Frank Uhlenbruch, Investment Strategist in the Janus Henderson Australian Fixed Interest team, provides his Australian economic analysis and market outlook.
Expectations for a post-vaccine global rebound were buoyed by further proposed fiscal easing from the new Biden Administration and US Federal Reserve (Fed) signalling of a long period of accommodative monetary settings. Burgeoning sovereign debt supply saw yield curves steepen and inflation expectations edged higher. Credit markets were relatively solid. The Australian bond market, as measured by the Bloomberg AusBond Composite 0+ Yr Index, ended January 0.42% lower.
The global and Australian economies are entering a recovery year as vaccination programmes are rolled out and policy settings remain supportive.
Yields at the shorter end of the yield curve remained anchored around the Reserve Bank of Australia’s (RBA) 0.10% cash and three-year government bond yield target. The three-year government bond edged up to 0.113% before ending the month at 0.111%.
Longer-dated government bond yields continued to lift, mimicking offshore moves as growth and inflation expectations were revised up and markets adjusted to significant sovereign issuance. Despite a brief risk-off period and Fed indications that there would be no premature end to its Quantitative Easing (QE) programme, the 10-year government bond yield ended the month 16 basis points (bps) higher at 1.13%. The 30-year government bond finished 19bps higher at 2.14%.
Partial demand indicators pointed to strong momentum over the December quarter, with strong gains in business conditions and building approvals though the most recent round of border closure knocked consumer and business confidence lower.
Labour market conditions continued to improve with strong lifts in hiring intentions recorded. The number of jobs lifted by 50,000 in December, bringing the total number of jobs added since May’s lockdown low to 784,000. The unemployment rate ended 2020 at a better than expected 6.6%.
On the prices side of the economy, the December quarter Consumer Price Index (CPI) came in stronger than expected. Headline inflation rose by 0.9% and was boosted by higher childcare costs as earlier support was withdrawn and higher tobacco prices. Most price gains reflected policy decisions rather than stronger demand. The average of the RBA’s underlying inflation measure rose by 0.5% for a 1.3% yearly rate.
Money market rates remained very low given the 0.10% official cash rate and RBA forward guidance for an extended period of highly accommodative policy. Three-month bank bills ended the month unchanged at 1bps, while six-month bank bills ended 0.5bps lower at 1.5bps.
After some profit taking activity seen heading into the new year, 2021 started on a positive note for credit market performance despite uncertainty over another round of state border closures. Reinvestment of bank senior maturities and cash built up over the holiday period saw spreads rally on both floating rate financials and corporate bonds as the alternative of sitting in cash at 0.0% remains undesirable for investors. Bank floating rate note (FRN) spreads rallied 3bps lifting returns to 0.09%, while spreads on corporate investment grade bonds tightened 5bps helping lift returns into positive territory.
Higher yielding spread sectors like bank hybrids and subordinated debt outperformed returning between 0.2-0.6% as a reasonable level of income remains in high demand. Cash bonds outperformed synthetic indices, with the iTraxx Australia Index widening 7bps in spread to 63bps following weakening in offshore derivatives over the month.
With the RBA Term Funding Facility (TFF) substituting supply of senior bank notes, the local primary market had a very quiet start to the year. University of Melbourne (AA+ rated) issued a $150m of 10-year bonds at a yield of 1.97% to refinance their upcoming 2021 maturity, while Mercedes Benz issued $150m of a 3-year maturity at 0.75% yield. The main primary supply of note was Westpac issuing $1.25bn of a new 10 non-call 5-year subordinated note at a spread of 1.55%. In total, the $1.55bn of Australian dollar credit supply was materially less than the $4.2bn of credit maturities for the month. NAB, Macquarie Group and ANZ all chose to issue in offshore markets, with a combined $4.4bn of TLAC eligible supply finding very robust demand from global investors.
The global and Australian economies are entering a recovery year as vaccination programmes are rolled out and policy settings remain supportive. In their latest forecast run, the International Monetary Fund (IMF) look for 2021 world growth to lift by 5.5% after falling by 3.5% in 2020. For 2022, they forecast 4.2% growth.
Following stronger domestic partial demand data, we have lifted our 2020 Australian economy growth forecast and now look for the economy to contract by 2.75%. For 2021, we look for the economy to lift by 5% which should see the economy return to the same size it was at the end of 2019 towards the end of the year.
Spare capacity remains though, and when combined with weak wages growth and a stronger currency, should act to keep medium term underlying inflation low. There is scope for a near-term lift in goods prices as strong consumer demand meets low stock levels, but this should fade as domestic and global production ramps up.
The global and domestic yield curve (cash 10-year spread) has steepened since late 2020 as markets factored in a cyclical rebound. This steepening occurred despite central bank asset purchase programmes and represents a tightening in financial conditions cet par. Market conviction in the recovery story is high with five-year, five-year forward rates (a proxy for the longer run cash rate) in the US rising back to pre-COVID-19 levels and in Australia’s case, to levels not consistently seen since mid-2019.
While some curve steepening should be expected given the improved outlook, we are mindful of periods where markets can get ahead of themselves. Recent currency strength and an eventual shift in the fiscal pulse from positive to negative should act as drags on growth and require the RBA to keep monetary conditions accommodative. An expansion/extension of its QE programme may be warranted to support medium term growth prospects.
Views as at 31 January 2021.