reading the CPI increased from 2.0% to 2.1%, a signal of embedded inflation.
We now don’t see the BOJ moving interest rates higher until next year, however, the Japanese 10-year bond yield is expected to move above 1% if the Yen remains weak. On Friday the Yen moved back above $150 to the USD briefly. We now don’t see the BOJ moving interest rates higher until next year, however, the Japanese 10-year bond yield is expected to move above 1% if the Yen remains weak.
Interest Rates
The recent climb in US rates peaked last week with most of the curve steady. Nevertheless MTD 2 yr. and 10-year treasuries have risen by about 0.30% each. This has been driven by strong recent economic data that has cast doubt on more Fed rate cuts this year and fears of a large fiscal spend post the upcoming election. All this rekindles inflation fears and gets reflected in long bond rates. The US yield curve remained slightly positive.
The European Central Bank cut interest rates by 25bps based on recent economic weakness and that the ‘disinflationary process is well on track’.
Australian rates rose well above US moves last week after a strong Labor Force Survey reported another above trend increase in employment growth. Yields were higher across the curve, 2-years up 0.04% to 3.88% and 10-years up 0.08% to 4.31%. Markets are pushing out the timing of an RBA rate cut. The Q3 CPI is released on October 30 and will give a better guide to the RBA’s potential actions.
Major Credit Markets
US investment grade (IG) margins remain firm with the market dominated last week by the major US Investment Banks issuing bonds after reporting season. A huge USD26bn across seven issuers was raised with most books multi-times covered. IG margins remain at multi-year tight levels; however, many now are questioning the value compared to treasuries given the tight margins. The strong economic data is blamed however as mentioned last week, it’s the absolute higher level of yield that investors are focussing on. False economy is reality.
The Australian IG credit market is strong currently underpinned by limited new issuance, a lack of selling volume and as mentioned above, the high level of outright rates, kicked upwards in recent weeks by the sharp jump in comm. gov. bond yields (10-year. +0.35% in October alone). Major bank sub notes continue to rally, margins in another 4-6 pts across the maturity curve. Bendigo Bank issued 4-year. senior floating and fixed rate bonds, $600m and $150m respectively both at a 0.96% margin. This resulted in the fixed rate version having a 4.79% YTM.
High Yield Markets
US high yield (HY) markets continue to rally especially “BB” and “B” rated issues. “CCC” rated issues after recent strong outperformances were flat last week. Nevertheless overall “CCC” rated securities are yielding on average 11.60%.
Hybrids remain incredibly steady after initial weakness early in the week. The average major bank hybrid margin hardly moved day to day. Volumes were slightly elevated, with the recently issued MQGPG leading volumes most days with over 70,000 traded for the week, the price rising by 0.57%, this being a 0.07% fall in margin to 2.20%. Longer dated AN3PL and WBCPK also saw elevated volumes.
Listed Hybrid Market
Hybrids relative to bank bonds
As mentioned in the sections above for many weeks, credit markets are very strong, especially bank credit. Below we show a concurrent margin trading example of a CBA senior, sub note and hybrid, all with similar maturities. The first chart shows the trading margins for each. Note since August 2023 the downward margin trend for each security. The hybrid margin shows much variation over time which would also show up in a relative valuation. This is shown in the second chart.
All roads lead to the senior bonds. The security is the benchmark from which others in the capital structure should be judged. One method to compare security margins is to construct a simple ratio. The chart below shows the CBA hybrid as a ratio to the each of the CBA senior and CBA sub note. With the hybrid margins showing much variation as mentioned above, it is expected the ratio will also show variation. The blue line of the hybrid to senior shows the hybrid is expensive relative to where the ratio has previously traded, especially in the past two months. Relative to sub notes, the hybrid also looks expensive but not to the same degree. This is one valuation tool for buyers of bank hybrids.
Forward Interest Indicators
Australian rates
Swap rates rise with bond rates again.
Swap rates:
- 10-year swap 4.34%
- 7-year swap 4.19%
- 5-year swap 4.07%
- 1-month BBSW 4.30%
