The following Chanticleer article in last weeks AFR was typically light on detail (Why Ray Dalio and Jamie Demon are looking past interest rate cuts to the ‘ticking time bomb’ of debt, inflation and geopolitics (afr.com)), but if we accept the headlines are true (just for a moment), these are:
- US Economy is in relatively good balance i.e. Agg D = Agg S.
- US rates will remain at current levels or pick up.
- The growth rate of the US budget deficit – now $1.8tn- is far more important as it is inflationary to the extent that it keeps Agg D > Agg S.
- Geopolitical risk is elevated and not being reflected in asset market pricing.
What the Chanticleer article does not provide is the ‘bones’ upon which these conclusions (headlines) are based. No doubt Dalio and Dimon had teams of analysts that had built huge pillars to support these headlines (conclusions) but we will give you two economic facts that support their conclusions.
1. US Employment growth remains at levels consistent with an economic recovery not even just a stable outlook at average reading of near 150,000 per month. The US economy only needs a reading of 100,000 per month for stable growth. The unemployment rate will remain at a level above ‘full employment’ (measured as unemployment @4.4%) and with wages growth significantly higher than a level consistent with inflation sustainably falling back to the 2% target there is a risk of cost push inflation emerging. Higher inflation has stressed household consumption, but despite the huge level of immigration over the past 2 years workers are still able to find extra employment to supplement the household budget. At this stage there is a significant risk, now that the transitory pandemic impacts are exhausted, of wages growth feeding into a higher inflation for longer.
2. Broad money growth in the US has now risen out of the negative territory – consistent with an economic expansion and with money velocity rising.
The global asset markets appear to be asleep at the wheel with their benign risk outlook. Never have we had so many risks building simultaneously. The list is huge but here are few examples:
• Rising global population with implications for famines, resource depletion and pandemics.
• An energy shift away from fossil fuels to higher cost alternatives – inflationary.
• Deglobalisation in the form of tariffs aimed by the US at supporting domestic industry and by the EU to restore the balance between EU carbon emission regulations and production from the developing world- inflationary.
• Instability in the Middle East.
• The Russian invasion of the Ukraine and the risk to greater Europe of Russian success.
• China threatening the sovereignty of the democratic Taiwan and the freedom of navigation in the South China Sea.
• China building the largest military force in the world that cannot be justified for defence purposes.
• North Koreas rocket program threatening both South Korea and Japan. War and peace on the Korean peninsula, by Martin Hart-Landsberg (Le Monde diplomatique – English edition, June 2024)
If there is a ticking clock then the ticking is getting louder but in the short term there are perhaps two key risks that warrant close attention:
- The Chinese economy. The market’s reaction to the Chinese government’s stimulus package was extraordinary. Greed may overcome fear, but it is remarkable that rational investors believed this response would solve the underlying problems. China may now be trapped in a period of secular stagnation not dissimilar to what Japan suffered for 30 years from 1989. This article provides some much needed perspective, China Is Suddenly Hot Again. Read This Before You Invest. – Barron’s (barrons.com). The following articles are worth reading too:
a. China’s structural changes nowhere in sight as market absorbs sugar hit (afr.com)
b. China stimulus: Xi Jinping will determine the policies that stimulate the Chinese economy (afr.com)
c. China’s central bank arms itself for rare bond market intervention (ft.com)
d. China’s Ghost Cities Are a Problem for Europe’s Luxury Brands, Too – WSJ
2. The French Budget and political stability. Last week’s Budget announcement solved nothing for France. Government bond yields are still trading at levels comparable with the PIIGS and even there they are higher than Portugal and Spain. It seems unlikely that the budget will achieve the outcomes forecast and so the day of reckoning has only been postponed, perhaps only until 31 October 2024 when the EU deadline arrives. These articles are worth reading:
a. What French Election Results Could Mean for Its Economy and Bond Markets – Barron’s (barrons.com)
b. France’s Crippled Finances Strain Macron’s New Government – WSJ
c. France’s borrowing costs converge with Spain’s as budget concerns grow (ft.com)
d. French PM Michel Barnier unveils shock therapy in 2025 budget (ft.com)
e. France asks Brussels for extra delay on spending plans (ft.com)
A word to Victorians. China and France have high government debt levels in common. When the debt levels in Victorian households, government corporations, government and the construction industry are combined the outlook looks far worse.
Interest Rates
US rates continued to rise on reduced Fed rate cut prospects backed up by moderate CPI (slight rise in September) and PPI (unchanged in September) readings. Markets have pared back the size November and December cuts. The Fed maintains a cutting bias but is very data dependant, retaining inflation as the primary driver rather than economic performance. The yield curve continues to steepen, 2 yr treasures up 0.02% to 3.95% and 10 yrs. +0.13% to 4.095%.
Australian sentiment indicators (Westpac consumer and NAB business confidence) have ticked up giving more reason for the RBA to hold. RBA minutes were released and did not contain the last two meetings comments that a rate rise was discussed. The neutral rate stance was continued. Australian bond yields again tracked changes in the US yield curve last week with strong rises across the curve; 2 yrs up 0.17% to 3.84% and 10 yrs. +0.18% to 4.227%, a 2-month high.
Major Credit Markets
US investment grade (IG) margins fell few points as banks unveiled robust quarterly results plus a November Fed rate cut still being possible. US IG issuance remains strong as corporates tap the demand after the recent rates jumps. We have seen this previously in 2024, a move in the 10-year treasury above 4% sparks investor bond demand across the risk spectrum despite the tight margins. Investors are focussed on the absolute higher level of yield. Issuers are quick to tap the demand.
The Australian IG credit market was strong with a ‘risk on’ sentiment predominating so far this month. Bank sub notes have rallied back to levels pre the APRA hybrid notice (tier 2 to sub for hybrids), with longer dated major bank sub notes contracting some 12-15 bps., the shorter end by 5-7 bps. Issuance was reasonable with NAB raising $2.75bn in 3 yr. dual tranche senior unsecured bonds. $2.4bn was floating at BBSW+0.70% and $350m fixed rate at 4.45%, at +0.70% to swaps. QBE privately place $45m of a 15NC10 Tier 2 note.
High Yield Markets
US high yield (HY) markets remained steady however monies are flowing at a moderate pace out of HY funds. Issuance remains solid given tight margins inducing companies to refinance. This may slow down if the absolute level of rates rises further. With economic conditions good, demand for ‘CCC’ rated bonds is strong, the ‘CCC’ to ‘B’ spread having contracted near 2% since June, the tightest gap since 2022.
Hybrids remain steady after some initial weakness early in the week. Margins are at still lows. Volumes have fallen back to 2024 average daily levels (around $28m pd). Last week longer dated major bank hybrids saw weakness with most issues widening 0.10-0.15%. Mid curve major bank hybrids were also weaker whereas demand was solid for shorter term issues, counteracting the longer dated widening. Similarly shorter dated Macquarie hybrids were weaker. This implies some of the buying for longer dated hybrid has abated.
Listed Hybrid Market
Hybrids – non major bank hybrids recent moves
Since the APRA paper release in mid-September, we have mainly focused on the moves in major bank hybrid margins. Below we look at the non-majors. For context, as mentioned above, hybrid margins are at lows. The chart shows changes from the date prior to the APRA release. The name for each hybrid is shown directly above the most recent margin point (blue dots). The red dot vertically above or below the blue dot is the corresponding margin for that hybrid on September 9. As shown there has been a lot of margin moves. mostly lower. Nearly all the second half of the curve is tighter, some by 0.30%. In the first half of the curve, it’s a different story. Most issues, apart from CGFPC and BOQPF, are the same or wider, especially the Macquarie issues wider. Hence the same pattern as with the major banks is apparent, the market has sold shorter dated issues for longer dated (although as mentioned above this unwound somewhat last week). Note all these non-major bank longer dated issues are just or well under a 2.50% margin, unthinkable 6 months ago.
Forward Interest Indicators
Australian rates
Swap rates rise with bond rates.
Swap rates:
– 10-year swap 4.32%
– 7-year swap 4.15%
– 5-year swap 4.02%
– 1-month BBSW 4.30%
