Pendal’s weekly fixed interest wrap

Here are the latest insights on inflation, rates, bond yields and credit from Pendal’s head of government bond strategies TIM HEXT

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Another week, another rise in yields; Australia the worst developed market

AT THE time of writing, Australian 10-year bond rates were up another 0.24% for the week – despite little hard data to explain it.

True, the Reserve Bank is expected to hike rates next week. But long bonds have underperformed short rates, which is not what you’d expect.

Interestingly, Australia was by far the worst performer among global markets. Europe was largely unchanged and the US was only 0.05% higher.

So we’re left with various possible explanations — though if truth be told, the scale of the selloff is a surprise to all.

One economic explanation is that our inflation seems to be settling down near 4% while the US is at 3%.

Even though our short rates are lower than the US, markets (for now) do not expect that to last in the medium term.

Maybe it was the avalanche of supply this month finally catching up with markets. 

The Australian government issued $8 billion of 30-year bonds which seemed to fill in all buyers requirements.

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Added to this was $13 billion of semi-government issuance this month, nearly all 10-year maturity or longer.

Corporates also issued $11 billion, larger than normal, with no signs of slowing down.

10-year yields knocking on 5%; semi-government bonds above 6%

Markets are now pricing inflation of 2.75% and real yield near 2.25% for the next 10 years.

South Australia on Tuesday today issued a 2038 maturity at 6.15%!

Perhaps term deposits will keep creeping up to 6% and stay there for the next 15 years. But I suspect that will not be the case.

This highlights the increasing hurdle rate for any other investment — be it equities, property or even absolute return strategies.

RBA likely to hike on Tuesday; but probably not beyond

The RBA has cornered itself into a rate hike through overly optimistic inflation assumptions made in August.

Though, we must emphasise the numbers were not that bad.

Market reaction would have you believe inflation is once again accelerating — though it was largely oil based, the price of which has now come back.

Inflation is still too high, but the RBA is not playing catch up.

The Q4 numbers out late January should be in the region of 0.7 to 1%, again confirming a pattern of inflation slowing to under 4%.

This makes a February rate hike, now priced at slightly over 50%, unlikely.

We have therefore tentatively dipped our toes into short-end duration, though saving some firepower for a move closer to 100% priced.

Credit has largely ignored equities this month

Finally, we should note the impressive performance of credit this month.

No, it hasn’t contracted. But it has also barely widened, despite higher yields and weak equities.

Last year those two events would have led to a decent widening in credit. This year the mood is different, since inflation is seen as under control and central banks largely done.

Earnings have also held up well with the stronger-than-expected economy. Liquidity could become more challenged into year end. But for now credit markets are functioning well.

About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.

Find out more about Pendal’s fixed interest strategies here

About Pendal

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

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