November 2018: A Month in Review – Risk On, Risk Off, Repeat
The roller coaster of speculation on trade wars continued. A new feature of the market was comments by the US Federal Reserve Chairman that rates might be approaching neutral. These comments combined with concerns about trade wars meant US bond yields fell (prices rose). Australian rates remain unchanged to very slightly higher.
Review of the US Market
The US 10-year bond ended the month at 2.99% with an intra-month high of 3.23% (the same level reached during October). The closing level compares with an October close of 3.12%. For the US market, the future effects of trade wars created a risk off tone for the second half of the month. For the bond market, this risk off tone magnified the effect of the Fed Chairman’s comments that interest rates may be approaching their neutral level. The market commentary therefore moved to speculating on fewer future interest rate hikes by the Fed than currently expected. The lack of certainty of Fed actions caused bonds to trade to the bottom end in yield of their short-term trading range (higher prices). It must be considered that this could be affected by a change in positioning by the market.
Review of the Australian Market
The RBA remains on hold. The RBA Cash Rate for December 2019 was indicating 1.60%, down 0.01% from the end of October. Many commentators are calling for RBA rates to be on hold until 2020.
The 10-year Australian bond finished 1bps higher in yield at 2.59% with slightly lower prices. Therefore, Australian bonds ignored the rally in the US and focused on the static RBA expectations.
The 3-year government bond’s yield also rose (prices lower) by 3bps to 2.01%. For Australian bonds to fall it seems new economic data affecting the domestic economy is required.
What about corporate bonds and BBSW?
Credit spreads, or the premium required to hold a corporate bond instead of a government bond, were slightly higher. The corporate bond index implies that credit spreads moved on average 5 bps higher. The change in premium was small enough that corporate bonds only slightly underperformed government bonds.
3 month BBSW was higher moving from 1.92% to 1.95%.
As we have discussed, the new levels of BBSW are starting to reflect in higher borrowing rates from bank customers. This in turn is putting a constraint on the economy even though the RBA is not changing its official rate.
Source Bloomberg and Australian Corporate Bond Company
The Bloomberg AusBond Composite Index for all maturities (the common benchmark) produced a small positive return of 0.07% for the month. This reflected slightly higher yields (lower prices) being off-set by income earned during the month..
The Treasury Index (government bonds) for all maturities which is the single largest contributor to the Composite Index produced a positive return of 0.08%.
The Credit Index (corporate bonds) for all maturities produced a smaller positive return of 0.02%. This is due to the fact that the premium required for holding corporate bonds increased slightly. When comparing corporate bonds to government bonds of the same maturity, corporate bonds generally under-performed their government equivalents as defined by the sub-indexes above.