Strategy commentary cont'd:

• Our long duration, daily liquidity, A+ rated Active Composite Bond Fund, which returned 6.35% after fees, outperforming the Composite Bond Index’s 1.47% result by 4.88% over the last year. The fund’s current gross running yield is 6.49% pa.

The coincident risk and bond rally was driven by a surprising retracement of long-term bond yields (since reversed out in April to date) despite a spate of worrying inflation data (see more later) with 10-year government bond yields contracting in the US (-5bps), Germany (-11bps), New Zealand (-16bps), Italy (-17bps), Australia (-18bps), and the UK (-19bps). This helped to push equities higher in Australia (ASX200 up 2.57%), the US (S&P500 Index up 3.10% and Nasdaq up 1.17%), New Zealand (NZX50 up 3.10%), Europe (Eurostoxx 50 (sx5e) up 4.22%), and the UK (FTSE 100 up 4.23%).

Lower bond yields powered the performance of long duration fixed-rate bond benchmarks, with the Global Aggregate Corporate Index up 1.26% in USD. Tighter credit spreads helped its zero duration counterpart return a still very attractive 0.86% with corporate bond spreads compressing in USD (down 6bps), GBP (down 6bps), and EUR (down 8bps). Down under, cash credit spread performance was much more mixed. Corporate bond spreads only fell by 1bps while 5-year major bank senior bond spreads were unchanged and 5-year major bank Tier 2 spreads actually widened 4bps care of ongoing issuance. One standout was the ASX hybrid market where 5-year major bank spreads dropped by a striking 23bps.

In synthetic CDS index markets, spread moves were generally much more contained with US CDX Index spreads only declining by 1bps, which was matched by a 1bps contraction in European Main Index spreads.

Strategy commentary cont'd: There were, however, notable moves in the price of both oil, with WTI Crude up 6.27%, and gold, which appreciated 9.08%, that could influence and/or correlate with intensifying inflation pressures.

S&P upgrades Aussie major bank Tier 2 bond ratings from BBB+ to A-

Aussie major bank Tier 2 bonds were upgraded on April 4 2024 from a BBB+ credit rating to A-, and Bendigo & Adelaide Bank and Bank of Queensland senior bonds upgraded from BBB+ to A-, which will massively expand the pool of global capital available to be allocated to these assets.

This is a result of Coolabah's unique late 2023 forecast regarding Standard & Poor's lifting Australia's Banking Industry Country Risk Assessment (BICRA) score from 3 to 2 coming to fruition (lower is better), with the market-leading credit agency today declaring:

• "Continued strengthening of regulatory and governance standards in the Australian banking sector has reduced industrywide risks. Simplified business models and advances in risk management have also contributed to this improvement."
• "We now assess the institutional framework for the banking industry in Australia at the lowest risk level on our scale, and in line with that in Canada, Hong Kong, and Singapore."
• "Consequently, we raised our long-term issuer credit ratings on most of the non-major Australia-based banks and other financial institutions."
• "We have also upgraded all the rated Additional Tier 1 and Tier 2 instruments issued by Australian banks and their New Zealand banking subsidiaries."

Coolabah published this forecast on 23 November 2023 at Livewire, predicting that S&P was likely to move around the first quarter of 2024. No other analysts globally shared the same view on this rating change at the time, although many did subsequently come to slowly embrace the idea.

Other interesting consequences that we forecast were an upgrade to the major bank's AT1 hybrid ratings from BBB- to BBB, which has also materialised.

Aussie major bank Tier 2 is now in the "A" band for the first time with all three key global credit rating agencies (CBA will shortly be confirmed for an upgrade with Moody's, based on our research).

Australia's banking system also has the lowest BICRA score globally alongside Canada, Singapore and Hong Kong, which is an entirely prudent determination.

US core inflation picks up in early 2024

The Fed’s preferred measure of underlying inflation – the core PCE deflator – increased by 0.3% in February, rounding up to be in line with market expectations, following a 0.5% rise in January (rounding up from an initial estimate of 0.4%).

The estimated trend shows annualised monthly inflation picking up from around 2% late last year to about 3.5%, echoing the recent re-acceleration in the more timely core CPI (note that the trend estimates can be revised as more data become available).

The pick-up in inflation has been broadly based, in that the estimated trend of the trimmed mean PCE deflator shows annualised monthly growth picking up from 2.50% last year to 3.75%.

Fed Chair Powell said that the February data were in line with expectations, repeating that the Fed needed more confidence before it reduced interest rates, where the return of inflation to the 2% target could be “bumpy” and the strength in activity meant that the Fed “[did not] need to be in a hurry to cut”.

Strategy commentary cont'd: Powell emphasised that the Fed had a “steady hand”, repeating how the FOMC did not overreact to the progress made on inflation late last year.

The next FOMC meeting is on 30 Apr/1 May, but the more likely window for the first cut is still the 11-12 June meeting, which is when the FOMC also updates its economic and financial outlook.

The FOMC then meets twice more before the 5 November presidential election, once immediately afterwards, and then again in December.

The Fed always stresses its political independence, but the election should see it act more cautiously than usual given Trump’s hostility towards the central bank, refraining from offering anything more than tepid guidance and emphasising that decisions will be data dependent.

As for consumer spending, real expenditure rebounded in February, up 0.4% after a 0.2% decline in January. The estimated trend in spending shows steady annualised monthly growth of about 3%.

US core PCE inflation picked up in early 2024

The trimmed mean PCE deflator indicates the pick-up in inflation has been broadly based

Strategy commentary cont'd:

The core PCE is echoing the higher and more timely core CPI

Trend growth in US real consumer spending remains strong

Persistent services inflation contrasts with falling goods prices

The monthly CPI for February showed underlying inflation tracking in line with the RBA's forecast profile, with persistent services inflation contrasting with falling goods prices in trend terms.

The ex-volatile items/holiday travel CPI rose by 0.5% in February after increasing by only 0.2% for four months in a row, where the increase in February was the largest rise since August.

This suggests that the RBA's preferred measure of inflation - the quarterly trimmed mean CPI, which is due on 24 April, ahead of the 6-7 May board meeting - is on track to post another increase of 0.8% in Q1, in line with the RBA's interpolated forecast.

There is still a margin of error in mapping from this monthly measure of underlying inflation to the quarterly trimmed mean CPI, although both rose by 0.8% in Q4.

Importantly, the monthly CPI echoed the trend shown in other advanced economies, where ongoing strength in services inflation contrasts with goods disinflation.

Goods and services prices have been seasonally adjusted and are broader in scope than the ex-volatile items/holiday travel CPI that proxies the trimmed mean CPI. But that is still useful in demonstrating how the RBA will need a material slowdown in services inflation to be confident that overall inflation will sustainably return to the 2.5% midpoint of its target.

Strategy commentary cont'd:

Market forecasts versus outcome for the monthly CPI

Underlying inflation is tracking in line with the RBA’s forecast profile

Strategy commentary cont'd:

Goods prices are falling, while services inflation remains strong

A snapshot of Australian bank/super fund exposure to commercial real estate

Commercial property prices have fallen sharply in most advanced economies over the past year or two, with Green Street Advisors calculating 20%-plus declines in the US and euro area and the RBA estimating a roughly 10% decline in Australia as at late 2023.

Against this backdrop, CCI has taken a snapshot of the exposure of Australian banks and super funds to commercial property and infrastructure.

In aggregate, bank loans to commercial real estate have reached about $0.4 trillion, edging up to 13% of total bank loans over the past couple of years.

This is a little above the 12% average of the past two decades, but well below the 17% peak reached during the global financial crisis.

However, there is a marked divergence in the exposure of different banks.

The exposure of foreign banks continues to trend higher and has reached a series-high 21% of their local loan book.

The exposure of the major domestic banks has edged up to 10% of their loans, while commercial real estate loans written by small domestic banks make up only 4% of their loans.

In comparison, superannuation fund holdings of commercial real estate and infrastructure currently total over $0.35 trillion.

While super fund holdings are a little smaller in dollar terms, the exposure of pension funds is greater than banks when expressed as a share of assets.

Strategy commentary cont'd: Across the pension system, commercial property and infrastructure – where most of it is unlisted – currently accounts for 16% of total super fund assets, which is at the high end of the range of a relatively short history.

Commercial property and infrastructure accounts for 19% of industry fund assets, 16% of public sector fund assets and 10% of retail sector assets.

Bank exposure to commercial real estate has picked up a little as a share of loans over recent years, with foreign banks most exposed relative to their loan book

Strategy commentary cont'd:

Super funds have increased their exposure to commercial real estate and infrastructure more than banks as a share of assets