Over the past 12-months in Australia, we have seen a flattening of the yield curve, which is the outcome of two significant trends; short-term yields increasing and long-term yields falling, a process known as bear flattening. This trend is favourable for short duration, floating rate securities.

The RBA headline interest rate has now been on hold at a record low of 1.50% since August 2016, with the last rate increase way back in November 2010 – over eight years ago. At the beginning of 2018, market participants were forecasting two rate rises by mid-2019 (the medium green upward curve) with many of the bank economists more bullish than the market. As of the end of 2018, the market is pricing in the ‘lower-for-longer’ mantra with no change by the RBA for the foreseeable future (light green line).

Despite no movement in the RBA rate, the 3-month Bank Bill Swap Rate (BBSW) has climbed to 2.0% and is trading at the largest gap to the RBA rate since 2012. The BBSW is the short-term rate that major banks lend to each other, so the increase reflects a rise in perceived credit risk of the big banks due to the headwinds facing the sector; higher overseas funding costs, a slowdown in property prices (and credit demand) and potential regulatory outcomes from the Banking Royal Commission.

The BBSW is highly important to the Australian bond market as it is used to calculate the interest payments on most floating-rate securities issued by corporates, financial and non-financial. Given this relationship, the recent uptick in the BBSW has increased the return on floating bonds by 25 bps, making them more attractive to investors. The simultaneous increase in bond yields and equity market uncertainty further improves the attractiveness of interest-bearing securities, in particular, non-financial corporate debt.

The non-financial corporate debt market in Australia has not experienced the same scale of expansion that has occurred in the US and Europe. Domestic corporates have preferred to raise funds through equity issuances that have led to the ratio of Debt/Equity fall since 2015. We believe that population-driven Australian growth and lower-for-longer rates will support non-financial corporate balance sheets and keep bankruptcy rates low. Coupled with the rising benchmark rate, this is a sector that warrants increased exposure.

As partners in your investment journey, it is important to us that we take the time to share key aspects of our approach and philosophy.

This article is part of our 2019 Economic and Investment Strategy Guide and one such starting point in our highly considered process that will ultimately manage downside risk and maintain the real value of capital.

For further reading of our 2019 Asset Class Assessments, please click one of the links below:

• Equities - A Few Reasons to be Optimistic

• Listed Property - Retail Property Demand Drags Market

• Market Overview

For more information on our approach to economic strategy or to obtain your own copy of our 2019 Economic & Investment Strategy Guide, please contact us on +613 9655 5000.