Uncertainty will reign after the re-election of Donald Trump and the Republican Red sweep on Capitol Hill, giving the Grand Old Party (GOP) a clear mandate for significant change.

After a campaign dominated by personal insults and grubby fearmongering, actual hard policy detail is somewhat scant. Initially, markets have responded by backing Trump and team GOP, with risk assets rallying, thrilled with an outlook of perceived positive growth policies centred around tax cuts, deregulation and less focus on environmental issues. However, markets must wait for more detail to truly release the animal spirits, as some touted Trump policies may threaten such growth outcomes by taking momentum out of the economy.

Will the bark of Trumpian policy be equal to the bite, or does the "art of the deal" translate into vocal threats without the downside of chosen short-term pain? The US budgetary outlook will provide guardrails to these expectations.

2024 has been a year of toppling sitting governments, as voters remain angry in a post-Covid world with extreme cost-of-living pressures. Opposition parties the world over are being swept into power, only to find that governance in the aftermath of such an environment is quite difficult: it is far easier to criticise from the opposition benches than solve the complex problems in government.

While the GOP has a clear voter mandate to lift living standards and restore low and stable inflation, some of the publicly suggested policy combinations threaten to deliver the opposite outcomes if enacted. Such moves could take the gloss off the initial market enthusiasm enjoyed since the election announcement.

Trump has touted an across-the-board 10 per cent import tariff as a tool to drive change in trade policies, attempting to level the playing field by making US products more competitive against lower-cost producers, while also encouraging US-based investment. He has also targeted specific countries, such as China, proposing tariffs as high as 60 per cent.

While this would help improve the US fiscal position by generating revenue from tariff taxes on imported goods, it effectively acts as a direct tax on American consumers, who would face higher prices on everyday items due to increased import costs. This would raise the general price level, stimulating inflation at a time when the Federal Reserve is lowering interest rates from emergency settings used to combat the last bout of Covid-induced inflation shocks.

It would likely be very politically unpopular and, despite the sweeping mandate just received, the midterm elections of 2026 are always in the back of political minds.

Trump has similarly proposed cutting up to $US2 trillion in deficit spending by appointing Elon Musk as a change agent to drive efficiency across federal government operations. While reducing waste is beneficial in the long term, the US economy is already reliant on significant government spending to bolster its somewhat slight growth profile―- all things considered―- given the already massive intervention of the government in the economy.

The deficit spend is simply unprecedented for non-war times, running at 6-7 per cent of GDP under the Biden administration. Such massive government spending is only generating a tepid 2.8 per cent GDP growth, all while the economy experiences significant positive tailwinds from immigration.

Removing such a large amount of spending from the economy would have significant growth implications if not replaced by other positive accretive outcomes such as a productivity enhancement. In these delicate political times, choosing such a deacceleration of economic activity seems an unlikely political choice.

Delicate choices and policy combinations need to be made by the Trump administration as tax cuts and spending for growth require financing inside a US budget set up that is already strained after large Covid spending programs.

Bond markets are on watch around the sustainability of the US fiscal position, now exceeding $US35 trillion and climbing (120 per cent of GDP), amid concerns that the budget has little room to provide a counter-cyclical buffer should the economy experience any type of recessionary outcomes.

Since the election, yields have stabilised, supported by ongoing interest rate cuts from central banks such as Sweden's Riksbank, the Bank of England, and the Federal Reserve.

Markets remain cautious, noting the potential risks of politically driven policies that lack economic foresight - highlighted by the swift removal of British Prime Minister Liz Truss after bond markets reacted sharply to her fiscal plans.

Until US policy plans are laid out in full, we maintain a preference for Australian and European fixed income assets, which offer stronger fiscal conservatism and higher credit quality. Overall, this environment underscores the importance of diversification, careful monitoring of fiscal policy announcements, and considering exposure to regions with more stable economic policies.

Australian residential property prices continued to rise for the 21^st consecutive month with a 0.3% increase, but signs of easing continue with Darwin, Canberra, Melbourne and now Sydney all experiencing a decline in value according to CoreLogic's National Home Value Index, with losses of 1%, 0.3%, 0.2% and 0.1% respectively. Whilst this demonstrates that it is not all smooth sailing in the Australian property market, Brisbane, Hobart, Adelaide and especially Perth continued to perform strongly with further monthly increases of 0.7%, 0.8%, 1.1% and 1.4% respectively. Whilst the national capitals only saw a 0.2% increase for the month, the combined regionals are still performing strongly with a 0.6% monthly increase.

This new monthly data with more capitals and regions beginning to see a reduction or easing in prices, has impacted quarterly data now showing that Darwin, Canberra, Melbourne and Hobart have experienced losses for the quarter (1.3%, 0.9%, 0.8% and 0.1% respectively) whilst Sydney has now only seen 0.1% quarterly growth. Brisbane, Adelaide and Perth have however continued to see significant growth for the quarter, with 2.4%, 3.7% and 4.1% respectively.

As we head into the holiday season, and with the RBA remaining hesitant to reduce interest rates, it is expected to continue to see easing amongst the Sydney, Melbourne, Canberra, Hobart and Darwin markets, however the undersupply of property within Brisbane, Adelaide and Perth is likely going to see continued growth despite interest rate pressure.

Property Values as at 4th of Nov 2024

Median Dwelling Values as at 31st of October 2024

Quick Insights

Housing market on the cusp of another boom

Australia's housing market shows signs of potential growth as experts anticipate that rate cuts in 2025 could drive higher demand, especially in Sydney, Brisbane, Adelaide, and Perth. Melbourne's market remains relatively affordable, but with possible rate changes, investor interest may increase across major cities. Keep a close watch -- 2025 could open up new opportunities in the property market.

Source: Australian Financial Review

One year on - cash rate holds at 4.35%

The RBA has held the cash rate steady at 4.35% for another month, citing high underlying inflation as the reason for not yet reducing rates. Despite headline inflation falling within target, the RBA remains cautious, aiming to ensure inflation returns to the midpoint of the target range.

While borrowers might be eager for a rate cut, experts suggest patience, with potential rate reductions anticipated in early 2025.

Source: Broker Daily

Author: Filippo Sciacca, Director - Investor Relations, Asset Management and Compliance

As bank issuance shrinks, corporate hybrids are in the ascendent, with non-financial corporate hybrids potentially instrumental in powering Australia's energy transition. So what do they offer the fixed income investor?

Australia's hybrid bond market rarely makes headlines, but in recent weeks it has been firmly back in the spotlight. The Australian Prudential Regulation Authority (APRA) recently revealed plans to phase out Australian banks' use of additional tier one (AT1) capital which APRA believes is riskier, thereby seeking to enhance the overall stability of the banking system. The announcement came on the heels of a surge in interest in corporate hybrids sparked by the successful raising for Australian Securities Exchange (ASX) listed mall operator Scentre Group. Yarra's outlook for Australia's hybrid bond market--of which bank AT1 hybrids make up around $41 billion--considers these latest proposed regulatory changes while focusing on the future potential for hybrids in funding corporate Australia's energy transition ambitions.

Investors and issuers alike are now navigating a market partly in transition. More immediately it seems that in the wake of APRA's announcement, some are betting that a shrinking pool of Australian bank hybrids will drive up demand, pushing prices higher and yields lower across Australia's big four banks. Since last month's announcement, spreads for Tier 1 securities have contracted ~16bps--so retail investors are eager to bid up assets and get a larger slice of a shrinking pool.

While uncertainty prevails in hybrid bank issuance for now, and short-term opportunities may arise, over the longer-term a broader set of dynamics is emerging for hybrids, particularly in sectors like energy and infrastructure.

Expanding role in Australia's energy transition

The potential scale of the energy transition in Australia offers an exciting growth opportunity for corporate hybrids. As energy transition projects such as new transmission lines and large-scale generation get underway, hybrids can and should play a role in funding the significant upfront capital costs and become a permanent feature of issuer capital structures.

We estimate a total system investment of $400 billion is required by 2050 in order to decarbonise Australia's energy market with a focus on new energy generation including investment in wind farms, solar, batteries, and associated transmission assets.

It is highly unlikely that equity alone will foot the bill for these expensive projects and that is why we see hybrids as an increasingly popular funding source in Australia's transition to a low-carbon economy, offering flexibility and capital efficiency.

The sheer size of the capital requirement means that corporates will need to tap into multiple funding sources, and hybrids offer a lower-cost alternative to pure equity issuance.

For large-scale energy transition projects, such as new transmission lines and renewable energy facilities, hybrids offer a way to fund significant upfront capital costs without putting undue strain on a company's balance sheet.

For that reason, we expect large blue-chip generation companies like AGL, Origin, APA, and even Woodside and Santos along with transmission companies like Austnet and Transgrid, to tap into hybrid issuance as part of their funding strategies for energy transition plans.

The recent success of Scentre's corporate hybrid raising demonstrates this growing interest from non-financial corporates looking to leverage a flexible funding tool, and we expect this interest to grow from here with further non-financial corporate issuance likely in FY2025.

While APRA's move signals tighter regulatory scrutiny and a potential decline in AT1 hybrid issuance by banks, there is also the possibility that as major bank issuance retreats in APRA's suggested 2027-2032 transition period, corporate issuers may step in to fill the gap.

Bringing it back to fundamentals

As the APRA development demonstrates, assessing and pricing the inherent risks of hybrids becomes trickier with regulatory change in the mix. But these upheavals should be viewed as atypical events in a sector that is actually offering attractive returns akin to longer term equity market averages, with the 'higher for longer' rates, which are thematic for fixed income assets, here to stay.

We are forecasting a new era for tactical fixed income, characterised by sustained, higher yields. In this environment, investors, particularly those focused on investment-grade assets, are increasingly comfortable holding instruments such as hybrids, viewing the attractive yields on offer as ample compensation for assumed risk.

We see further opportunities for investors to access the higher yields and risk-adjusted returns that have made the hybrid instrument so popular recently.

Further, with APRA's decision to phase out AT1 hybrids, there is an expected shift of a substantial pool of capital, estimated to be around $41 billion, that will be seeking new investment avenues. This development is likely to create significant opportunities for corporate hybrids to emerge as a viable alternative for retail investors who are in search of yield. Consequently, we anticipate that corporate hybrid instruments could play a crucial role in filling the gap left by the diminishing bank hybrid market. This shift could potentially lead to a resurgence of hybrid issuance on the ASX, ensuring that investors continue to have access to the attractive yields they have grown accustomed to with bank hybrids, but now through corporate issuance by larger, investment-grade companies.

In addition to the rise of corporate hybrids, another area that warrants close attention as AT1 hybrids are phased out is the potential for Bank Tier 2 paper - that is, subordinated debt which provides an additional layer of protection for banks - to become more prominent on the ASX.

It is conceivable that banks may opt for increased Tier 2 issuance as a strategic move to maintain access to retail capital pools and fulfill their capital requirements while they gradually wind down their AT1 hybrid instruments. This strategic shift towards Tier 2 issuance could provide banks with the necessary flexibility to navigate the changing regulatory landscape and continue to meet their capital needs effectively.

Hybrids in portfolio construction 

A key performance factor here is the issuer's credit strength--when dealing with investment-grade hybrids from strong issuers, the chance of conversion or extension is significantly diminished but investors still get rewarded for taking on what are essentially low-probability events.

These features allow investors to effectively double the credit spread, significantly increasing returns without taking on a disproportionate increase in risk. For instance, investors in Scentre Group's recent hybrid issuance picked up a credit spread that was 1.8 to 1.9 times the spread on the company's senior debt, providing a return close to 6%.

Chart 1: Scentre Group Bond Curve - 4 September 2024

Source: YCM, Oct 2024.

Myths about hybrids

There are several misconceptions about hybrid securities that often lead to a misunderstanding of their risk and reward profile, particularly among investors who may equate them with pure equity. One common myth is that hybrid bonds are simply 'equity in disguise'. While hybrids can have equity-like features, particularly in times of financial stress, as mentioned their risk-reward profile more closely tracks the underlying credit quality of the issuer.

Provided you are investing in high-quality issuers the likelihood of hybrids not being refinanced at their call (redemption) dates or experiencing write-downs should be quite low.

This is why, despite these structural complexities, we believe hybrids offer compelling risk-adjusted returns over both the short and long term. Their attractive yields compensate investors for these theoretical risks, while the actual occurrence of negative outcomes remains infrequent.

This dynamic has made hybrids a popular choice among sophisticated fixed income investors seeking higher returns without assuming the full risk profile of equity.

An elegant solution for balancing capital needs and sustainability goals

For corporate issuers, hybrids offer a number of attractive properties, particularly if a company is looking to fund expensive infrastructure development, mergers and acquisitions, raise capital without having to sell assets, or strengthen their balance sheet.

Because of their 'hybrid' nature--whereby half of the amount on issuance is counted as equity and, therefore, not included in that gearing calculation--hybrids can be a great source of capital flexibility. This can mean the ability to run a little bit more debt, negate the need for asset sales, optimise the amount of equity capital, or support and protect a credit rating.

These useful features make them relatively more appealing as a funding instrument for utilities and other infrastructure providers where capital is intensive and locked into large-scale projects with long-term build horizons. That is why we expect hybrids to feature more prominently in Australia's utilities sector, providing flexible capital sources for the energy transition build, including both for renewable energy infrastructure and energy transition infrastructure.