Welcome to Neu Capital’s market insights.
It’s hard to imagine 2024 could finish so differently to what was forecast at this time last year.
Let’s start with a refresh…
As a result of the RBA lifting official interest rates from 0.1% to 4.35% in the period from May 2022 to 4.35% in November 2023, the expectation was that this impact of material cash rates rises would materially impact consumer spending.
Faced with tighter monetary conditions, economists were predicting a material economic slowdown as the impact of higher debt servicing obligations and higher cost of living drained excess savings and materially reduced consumption. It was predicted that this environment would lead to higher unemployment, higher arrears and lower property prices. In turn, and perhaps quite quickly, this would see inflation move back into the RBA target band of 2-3%, enabling the RBA to reduce official cash rates to ease household pain.
Accordingly credit spreads remained subdued as investors maintained very cautious about additional exposure to consumer and SME assets.
Fast forward 12 months and we couldn’t be finishing further away from the late 2023 consensus forecasts.
Albeit arrears have increased, the projected loss rates have not eventuated. The excess savings accumulated during the pandemic have been larger than expected. Unemployment has stayed lower than forecast with Australia’s record infrastructure spend underpinning jobs, notwithstanding a slowdown in residential property construction.
A combination of record immigration and reduced new housing supply has underpinned house price growth. This notably created rental housing shortages and an increase in rents. Despite relatively weak GDP growth, unemployment has stayed low, making the RBA’s task of reducing inflation more difficult. Consequently, official rates have not changed over 2024.
So in summary, whereas the market was predicting a weak economy, 2024 saw a much more resilient consumer. Albeit there remain some signs of fragility, this is possible exposing itself at the public debt level, most notably in Victoria.
In addition to a market being wrong-footed by a better economic environment, the higher interest rate environment generated significant inflow into credit funds, with many funds able to produce equity like returns. Concurrently, the assets of the super funds continued to grow, boosted by strong inflow and investment returns. As at September 2024, the combined value of super was just over $4 trillion, up 13% on the same time last year.
As a result of the inflows into credit this year, both due to market participants actively allocating to credit, and the direct investment into credit funds, 2024 has seen a material rally in credit spreads, notably in the lower rated notes.
So what’s in store for 2025?
Will the record inflows into credit, both directly and via CIO allocations, continue?
Will credit spreads continue to rally?
What will a change in the US Presidency bring (that hasn’t already been priced in)?
Can the consumer and SMEs keep hanging tough?
Will the lift in bank and fund manager share prices in 2024 spill over into non-bank lender valuations, or will their share prices remain subdued?
Will we see a major market wobble, and if we do, what will be the catalyst and where will the casualties occur?
We have some views on all of these so please reach out if you’d like to discuss our thoughts on why the rally in credit spreads probably has further to run.