US Fed highlights concerns about raising rates too early

By InvestSMART · 19 Feb 2015

By InvestSMART ·
19 Feb 2015

Comments

Given that valuations at the start of the year were already above-average and earnings expectations are barely positive, one could only put the early 2015 Australian share rally down to central bank policy, both domestic and foreign. The February RBA rate cuts and reductions in 13 other countries and a QE in Europe has reignited the global search for yield and increased demand for our higher yielding securities in both equity and bond markets. There will be two waves in Australia from the search for yield surge and we are currently seeing the first with lower bond yields sparking a rise in valuations with investors paying above-average prices for below-average earnings. However, there is likely to be another large waves which may have started yesterday as cashed up global businesses take advantage of the declining Australian dollar and make bids for our large industry leaders. The Japan Post bid for Toll Holdings was excessive and won’t be the last. Indeed, in the next six months is a significant rise in the level of M&A in Australia is expected to as the lower Australian dollar offsets the valuation premium that global companies have to pay to acquire their targets. Toll will not be the last, nor the largest takeover in 2015.

Summary

Regional sharemarkets were mixed overnight as speculation grew that Greece was inching towards striking a deal with the Troika which would alleviate risk of a more damaging bank run starting in Europe's most fragile economy. Apparent concerns among policy makers, which were detailed in the latest round of US Fed minutes, about the damage of raising rates too early in the US saw an early decline fade coming into close and bond markets rally. Meanwhile, economic data was mostly below expectations, particularly in the US, but corporate news in Australia prompted the market to continue its recent strong run, although valuations have risen so much, it is hard to identify one quality business that has an attractive valuation. Elsewhere, it was a bit quiet on other markets and with around one hour left in the current US session, the MSCI World Index is higher ( 0.2%) with advances in Europe ( 0.9%) and Asia ( 0.4%) offset by a modest decline in the US (-0.1%).
In other financial markets, 10-year government bond yields rose in line with better data out of Europe, but only by a few basis points (US Treasuries up to 2.05%, UK gilts higher at 1.68% and Japanese bonds closed at 0.42%), high beta currencies were mixed (AUD 0.3% to 77.62 and the Euro -0.1% to 113.90) and commodities were universally higher:
- oil -2.8% to USD52.06 per barrel.
- iron ore -0.9% to USD63.50 per metric tonne in US futures markets.
- gold -0.6% to USD1,201 per troy ounce.
- base metals were mostly lower.
- Dr copper 1.1% at USC261 per pound.

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Frequently Asked Questions about this Article…

Why are Australian shares rallying despite average earnings expectations?

The early 2015 Australian share rally can be attributed to central bank policies both domestically and internationally. Rate cuts by the RBA and other countries, along with European QE, have fueled a global search for yield, increasing demand for higher-yielding securities in Australia.

What impact does the declining Australian dollar have on mergers and acquisitions?

The declining Australian dollar makes it more attractive for global businesses to acquire Australian companies. This offsets the valuation premium they have to pay, leading to an expected rise in mergers and acquisitions, as seen with Japan Post's bid for Toll Holdings.

How are global bond markets reacting to economic data and central bank policies?

Global bond markets have seen a rally, particularly in the US, as concerns about raising rates too early have been highlighted by the US Fed. This has led to a decline in bond yields, despite mixed economic data.

What is the current trend in commodity prices?

Commodity prices have been universally higher, with oil, iron ore, and gold seeing declines, while base metals have mostly decreased. Dr. Copper, however, saw a slight increase.

What is the significance of the Japan Post bid for Toll Holdings?

The Japan Post bid for Toll Holdings is significant as it highlights the trend of global companies taking advantage of the declining Australian dollar to make acquisitions. This bid is seen as excessive and is expected to be followed by more takeovers in 2015.

How are regional share markets performing amid speculation about Greece?

Regional share markets have been mixed, with speculation that Greece is nearing a deal with the Troika. This has alleviated some risks, leading to advances in Europe and Asia, while the US market saw a modest decline.

What are the concerns about raising interest rates too early in the US?

The US Fed has expressed concerns that raising interest rates too early could damage the economy. This has led to a rally in bond markets as investors anticipate a more cautious approach to rate hikes.

Why is it challenging to find quality businesses with attractive valuations in Australia?

Due to the recent strong run in the market and rising valuations, it has become difficult to identify quality businesses with attractive valuations. Investors are paying above-average prices for below-average earnings, driven by the global search for yield.