Last week was quite dramatic with the markets digesting the following events:
- The Iranian direct attack on Israel with 300 missiles.
- The highly successful defence of Israel through a combination of Israeli, US/UK and Jordanian Air Force planes as well as Israel’s air defence systems.
- The equity market’s acceptance that inflation and interest rates in the US will be higher for longer.
- Israel’s retaliatory attack on the sovereign state of Iran with a few drones to clear an air corridor through Syria so that Israeli Air Force jets could fire long-range rockets over the border at several Iranian military assets.
A few points:
US equity markets began to fall 2 weeks earlier making last week’s fall the third in a row. The primary driver of this fall was the growing realisation that inflation and interest rates would be higher for longer. High interest rates drove the prices of the tech stocks down but during the first 2 weeks this impact was centred on the narrow leadership group while the broader market held up. That pattern-switching into a broad cross-section of the market – to benefit from a more robust economy – ended last week. This can be seen in the NASDAQ chart.
Although the Iranian attack and subsequent tiny Israeli retaliation may be important geopolitically and economically over the medium to long term, it is clear that the sell off last week was primarily driven by the market realisation and apparent acceptance that inflation is no longer falling. The sell off looks like capitulation selling to a degree. The main impact was on the S&P but there was also a late and sharp selloff of the NASDAQ. The Dow fell early in the week but found support that may enable a rally this week, even though it looks rattled. The fall to the next support point near 37,000 is plausible.
There was also a couple of odd outcomes that might well have implications in the weeks ahead. These were:
- The fall in the oil price despite the increased hostilities in the Middle East that saw the oil price break the expected support near 82 dollars. This fall in the oil price may have reflected the reports that Iran had been exporting record amounts of crude in the weeks preceding the attack. This would be around expecting Western sanctions.
- Despite some sporadic shifts into US Treasuries from equities, the US bond market yields finished the week very near recent highs. The bond market also ignored the fall in the oil price, but perhaps in this new “EV world” it was more concerned about the rise in the copper price.
Interest Rates
It was an odd week for the US bond market with a lot of uncertainty from geopolitical events that resulted in the 10-year bond yield standing still on both Thursday and Friday. Bonds initially rallied with the sharp selloff in the equity market induced by the Iranian attack on Israel, but then weakened back towards recent highs despite a fall in the oil price and the subsequent Israeli response. Traders reported good two-way trade in a directionless market. Chairman Powell commented that further delay until rate cuts in the face of persisting inflationary signals.
There was very little change in the shape of the Aussie yield curve despite the geopolitical events last week. Australian yields tracked changes in US yields in a very narrow range. Much of the rally into the close on Friday will be unravelled on Monday morning.
Major Credit Markets
Understandably, given the correlation between equity markets and credit spreads, US corporate bond margins rose last week, but are still well below the levels seen last October when rising fixed yields were approaching the 5% level and threatening a return to a dysfunctional treasury market. Spreads should contract if the equity market stabilises this week.
Aussie Senior margins rose sharply last week due to the increased geopolitical uncertainty and in line with the equity market weakness. If the calm does return to markets this week, then the Aus 5-year iTraxx index should fall back in the absence of new issuance. Despite the market volatility, Bank of Qld issued $900m 5-year senior at +128bps after reporting better than expected results. The other main issuer last week was Sydney Airport with a senior secured $850m tap of its Euro bond at +147bps.
High Yield Markets
Falling equity markets and rising interest rates are a poor cocktail for high yield (HY) markets. HY margins have risen off recent lows but there has not been a panic. There is plenty of room for margins to keep rising if market volatility continues given margins are near 10-year lows. What is keeping investors interested is the absolute level of the total yield on offer in the sector – an average HY margin of 3.40% gives a 5-year total yield over 8%. Primary issuance, although slowed, is still active showing a bid tone for new issues.
Rather than widen, which would be expected from the recent credit and equity market volatility, hybrid margins remain historically quite tight as the market prepares for the large funds from the CBAPH redemption on 26 April (see next page).
Suncorp issued $360m of a new hybrid with a reinvestment offer for the June-maturing SUNPGs. The issue was flagged by Suncorp several weeks ago. The tenor was 6.2 years to first optional maturity date and margin set at 2.80%, the bottom of the 2.80-3.00% range. The offer opened and closed in one day.
Listed Hybrid Market
Hybrids – margins driven by liquidity.
We have often cited liquidity as a major driver of hybrid margins along with the general levels of both credit and equity markets. Usually, the liquidity factor arrives from large major bank issuance having the effect of widening margins. However last week, and over the next few weeks, the liquidity factor will arise from a large market redemption, pushing significant funds into accounts of hybrid investors, who will, in part, look at the secondary market to maintain exposure. The CBAPH security is to be repaid on 26 April, $1.59bn of funds. There was no reinvestment or alternative offer. CBA hybrids are extremely popular in hybrid portfolios. Investors will seek alternatives from the secondary market, especially current CBA hybrids and longer-dated issues given the absent replacement would have been at the long end of the curve.
The chart below shows market action on the margin curve over past weeks. The most recent curve from 19 April (blue) and 1 April (red) are shown (note labels are shown for the most recent data, 19 April, the corresponding red dot above or below is the same security at 1 April). Most of the curve has shifted downwards, especially from short to 5 years. Most longer data issued have not moved. Overall, the CBA issues are at the lower part of the most recent curve, indicating where buying is getting set in advance of the redemption, the exceptions being CBAPL and CBAPM, which has actually moved slightly wider although below comparable maturities. Best value is CBAPL and CBAPK, both of which should attract their fair share of buying.
Forward Interest Indicators
Australian rates
Swap rates leap again following large rises in bond rates.
Swap rates:
- 10-year swap 4.47%
- 7-year swap 4.33%
- 5-year swap 4.22%
- 1-month BBSW 4.30%
