Term Deposit Review: January 2019

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1 Fixed Income Markets Credit Research 7 February 2019 Term Deposit Review: January 2019 Simon Fletcher Head of Research (+61) simon.fletcher@bondadviser.com.au Charlie Callan Credit Analyst (+61) charlie.callan@bondadviser.com.au January proved to be a solid start for markets in 2019 as a softening in the Fed s rhetoric and strong(ish) Australian CPI data encouraged sentiment. Fed Chairman Jerome Powell announced the Fed would be patient on any future rate changes and signalled flexibility in its balance sheet normalisation policy, which tempered volatility for the time being. Brexit and US-China trade war headwinds continue to persist whilst US reporting season produced a mixed bag of results. Domestically, CPI data came in above expectations for the first time in two years but was still fairly soft (0.5% for the quarter and 1.8% for the year) as the RBA downgraded its outlook for the Australian economy based on softer data. The banks are feeling the pressure of rising funding costs from a rising / sustained 3M BBSW and intensifying market competition, which has seen short-term and long-term TD rates fluctuate in January. Figure 1. Term Deposit Spread Over Relevant BBSW: January 2018 vs December % Change in Spread January December 0.20% 0.00% -0.20% -0.40% -0.60% -0.80% 1M 3M 6M 1Y 3Y Average "Special" Spread Source: RBA, BondAdviser Background on Term Deposits Deposits offer investors a range of benefits over other types of investments: The diverse offering in Australia allows for investment flexibility. Deposits offer certainty of returns. Her tenor of deposit and rate on the transaction is unchanged for the duration of the investment. This avoids any market volatility. For amounts up to $250,000 deposits are guaranteed by the Federal Government. 1 Bond Adviser Pty Ltd Key negatives of term deposits include: Interest Rate Risk: the risk that a subsequent market interest rate is higher than the rate locked-in on the purchased TD. Liquidity Risk: TDs can only be liquidated earl with the issuing institution (i.e. there is no open market) and will usually result in a reduction in the effective interest rate for the term. This also typically requires 31 days notice. TDs offer no capital upside, which can occur in fixed-rate bonds and hybrids. Income from TDs is fully taxable at the investor s marginal tax rate (i.e. no franking).

2 Mar 18 Apr 18 May 18 Jun 18 Jul 18 Aug 18 Sep 18 Oct 18 Nov 18 Dec 18 Jan 19 Feb 19 Bank Rate Strategies Converge The domestic funding landscape complicated over January as the banks battled rising funding and regulatory costs as well as intensifying competition for market share. Strategies on how to best manage these pressures diverged with banks moving rates in converse directions despite a stable cash rate. The rising interbank bill swap rate (BBSW) has put significant downward pressure on the banks Net Interest Margins (NIMs) over the last 12 months, as it drags the wholesale cost of funding for the banks higher due to its use as a benchmark rate. In response, most banks have raised interest rates on mortgage loans in a bid to ease pressure, with NAB s inevitable variable rate increase on 24 January meaning all majors have now done so. Figure 2. Changes in 3M BBSW (Last Twelve Months) 2.20% 2.10% 2.00% 1.90% 1.80% 1.70% Source: BondAdviser, Bloomberg NAB s headline increase ended its four-month resistance as it finally gave in to profitability despite its best PR efforts. BOQ and NAB-owned UBank also raised rates, with BOQ s high TD rates (in a bid to attract deposit funding) ultimately proving a big strain on the bank s NIM relative to its competitors. In contrast, Citi slashed 240 bps off principal-and-interest loans to become among the sector s cheapest offerings (from one of its most expensive) as it looks to leverage its significant global size Adelaide Bank and Bankwest similarly announced cuts in a bid to capture additional market share amid slowing lending growth. Under pressure on all fronts and with the near- and long-term outcomes of the Hayne Royal Commission uncertain, the banks have this month looked to their TD rates as another tool to assist profit margins. Figure 3. Changes in Bank Mortgage Rates (in basis points) January Ubank NAB Bank of Queensland -240 Adelaide Bank Bankwest Citi The coming months will prove quite testing for the banking and financial sectors as they manage the fallout from the Hayne report, and aforementioned pressures. This may bring even more volatility to TD and mortgage rates as the jostling for market position continues. The RBA cash rate remains on hold at 1.50% for the 30 th consecutive month, but a glimmer of inflation does add some interest to the rate rise debate. However, with the RBA downgrading its outlook on the economy due to soft economic data (including misses for retail sales and building approvals in recent months) we believe rates are very unlikely to rise anytime soon. Markets are currently pricing in a 50% chance of rates being lower come the year s end; however, it would likely take a significant and continued deterioration in economic conditions for the central bank to actually cut rates. We maintain our base case of rates being on-hold until at least well into 2H19. 2 Bond Adviser Pty Ltd

3 Market Commentary: Fed Softens Outlook Markets rallied in January as Federal Reserve Chairman Jerome Powell announced that the Fed would be patient on any future interest-rate movement and shied away from its previously-held position of aggressive asset sheet normalisation. This outlook is a considerable shift from last quarter when Powell indicated that 2019 would bring more rate rises and aggressive asset shedding, which saw market volatility spike throughout Q The revised outlook better aligns with the market s expectations and indicates that policymakers may have come to the realisation that current rates are closer to neutral than previously thought. The announcement calmed concerns that the Fed would continue raising rates in the face of signs that the economy may be cooling and indicates the FOMC is now seeking to sustain expansion rather than prevent an overheating. Powell cited global economic and financial developments and muted inflation pressures as the catalyst for more patience as it determines what adjustments are appropriate to support a strong labour market and ~2% inflation. The Fed s pivot in policy regarding quantitative tightening (QT) was also a notable inclusion in Powell s latest speech. Whilst leaving the door open to adjust any details in response to changes in market conditions, Powell announced that the balance sheet normalisation process would be completed sooner and with a larger balance sheet than previous estimates. Given that the Fed s attempt to reduce its ballooning balance in 2018 had considerable impact on volatility and liquidity (users can find more analysis in our November 2018 Monthly Market Review), this latest announcement will temporarily allay fears of a 2013 Taper Tantrum repeat in As markets welcomed the news, the treasury yield curve steepened slightly, with a 2 bps fall in the 10Y yields lagging the 4 bps fall in the 2Y yield. The spread between the 2- and 10-Y yields rose to 16.9 bps. Figure 4. Australian Treasury Yield Curve 3.20% 3.00% 29/01/ /01/ % 2.60% 2.40% 2.20% 2.00% 1M 2M 3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 20Y 30Y Source: BondAdviser, Bloomberg Comparing Term Deposit Rates January saw minimal movements in term deposit rates with most of the change coming in the medium- and long-term. Short term-rates (ST ~3 months) held steady with no change from any of the lenders*. BOQ remains as the best value for customers in the short-term market, offering 5bps over ANZ and 40 bps over all others. Rates in the medium-term (MT ~6 months) experienced some change with Bendigo and BOQ cutting rates by 25 bps and 20 bps respectively. NAB, in contrast, marginally increased rates by 5 bps to 2.10%. ANZ now* offers 2.60% in the MT, delivering considerable value for depositors (+55 bps), relative to its Big 4 competitors. In the long-term (LT ~12 months), BOQ continues to provide the highest rate (2.65%), offering 25 bps over its nearest competitor (NAB at 2.40%). This comes after NAB cut its LT rate by 20 bps. *Note: The ~100 basis point increase for all ANZ TD rates reflects BondAdviser switching ANZ s TD rate input from the ANZ Term Deposit to ANZ Advance Notice Term Deposit. BA believes the new rate is a more appropriate market comparison. 3 Bond Adviser Pty Ltd

4 All sources: BondAdviser, Company Reports Note: Short Term (~3M), Medium Term (~6M), Long Term (~12M) Figure 4. Monthly Change in Short Term TD Rates Figure 5. Short Term TD Deposit Rates Figure 6. Monthly Change in Medium Term TD Rates Figure 7. Medium Term TD Deposit Rates Figure 8. Monthly Change in Long Term TD Rates Figure 9. Long Term TD Deposit Rates Figure 10. Monthly Change in Online Saver Rates Figure 11. Online Saver Rates 4 Bond Adviser Pty Ltd *Note: The ~100 basis point increase for all ANZ TD rates reflects BondAdviser switching ANZ s TD rate input from the ANZ Term Deposit to ANZ Advance Notice Term Deposit. BA believes the new rate is a more appropriate market comparison given similar terms and conditions applied across other products in the market.

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