So much has happened in the markets over the last few weeks, we thought it worth trying to unpick what’s gone on.
A quick review of the US market
In our last monthly review of the markets, I stated “Many analysts are looking for the US 10 year bond yield to accelerate to higher yields if it can have several sessions above 2.40%”. This is what happened in January – after starting the year at 2.41%, yields steadily increased throughout the month.
On 3 February 2018, US data showed stronger than expected wage growth. Following this release, the benchmark 10 year bond touched 2.88% in yield (bonds sold off), up 8 basis points on the day. This stronger wage data and higher yield to maturity (YTM) spooked equity markets, as was widely observed. Currently, the 10 year bond has a YTM of 2.90%.
A quick review of the Australian market
On the last day of January, CPI printed below expectation and caused the yield of bonds to fall and prices to rise across the board. The movement in US bond and equity markets dominated headlines. Domestically, the RBA left interest rates on hold, as was widely predicted. The RBA stated they expected any rise in inflation to be gradual. Later in the month, Australia’s own employment data printed broadly in line with expectations.
What’s happened this month?
- US 10 year bond moved from 2.71% to 2.90% (up 19bps).
- Australian 10 year government bond YTM increased from 2.81% to 2.89% (up 7bps) moving in the same direction (higher YTM and lower prices) as the US 10 year market.
- Australian 3 year government bonds moved from 2.14% to 2.12% (down 2 bps) which is the opposite direction of US 10 year bond yields.
- The change in yields between 3 year and 10 year bonds is called a “Yield Curve Steepening”.
- The pricing of the ASX 30 Day Interbank Cash Rate futures in Dec 2018 actually fell from 1.72% to 1.66% (down 6 bps).
What about corporate bonds?
Credit spreads, or the premium required to hold a corporate bond instead of a government bond, spiked higher – but have generally returned to levels slightly higher than at the end of January. This is observed in index returns below.
- I expect the RBA to remain on hold during 2018 and the Federal Reserve to increase rates at least 3, possibly 4 times this year. US 10 year government bonds will touch 3.00% and may head to 3.25% during 2018.
- I expect Australian 10 year bonds to continue tracking the US market.
- Australian 3 year bonds should reflect RBA expectations throughout the year.
- Credit spreads for corporate bonds will probably remain around current levels until we see a change in the ECB’s quantitative easing policy. This is likely to be in September.
- We will probably see continued volatility in equity markets, this may constrain the amount US bonds increase in yield.
- I would expect the late summer in the northern hemisphere to be a period of increased volatility for all markets.
|INDICES||MATURITY||FEB 2018 TO DATE (MTD)||2018 TO DATE (YTD)|
|Composite Bond||All Maturities||-0.12%||-0.39%|
|Treasury (gov. bonds)||All Maturities||-0.21%||-0.64%|
|Credit (corporate bonds)||All Maturities||0.04%||0.07%|
|Composite Bond||0-3 Years||0.10%||0.24%|
|Treasury (gov. bonds)||0-3 Years||0.09%||0.32%|
|Credit (corporate bonds)||0-3 Years||0.13%||0.40%|
|Composite Bond||3-5 Years||0.12%||0.20%|
|Treasury (gov. bonds)||3-5 Years||0.16%||0.22%|
|Credit (corporate bonds)||3-5 Years||0.12%||0.34%|
|Composite Bond||5-7 Years||-0.02%||-0.26%|
|Treasury (gov. bonds)||5-7 Years||0.02%||-0.23%|
|Credit (corporate bonds)||5-7 Years||-0.02%||-0.20%|
|Composite Bond||7-10 Years||-0.26%||-1.06%|
|Treasury (gov. bonds)||7-10 Years||-0.28%||-1.16%|
|Credit (corporate bonds)||7-10 Years||-0.21%||-0.76%|
|Composite Bond||10+ Years||-0.72%||-1.74%|
|Treasury (gov. bonds)||10+ Years||-0.75%||-1.77%|
|Credit (corporate bonds)||10+ Years||-0.26%||-1.57%|
The Bloomberg AusBond Composite Index for all maturities (the common benchmark) produced a negative -0.12% so far for the month.
The Treasury Index for all maturities, which is the single largest contributor to the Composite Index produced a negative -0.21% return.
The Credit Index (corporate bonds) produced a small positive return of 0.04%.
These sorts of results are to be expected when interest rates rise or the yield curve steepens. This is because the Treasury Index which contains just government bonds has a longer average life than the other indices.