It should not go un-noticed that there was quite a lot of volatility in the currency markets on Friday. We may be getting an early warning signal of another bout of Yen Carry Trade unwinding-risk off trading this week.
The following exchange rate charts show that the Yen is reaching towards the same levels that were last seen on 6 August when the Yen Carry Trade unwinding hit all global markets.
Since 6 August the Bank of Japan has stated that it won’t increase rates again if markets are unstable. There are, however, two different views in the market on future BOJ policy:
- The BOJ will be forced to increase rates to 1% by the end of the next year because wages growth and services inflation (strong connection) are near 30-year highs.
Falling core inflation in Japan will mean that the BOJ can now remain on hold for some time.
The dreaded ISM PMI results did not move the markets. The PMI manufacturing (47.9 v. 48 expected and PMI services (51.5 v. 51.1 expected) indexes both came in as expected. It appears that the July readings that showed both the services and manufacturing indexes predicting an economic contraction with readings below 50 were, like the non-farm payrolls, distorted by weather events.
The infamous non-farm payrolls data on Friday night was a tame result and in line with expectations of an increase of $140,000. Of more concern were the 25,000 downwards revision to the already weak 114,000 July raising and 61,000 downwards revision to the June numbers.
Interest Rates
US rates fell over the week with a volatile equity market and Friday’s August payrolls report failing to give a clear signal as to the size of the upcoming Fed rate cut due 18 September. However, subsequent to the disappointing payrolls data, the market is now doubting a 50bp cut will happen.
Fed speakers late in the week also cast doubts on the likelihood of a 50bp cut. Despite all this treasury yields fell to 15-month lows, 2-year yields down a huge 0.25% to 3.65% and 10 years down 0.15% to 3.71%. The 2 to 10-year yield curve has thus moved positive after a flirtation with zero in early August.
The brawl between the RBA and the Treasurer continues over the RBA’s stance, which appears to be having some effect with the national accounts for the June quarter showing that private sector demand is stagnant. And most doubt there has been any improvement since June end. Australian yields fell but not at the pace of US yields. 10-year Comm. gov. bonds fell 8bps for the week to finish at 3.90%.
Major Credit Markets
Credit markets weakened with the rise in equity market volatility, however this is off very tight levels. The US iTraxx investment grade (IG) index widened from 0.496% to 0.54% over the week with much of this occurring Friday night, perhaps driven by a re-emergence of currency volatility.
Australia credit margins also widened over the week, the Australian IG iTraxx up by 3bps to 0.644%. Issuance was strong: QBE Insurance Group raised A$750m from a heavily oversubscribed dual-tranche Tier 2 note issue of which A$400m was in a 10.75NC5.75-year FRN at 3m BBSW +1.95% and A$350m in a 15NC10 fixed to floating-rate note at a 6.3025% yield which was swap+2.05%. Scentre priced a $900m dual tranche 30NC5 hybrid deal, tightening from 245-250 guidance into +230 at final, with books >3.4bn. WOWAU priced n $200m tap of its 2031s bond at swap+138bps.
High Yield Markets
High yield markets were weak on a few factors. Firstly, weaker equity markets and especially some days with large drops which always negatively impacts HY spreads. Secondly, and related to the first, outflows out of HY funds as investors get scared. Thirdly, large issuance which sucks liquidity.
The average major bank hybrid margin moved lower through the 2% barrier last week, due to not only a recovery from the Macquarie Group hybrid selling but also from a large number of major bank hybrids going ex-dividend, 16 majors in all as well as 12 more non-majors. In a steady state market hybrids often exhibit a “franking saving” event ex-dividend, where the franking credit value is not adjusted for ex-div pricing. For example, CBAPM paid a $1.30 fully franked dividend, the franking value being $0.55, total value $1.85. Hence the price should fall $1.85 in order for the margin to remain steady. However, the price fell only $1.45, resulting in a margin fall of 4bps. There are also some examples where some of the cash amount was saved, that is the price fall was lower than the cash amount, resulting in a margin fall.
Listed Hybrid Market
Hybrids – margins back to lows and no wonder
The average major bank hybrid margin fell last week, helped by most major bank hybrids going ex-dividend (all of ANZ, CBA and NAB hybrids). As described above, unless there is stress in the market, the market often incorrectly doesn’t mark the ex-div price down by the full franking amount. This occurrence is common. Hence the ex-div margin level contracts (the price is higher than it should be). When three major banks go ex-div in one week, the average margin is impacted as previously described above. Over time some of this mis-pricing washes out, but despite this being somewhat artificial in the short term, market prices are where transactions are taking place. If an investor is selling, transacting just after the ex-div date is optimal.
Right now, the average major bank margin has dipped below 2%, the target we have mentioned in the past month subsequent to the Macquarie Group issue. The first chart shows this is not far from a key minimum level post Covid (the environment where interest rates have risen resulting in increasing hybrid yields). The lows in the chart marked 1 and 2 were at December ends when hybrid margins do tend to rally because of illiquidity. Low 3 in mid-July 2024 was after a period of little issuance. As we know, hybrid margins are in part driven by credit markets. The second chart shows the iTraxx index over the same period. This index, representing the top 25 Australian companies’ senior bond margins, is the best daily representation of the senior Australian credit market and despite only being 24% weighted to banks, is a good bellwether for hybrids. The iTraxx index chart shows a similar pattern to hybrids (or to be accurate, hybrids are similar to the iTraxx). The current index margin is close to lows, having bounced of the low at the end of August.
Putting the two charts together is best as a ratio – in this way the current level is easily comparable to previous data. The chart below shows the current ratio and the average for the chart period. The current ratio now is smack on the average. In other words, given where the major Australian credit market is now at, an average major bank hybrid margin just under 2% is very fair. Note also the red circle in the chart – this was a period where hybrids were expensive relative to the credit market. We maintained at the time this was artificial, being due to strong buying from ASX participants when interest rates were strongly rising, as hybrid exposure for some of these participants was the only method of getting exposure to the rising cash rate. Given rates are now steady, equilibration has returned.
Australian rates
Swap rates steady with market rates.
Swap rates:
- 10-year swap 4.03%
- 7-year swap 3.87%
- 5-year swap 3.74%
- 1-month BBSW 4.30%
