Weekly Reports | Mar 02 2018
Weekly Broker Wrap: currencies & interest rates; banks; and lithium.
-Slow progress on employment suggests official rate hikes could be delayed
-AUD likely at a peak and to ease by the end of the year
-Mortgage growth slows, bank valuations remain attractive
-Expansion of low-cost lithium supply likely to end the market surplus
By Eva Brocklehurst
Currencies & Interest Rates
National Australia Bank analysts suspect that weak wages growth and slow progress in reducing unemployment mean it is becoming less likely that their previous call for two increases to official interest rates in 2018 will be realised.
The analysts now envisage the RBA will raise rates only once, late this year. November is considered the most likely start date for a gradual hiking of official rates.
By late 2018 growth should be near 3% and the unemployment rate approaching 5%. Together with increasing tightness in the labour market this may mean private sector wages start to edge up. Still, the analysts concede it is not impossible for the central bank to stay on hold for 2018 and raise rates in 2019.
ANZ FX researchers suggest a top has formed in both the Australian and New Zealand dollars. Domestically the environment is benign but globally it is continuing to deteriorate for both currencies. Rising yields will add volatility to markets and undermine more cyclical deficit currencies such as this pair.
Beyond a rise in yields, broader liquidity is also looking more vulnerable and the positive growth story appears close to being fully discounted. The analysts suggest global growth has reached a point where expectations look extended and caution is warranted.
Westpac analysts suggest the Australian dollar is likely to fall to US$0.74 by the end of the year. Underpinning the view is an expected fall in commodity prices through 2018 and 2019 and a sharp widening in the AUD/USD interest-rate differential.
Westpac expects a considerable widening in the US/Australian interest-rate differential as the US Federal Reserve raises rates while the RBA remains on hold.
Markets are currently pricing in a yield differential between US and Australian overnight rates of -45 basis points by the end of 2018 whereas Westpac expects -63 basis points. Markets are pricing in a differential of -42 basis points versus Westpac's forecast of -112 basis points by the end of 2019.
Macquarie continues to view bank valuations as attractive at current levels. Earnings growth is subdued and the credit environment remains favourable. The broker expects banks to return capital to shareholders via special dividends and buybacks.
The sector continues to trade at a deep discount to the market, which the broker currently calculates at -31% versus the industrials and there is relative value at current levels. The major bank should continue to benefit from improved deposit pricing.
Morgan Stanley calculates that mortgage growth has slowed to around 6%, the sharpest slowdown since July 2013, and expects 4% growth in 2018. The broker notes APRA's 30% cap on new interest-only loans and tighter policy terms are having an impact on the mix of housing lending. Housing growth at the banks is tracking below the broker's first half forecasts, besides ANZ Bank ((ANZ)).
Meanwhile, household deposit growth remains at its lowest levels since 2005 and the broker suggests this signals the end of margin tailwinds from lower deposit pricing. It could also indicate the Australian consumer is struggling to save.
Over the year to January 2018, total credit provider to the private sector increased by 4.9%, of which housing credit stood at 62% and rose by 6.2% over the year, while business credit at around 33% rose 3.4% over the year. System credit growth continues to run in line with the broker's projections in FY18.
Mortgage brokers have come under the spotlight in the lead up to the Royal Commission on banking as the Productivity Commission has singled out potential conflicts and high fee structures.
Credit Suisse believes, if the Royal Commission finds sufficient misconduct in the mortgage broking industry, it could mean the government acts to increase transparency on fees and regulate to improve scrutiny and the standards of aggregators.
If the government acts on fees, a removal of upfront commissions is seen benefiting banks, as it would reduce the cost of originating loans. Alternatively the government could force disintermediation and here, Commonwealth Bank ((CBA)), as the owner of Aussie Home Loans, would be most negatively affected.
If underwriting standards are further regulated, Credit Suisse suggests, for the banks, this would likely lead to improved credit outcomes.
Morgan Stanley suggests increased electric vehicle penetration will be insufficient to offset the new low-cost supply of lithium from Chile. A number of projects and expansions threaten to add around 500,000 tpa to global supply by 2025.
This includes increase production by low-cost Chilean brine operators SQM and Albemarle. This will challenge higher-cost operators in China and Australia that are also expanding.
Supply additions are expected to swamp forecast demand growth and Morgan Stanley expects 2018 to be the last year of a global lithium deficit, with significant surpluses emerging from 2019. The broker reduces earnings estimates across its lithium coverage by an average of -26% in 2020 and downgrades Galaxy Resources ((GXY)) to Equal-weight from Overweight.
Ord Minnett, too, observes global lithium stocks have underperformed other materials over the past week because of increased speculation that price declines over the medium-term are imminent. This remains consistent with the broker's recent analysis.
However, the incentive price, which Ord Minnett calculates at US$10,000/t of lithium carbonate equivalent, is likely to remain supportive. Given the rapid increase in both supply and demand, higher-cost upstream assets with no vertical integration are expected to be the most exposed to price volatility.
Ord Minnett retains a preference for producers over developers and battery grade exposure over hard rock exposure. Stock preferences include Galaxy Resources, Orocobre ((ORE)) and Kidman Resources ((KDR)).
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