Mixed bag for investors amid credit market volatility
Insights on the Australian interest rate outlook, US tax reform, and winners and losers in fixed income featured in Morningstar's Australian Credit Monthly for December 2017.
Insights on the Australian interest rate outlook, US tax reform, and winners and losers in fixed income featured in
.
Macro-economic sentiment at home and abroad affected yield expectations and currency movements last month, according to Morningstar's director of equity and credit research, John Likos.
He pointed to heightened expectations of an interest rate increase from the Reserve Bank of Australia by August 2018, "with two-year yields up 23 basis points, while 10-year yields moved up 15 basis points for the month."
In North America, the President Donald Trump administration's tax reform measures introduced more volatility into the mix.
"The tax plan will increase the budget deficit by an estimated US$1.5 trillion, to be funded by government borrowing.
"As such, the spread on two- and 10-year Treasuries was volatile in December, increasing to as much as 0.62 per cent, before declining to finish the month at 0.51 per cent," Likos says. Overall, this spread had been narrowing through 2017, driven more by the sharp rise in the short end of the curve, as shown in the following graph.
Exhibit 1: The spread on U.S. Treasuries continues its downward trend
Source: FRED Economic Data, Thomson Reuters, Morningstar
Likos believes the expectation of three rate hikes by the Federal Reserve in 2018 is "supporting the front end of the curve, while global factors suppress the long end".
Further North in Canada, yields increased 20 basis points to 2.08 per cent in December, in response to a falling unemployment rate--the lowest in a decade--and an oil price uplift.
Credit market performance
Likos also discussed the positive price environment for Australia's major bank hybrids during December, particularly for WBCPD and National Australia Bank hybrids NABPC and NABPD.
"On average, major bank hybrids finished the month 23 basis points tighter than November," Likos says.
The opposite was true for some non-bank bonds, including Tatts Bonds (TTSHA), with a final decision struck on the Tatts-Tabcorp merger agreement. These had a "volatile month, ending 85 basis points wider".
He also pointed to some other corporate bonds that had a smoother ride during the month, including AGLHA.
In the US credit market, where yield curves are their flattest since before the global financial crisis, Likos says there "were a few spikes in volatility earlier in the year [but] volatility was subdued in the fourth quarter".
In US corporate bonds, fundamentals for corporate credit risk generally remained strong, along with a "constructive" economic outlook.
Domestic economy
On the home front, Likos discussed the effect of rising workforce participation rates on national gross domestic product--leading to higher compensation rates overall, even as Australian wages remained flat over the year to September 2017.
"The unemployment rate remained steady at 5.4 per cent, while the participation rate increased 0.3 per cent in November," Likos says.
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Glenn Freeman is Morningstar's senior editor.
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