Not surprisingly the Australian Government Bond yield curve has flattened signficantly over the last month. The longer part of the curve is lower than it has been for much of this year which is typically an indication of less confidence in the economic outlook in our country. On the other hand, the shorter term yields are above what they were during March which is possibly a reflection of the relatively hawkish views of the Reserve Bank regarding inflation and their own interest rate intentions.
Equity markets have clearly had a strong decline since peaking around April 11 and the latest reason in the Euro sovereign crisis and the likely default by Greece. Many suggest that this is far removed from Australia but lets not forget the potential flow-on effect…i.e. A Greek, Irish, and/or Portuguese sovereign default results in a collapsed banking system in each country which flows onto the balance sheets of other Euro banks, and then around the world…hence there is the potential for another Lehman Brothers-style liquidity crisis in a worst-case scenario. Whilst, at the moment, I don’t believe a liquidity crisis will occur, the associated risks cannot be ignored and lets hope Spain doesn’t come into it.
From an investment perspective I would stay away from credit securities as they offer limited upside and equity-like downside. For those who believe its all likely to be a storm in a teacup I’d still stay away from credit securities and believe equities are better thanks to the larger upside potential.