RBA TO CUT IN MAY AFTER INFLATION DATA

In April global market data remained patchy. The US economy slowed as stronger USD and severe weather on east coast continues to weigh on data. US Non-farm payrolls for March missed by over 100,000 jobs and ISM surveys declined. GDP data for Q1 was an anaemic 0.2% for the quarter. Market watchers would assume softer data will curtail a data dependant Federal Reserve. The Citibank US Economic Surprise Index remains in deeply negative territory at -62 declining from a reading of zero in February, meaning incoming economic data is significantly weaker than market estimations (including the FOMC’s).

Australian economic data was mixed with better jobs numbers at +37k, but inflation data remained subdued. This should allow for the RBA to cut at the May 5th meeting to 2.00%.

With the onset of the ECBs 1.2 Trillion euro QE program in Feb 2015 (at 60bn per month) German 10yr Bund yields continued to rally from March to an all-time low of 6bps. By the middle of April several high profile investors including Bill Gross, Alan Howard and Jeffrey Gundlach commented publically that Bunds looked expensive despite the 60 billion Euro a month ECB QE buy program.

Whilst we believe German rates at negative or low levels to be of limited value, we question some of the commentary from the investors mentioned, particularly Jeffrey Gundlach who stated that ‘’shorting the German 2yr 100 times leveraged at negative yields produces positive carry.’’ Any fixed income investor knows there is no leveraged carry opportunity given German general collateral (GC) is -20 bps plus you also need to pay a running repo charge to borrow the bond for delivery, over the life of the short position, hence ruling his strategy mute. We think many of these comments were driven by opportunistic market positioning looking to exploit a European investment community that has too much one way (long only) risk and over exposures to curve flattening structures. At time of writing Bunds have sold off 32 bps to yield 38 bps, spilling into other fixed income markets into month end. This sell off is technical in nature and not fundamentally driven. It will be a buying opportunity for duration in time, ahead of European summer trading.

Domestically the Australian Government bond market was dominated by redemptions and coupon payments of ACGB and semi government bonds totalling 28 billion dollars. The market was well supported from the early to middle parts of the month with many investors reinvesting proceeds. However, with the onset of the selloff in German bonds taking other markets to higher yields, not even these significant reinvestment flows could stem the pressure to higher yields for ACGB’s closing the month 33 bps higher in yield at 2.65% despite the benign CPI data on the 22nd of April (seen by the market as no road block to another interest rate cut from the RBA)

JCB hold our long held view that the RBA will cut interest rates in May after deciding to hold rates steady in April. We expect to see more volatility in bond markets and we expect this to flow to other investment classes in the months before European summer hits full swing.

FUND HIGHLIGHTS & POSITIONING

JAMIESON COOTE BONDS ACTIVE FUND DECLINED THROUGHOUT APRIL POSTING A LOSS OF 0.69%. BOND PRICES REMAINED VERY WELL SUPPORTED AT THE START OF APRIL ON THE EXPECTATION THAT THE RBA WOULD CUT THE CASH RATE TO 2.00% WITH MARKET ASCRIBING AN 80% PROBABILITY PRIOR TO THE APRIL 7TH MEETING.

JCB felt an April cut was premature ahead of Q1 inflation data due later in the month, as the RBA likes to see the inflation data before adjusting rate policy. We wrote about this in our March Market update, ”JCB maintains its long held view that the RBA will cut the cash rate in May to 2.00% (after seeing April 22nd Q1 CPI inflation data) with further cuts to come later in the year.’’

As a result we lowered our duration and risk into the RBA meeting which proved correct as RBA passed on a rate cut in April but maintained an easing bias, therefore setting up market for a cut in May post the CPI data. With the market being 80% priced for a rate cut ahead of April, a sell off resulted and we used this pull back to add some duration ahead of CPI data which we expected to be benign thereby allowing for a rate cut at the May RBA meeting.