June CPI analysis

Funds Management

by Carolyn Herbert

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Transcription of Finance News Network Panel Discussion with Antares Fixed Income Fund Investment Manager, recorded on July 27th 2016, Ken Hyman and Portfolio Managers, Tano Pelosi and Mark Kiely.

Ken Hyman: So we’ve just had the long awaited June CPI release today, a bit of a mixed bag, Tano your key take-outs?

Tano Pelosi: Yes there’s a couple Ken. We saw a headline of 0.37 per cent, just slightly below consensus on the headline. It actually takes the year-on-year measure now to 1 per cent, which is actually the lowest we’ve seen since June of 1999. Key drags were really things like holidays and motor vehicles in terms of the negatives. And on the positive side, we saw prices going up in terms of automotive fuel and the like. So all in all, a mixed bag as we say. I think there’s still a large element of the basket, the goods and services basket that’s reporting negative changes in prices. And this will create somewhat of a conundrum for the RBA, as it goes into its meeting next Tuesday.

Ken Hyman: For sure, I mean that’s what investors are thinking about at the moment. The market was anticipating - it was giving a 65 per cent probability that the RBA would cut rates in August. I think after the CPI release that probability has dropped to about 50 per cent. I’d make the point that the FOMC meeting, which is happening overnight Aussie time, which we’ll see their statement tomorrow morning. That’s going to be a key determinant of the RBA strategy. Because if the FOMC decide to have a more hawkish conversation, and given the very good economic data we’ve seen for the last two months, housing in particular, consumer spending, consumer confidence. If they were a little bit hawkish or upbeat, markets would anticipate that they could be tightening before December.

Because at the moment markets anticipating that the US only tighten, in fact half of the tightening in December, now that’s brought forward, it’s going to put a real rocket under the US data. The US data could strengthen, Aussie would weaken, just what the RBA is looking for. So watch the FOMC, I feel that a bit more hawkish from the FOMC, Aussie dollar will weaken and then that’ll take quite a bit of heat off the RBA, to do anything next Tuesday.

And then don’t forget the Bank of Japan meeting on Friday. This has been eagerly anticipated, are they going to print money? We talk about helicopter money where they literally just shower money into consumers banking accounts. We don’t know, but it could be a market-moving event. Mark, what we call the risk-on in the markets; there’s been a very strong bid for bonds, for credit, merging markets and equities, over the last two months, particularly since Brexit. I mean it has been surprising, any key thoughts on that development?

Mark Kiely: Yes absolutely. Well obviously post the Brexit vote; I guess there’re a lot of expectations, initially we had a bit of a risk-off shock and that sort of came through for a few days, a little while. And then obviously the market got its mind around that central banks were going to underpin, essentially the market. So we found a lot of money then float back into risky assets, equities, currencies. We also found a lot of money also driving through into the bond market and credit market particularly. We saw credit spreads compress quite a lot.

So a lot of money then started to get pushed further out into the risk curve, into the merging markets and also high yield intervention. So we’re finding a lot of the money now, and this is probably a theme we’ve been seeing play out over the last few years, is actually playing the central bank activity and what the central banks are going to do, rather than actually applying the underlying fundamentals. Obviously they’re linked, but there’s definitely this expectation that the central banks around the globe, be it the Central Bank of Japan, the European Central Bank or even The Fed are going to support investors.

And that’s meant a lot of them in this low yield environment, particularly the negative yield environment we’re seeing in Japan and Europe, have actually gone out along the risk curve to try and find additional yield. And that’s driving a lot of investors into asset classes that they probably haven’t been in before, such as high yield. Which potentially means that somewhere down the track, there could be a bit of volatility around some day’s investor positioning. So we’ll see how that plays out. But at the same time, there’s a fairly benign sort of environment we’re facing at the moment. And in that environment rates are structurally low.

Ken Hyman: I’d add to that, I think you’re very kind to say in places they haven’t been before. I think they’re also taking on a risk way, way more than what their comfort zone is. And volatility, I think volatility is just code for you could actually lose a fair bit of money, when those markets correct. So if we look at the valuation of bonds at the moment, our fair value through our scenario process is 2.4 per cent for an Aussie 10-year bond, it’s trading at $195, probably similarly for the US.

So we are – is there a central bank or like QE overlay that you’ve got to place on top of your fair value for a bond. It’s hard to justify buying a 10-year bond at the moment, at $195. But the market is paying that price and as investors, is there something more to it than just that valuation?

Tano Pelosi: There is certainly more to it, but I think in the interim central banks around the world are clearly trying to reflate. And bringing back to today’s CPI, the only real game in town is to try and get your tradeables inflation up, by virtue of having your currency collapse, or at least fall somewhat. Because we know that the non-tradeable side is really, really very benign, very weak and that’s consistent with the weakness in the wages we’re seeing currently.

So there’s certainly a weak impetus on the growth side and to that extent is weak underlying inflationary pressures, which is also underpinning those low bond yields that you referred to Ken.

Ken Hyman: OK, well Tano and Mark, thanks for the chat and until the next time we meet.


Carolyn Herbert

Finance News Network
Carolyn joined FNN in August 2015 as the Head of News and also presented the Market at Midday and the Market Wrap. With more than five years of broadcast journalism experience, Carolyn has worked as a finance anchor on the Sky News Business channel and as an anchor and reporter for ABC News. She is also a qualified corporate lawyer specialising in IPOs, takeovers and mergers and acquisitions.