The BFG Report

Welcome to the 2016 Summer Edition of the BFG Report

US interest rates poised for further hikes

The US Federal Reserve (commonly referred to as the Fed) didn’t raise interest rates during the quarter. The world’s central bankers arrived in Jackson Hole in August for their annual economic meeting and conference. Investors carefully listen to what central bankers say at Jackson Hole because it can offer some clues as to future policy decisions. Investors were particularly interested in Janet Yellen’s speech for guidance on future US interest rate hikes.

Janet Yellen, the Chairman of the Fed, indicated that “the case for an increase in the federal funds rate has strengthened in recent months”. This sent the probability of a September rate hike soaring to 52 per cent but the Fed kept the main cash rate in a range of 0.25 to 0.50 per cent. This was because of mixed labour market data and inflation continuing to run well below the target of two per cent.

This helped US shares hit an all-time high with the S&P 500 climbing to just below 2,200 points. Federal Reserve members were divided in the meeting, with three of the ten voting members preferring an immediate 25 basis point hike. This adds to our view that the Fed is on track for monetary policy tightening in December.

Could crude oil production be cut?

The price of crude oil almost reached US$48 in September after the Organisation of Petroleum Exporting Countries (OPEC) surprised investors by indicating that a production cut is necessary to lift prices. OPEC proposed a cut of up to 700,000 barrels a day on the level of oil they produced in August. This potential cut won’t be finalised until the official OPEC meeting in November. Historically, it has proven difficult for OPEC to carry through on its desire to cut production. Countries that are part of OPEC need oil prices to rise and this could be achieved by cutting production.

Japan fails to reach goal of two percent inflation

The Bank of Japan (BOJ) is struggling to meet the challenge that other central banks have encountered in attempting to revive growth and boost inflation. This is despite the use of quantitative easing and in Japan’s case introducing negative interest rates. Inflation in Japan was negative 0.4 per cent in July, far below the BOJ target of two per cent.

The BOJ has therefore announced an innovative approach to reaching its inflation target. The BOJ has decided to buy more short term bonds rather than longer term bonds, this reduces the yield on short term bonds and should encourage banks to lend money to borrowers.

This approach should be positive for bank profitability in Japan because banks typically borrow money short term and lend it out over the long term. Insurance companies and pension funds should also benefit because they are buyers of long term bonds, which should have higher
yields because the BOJ is reducing purchases of these in favour of
targeting short term bonds.

Investment Market Review – Quarter Ending 30 September 2016

Asset Class – Australian Shares
1 year return is 13.50% p.a.
5 year return is 11.00% p.a.
10 year return is 5.00% p.a.

The S&P/ASX 300 Accumulation Index rose 5.3% in the September quarter. The best performing sectors were materials, up 12.8%, consumer staples which rose 10.5% and information technology that climbed 9.0%. Materials led the market despite a volatile quarter that saw iron ore fall 10.3% and crude oil fall 1.3%. The worst performing sectors were telecommunications, which fell 8.8% and utilities which lost 3.3%.

Asset Class – Listed Property Trusts
1 year return is 20.80% p.a.
5 year return is 19.50% p.a.
10 year return is 1.70% p.a.

The A-REIT sector declined 1.9% during the September quarter. The sector underperformed the general market and lost some of its attraction to investors as global bond yields rose. Some market participants view REITs as a proxy for bonds so with the US three-year and ten-year bond yields rising 18bps and 12bps, REITs experienced a fall in demand. Low interest rates in Australia are still supportive for A-REITs but the sector is expensive on an historic, relative and absolute basis.

Asset Class – International Shares
1 year return is 2.50% p.a.
5 year return is 17.80% p.a.
10 year return is 4.80% p.a.

International shares posted strong results for the September quarter. Share markets showed resilience despite events such as the UK’s decision to leave the European Union (EU), which did not have the negative impact that some participants expected it to. The S&P 500 gained 3.3%, the FTSE 100 was up 6.1%, the German DAX 30 rose 8.6% and the Nikkei 225 climbed 5.6%. The MSCI World Index in Australian dollar terms was up 2.0% in the September quarter.

Asset Class – Fixed interest and cash
1 year return is 5.70% p.a.
5 year return is 6.00% p.a.
10 year return is 6.50% p.a.

International bond yields were mixed over the quarter. The US ten-year bond yield rose 12 basis points but the Australian ten-year bond yield actually fell 7 basis points. The mixed performance reflects diverging monetary policies as the US Fed is likely to increase interest rates by 25bps this year but the Reserve Bank of Australia has cut interest rates to 1.50%. Global bond yields moved higher towards the end of the quarter as the European Central Bank’s decision to keep monetary policy unchanged began a bond market sell-off offshore. The Bank of Japan’s decision to steepen the Japanese Government Bond yield curve by implementing a yield curve targeting measure also helped global bond yields move higher.

Asset Class – Cash
1 year return is 2.20% p.a.
5 year return is 2.90% p.a.
10 year return is 4.20% p.a.

The RBA lowered the cash rate by 25bps to 1.50% in the September quarter. Inflation was an important well below the RBA’s medium term target zone of 2.0% to 3.0%. Catalyst in the decision because headline inflation was reported at 1.0%.

High Yielding Internet Savings Accounts

Financial Institution and Interest Rate

RaboDirect Bank – Rate 3.20% p.a.

Rams Saver – Rate 3.15% p.a.

Bank of Melbourne Maxi Saver – Rate 3.00% p.a.

ME Bank Online Saver – Rate 3.05% p.a.

BankWest – Telenet Saver – Rate 3.00% p.a.

Citi Online Saver – Rate 3.00% p.a.

Rates are subject to conditions and change.

Rates are correct as at 30/11/2016.