The way the markets reacted to the US data releases last week was a little odd. Perhaps the Wall Street Junkies are all blinded by the impending Federal Reserve interest rate decision where they now expect a 50bps cut and if they don’t get it they will not be happy because it will be sobering?
US data releases
Although headline CPI ticked down to 2.5%pa from 2.7% in July, this fall was mainly the maths of the rolling data set. The market had hoped for a similar fall in core CPI but was disappointed with a slight increase.
PPI
The market ignored the uptick in the PPI in August from 0.1% to 0.2% and the core from -0.2% to +0.3%. The PPI is good leading indicator of the CPI and PCE prices index with a lag that varies due to supply and demand at the retail level. A further move down in the “transitory price” factors seems unlikely from here and so inflation will be driven by wages and service costs.
Import prices
The market saw the slight fall in US import prices as good news for the inflation outlook – and it was. Under a flexible exchange rate regime, the transition mechanism from monetary policy to change the economy is via the exchange rate. The USD has been very strong over the past 18 months and yet we have not seen any change in the difference between the value of exports and imports. We need to see the strong dollar resulting in a rise in imports (because the strong dollar makes them cheaper) and a fall in exports and then factors of production moving from export industries so that the economy contracts. This has not happened yet.
Interest Rates
Yields appear to be moving to test their 18-month low points continuing their recent direction trend. 2-year yields were down 0.068% to 3.58% and 10 years down 0.057% to 3.65%. The market waits for the upcoming Fed meeting this week.
The Australian yield curve continued to track changes in the US yield curve last week with some steepening at the long end. Much like the US 10-year yield, the Australian 5 and 10-year yields appear to be breaking down to test the lowest levels we have seen for 18 months. We may see these yields as a medium-term low point with increased Commonwealth and state issuance expected into the end of the September quarter and in early October. The markets are still awaiting the S&P ratings review on TCV (Vic state) debt. This may prove to be a flash point for all semi-government bonds even though it is clear that not all state debt positions are as dire as Victoria.
Major Credit Markets
Investment grade (IG) primary market issuance last week was a large US$38.225bn and average credit spreads tightened 2bps to 99bps. YTD credit spreads have tightened only 5bps. So much of the buying demand will relate to an expectation in the equity and credit markets that the Federal Reserve will cut rates by 50bps in the week ahead. Of note was the Moody’s announcement that Boeing’s rating is now on review for possible downgrade to junk (below BBB-).
Australian IG margins moved in a tight range last week balanced between supply and demand. Westpac issued a massive $2.5bn 5-year FRN at 85bps. Of note was that demand for the fixed rate offer was a mere $200m. There is some concern re the APRA proposal regarding that hybrid securities be replaced in a bank’s capital structure by Tier 2 debt, whose margins moved wider after the announcement by 5pts.
High Yield Markets
After a good recovery from the mid-August volatility jump, high yield (HY) markets have deteriorated in the past week with credit margins expanding. This has been observed across most HY sub sectors except Real Estate and Telecom. The reason is a fall in expectations of overall economic growth and a smaller rate cut now being probable. Interestingly, the rise in spreads has mainly been in “BB” and “B” rated bonds, “CCC” remaining reasonably stable.
The APRA bombshell regarding the cessation of issuance of AT1 hybrids saw large secondary market buying pushing most spreads tighter (see next page). The average major bank hybrid margin, already tight, fell by 0.12% to 1.81%, a low of the past 10 years. Weekly volume was $193m vs. an average of $150m so far in 2024. Buying was concentrated in long-dated hybrids, with AN3PL leading the volume, followed by WBCPM, NABPH, NABPK, AN3PK and AN3PH. CBAPJ was the only CBA hybrid trading well above its typical volume.
The new Macquarie Bank hybrid lists Tuesday and should enjoy a pricing uplift given the recent rally.
