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Income and Fixed Interest
Debunking a myth about fossil fuels and sustainable fixed interest
High fossil fuel prices can understandably discourage investors from allocating to sustainable strategies.
Sustainable portfolios generally exclude exposure to fossil fuels, which may mean underperformance when oil prices rise, for example.
But that’s not necessarily the case across all asset classes, says Pendal’s head of credit and sustainable strategies, George Bishay.
“There’s a perception that all asset classes face these potential performance risks when prioritising sustainability.
“But Australian sustainable fixed-income exhibits minimal sensitivity to oil markets or any other screened activities,” writes George in a new Pendal paper.
Fossil fuel companies typically make up a large part of equities indices (about 15 per cent of the ASX300 in July 2024).
But issuers involved in fossil fuel extraction, exploration or refining are a small component of the Australian fixed-income benchmark.
“This differentiation allows investors to integrate sustainable fixed income into their overall core fixed-interest allocation with minimal additional benchmark risk,” says George.
“By incorporating Australian sustainable fixed income alongside other traditional assets, investors can achieve a robust portfolio while also supporting climate stability or the underserved in society.”
Tim Hext: Why Aussie fixed-income investors can largely ignore a potential August rate hike
Play podcastTim Hext: Why Aussie fixed-income investors can largely ignore a potential August rate hike
Australia appears to be at different stage of the rate cycle compared to international peers – a “lagging cycle compared to the rest of the world”, as Pendal’s Tim Hext puts it.
“Globally, people are looking at very high interest rates and going, ‘We just don’t need them anymore.’
“In Australia, though, inflation’s proven to be quite sticky around 4 per cent in the last couple of quarters. The RBA’s patience is being tested.”
August is a live meeting in terms of potential rate changes and next week’s CPI figures will be key to the decision, says Tim – Pendal’s head of government bond strategies – in a new fast podcast.
A higher-than-expected number could prompt a hike. A lower-than-expected number would mean rates stay where they are.
However, if an August rate hike eventuates, investors should largely ignore it, he argues.
Fixed income: the likely impact of rates, inflation and a Trump presidency
Play podcastFixed income: the likely impact of rates, inflation and a Trump presidency
Services – particularly wages and rental inflation – have held up prices recently. But Pendal’s forward indicators show the drivers of these two factors weakening.
That means inflation in developed markets should continue to fall and central banks globally can start cutting rates, says Pendal’s head of credit George Bishay.
It’s a bullish scenario for bonds as well as credit and equity markets, he says.
But one of the risks for that scenario is a Donald Trump victory in November.
“If Trump wins the election, will he have the ability to change policy? Will he have a majority in both houses of Congress?
“If he does, that’s problematic for bonds because ultimately that’s likely to be inflationary,” says George.
The impact of a Trump presidency is more skewed towards longer-term bonds because his policies would likely have a medium-term impact on inflation, George says.
“The short end should continue to perform because central banks will be easing rates as current inflation comes down.”
Are we getting over-confident on falling inflation? Tim Hext reviews the evidence
Play podcastAre we getting over-confident on falling inflation? Tim Hext reviews the evidence
Investors have been getting used to good news on inflation.
But does the latest US data suggest we’re getting ahead of ourselves? Pendal’s head of bond strategies Tim Hext reviews the evidence in this week’s fast podcast.
There is still opportunity in government bonds, despite US inflation data surprising to the upside, says Tim.
“People like myself are paid to worry about weekly fluctuations, but I think for investors the trend is still in place.
“We have higher interest rates than we need given the inflation backdrop now, as opposed to 12 months ago.
“Central banks have recognised that and will deliver on cuts. The theme is still lower rates in the US across the year, and Australia will likely follow towards the back after the year.”
Tim expects rates to fall from 4.35% to around 3.6% by the end of this year and possibly lower in 2025.
Amy Xie Patrick: How to manage fixed income portfolios in a turning-point year
Play podcastAmy Xie Patrick: How to manage fixed income portfolios in a turning-point year
A year ago the investment base case was a US recession, an inverting yield curve, an end to the inflation fight and optimism about China reopening.
Now, at the start of 2024, it couldn’t be more different, says Pendal’s head of income strategies Amy Xie Patrick.
“Recession is nobody’s base case. China is the last place people are optimistic about.”
It’s evidence that investors need many levers to pull when navigating the cycle, says Amy.
“Risk number one is that a soft-landing narrative led by the US economic story may not end up being the case.
“The biggest risk is always what’s outside of consensus. It’s not to say that consensus can’t happen, but if the consensus is the case, markets tend to be priced for it.
“Another risk is markets pricing in six Fed cuts, despite data showing resilient growth.
In her new podcast, Amy explains how she’s preparing for risks – and opportunities – the market may not be considering.
Tim Hext: Why bonds still look better than term deposits
Play podcastTim Hext: Why bonds still look better than term deposits
Have you missed the boat on bonds? No, says our head of bond strategies Tim Hext.
“Australian 10-year bonds did briefly touch 5% at the end of October. People may look at that and say, ‘Oh, I’ve kind of missed it’.
“But around 4.5% is still very attractive if you believe inflation is going below 3%.
“When I look across the spectrum of what you can buy in bonds, government bonds are around 4.5%, state government bonds 5.25%, and bank debt around 6%.
“On term deposits, my question to investors would be: Okay, let’s assume term deposits are at 5% and you’re locking yourself into those with no liquidity.
“Where do you think on average they’re going to be over the next five or 10 years?
“I think most people would assume they’re going to be a little bit lower, not higher; and that cash rates will come down rather than go up a lot more.
“The other advantage of bonds is that they’re liquid.
“That’s particularly important if you saw a sudden sharp sell-off in equities and you’re wanting to buy them – but your money’s locked up.”
Tim Hext: Bonds offer returns and cheap insurance right now
Bond yields are hitting multi-year highs. Why is it happening and what’s next?
Resilience in the US economy is the main factor, says Pendal’s head of bond strategies Tim Hext.
That’s due to the dominance of fixed-rate loans there and Joe Biden’s big-spending government.
Meanwhile, the Australian economy is holding up better than expected and the fixed-rate cliff hasn’t impacted as much as people thought.
“I think it’s a good time to be buying bonds,” says Tim. “At the moment you can buy state government debt at 6% yields.
“The cash rate is likely going to 4.35%, but I don’t expect it to be well above 5% for the next decade or two.”
Bond investors are rewarded in two ways, argues Tim: the return and the insurance.
“If things were to get out of hand – if you get a collapse in equities, if you see major geopolitical disruptions in this heightened risk environment – then bonds should perform their defensive role. I do think they’re cheap insurance.”
Fast podcast: Why China is hesitating on stimulus – and what’s likely to happen next
Play podcastFast podcast: Why China is hesitating on stimulus – and what’s likely to happen next
Why doesn’t Beijing pump stimulus into the Chinese economy as other countries do?
“We have to remember the Chinese political system is not democratic, and its principles are very socialist at heart,” says Pendal’s head of income strategies, Amy Xie Patrick.
“A very classic characterisation of the Chinese style of socialism is they don’t believe in ‘helicopter money’.
“They believe money going directly into people’s pockets isn’t the way to common prosperity. Instead, everyone should toil in order to achieve that prosperity.”
Even so, the severity of the Chinese property story may prompt action, says Amy.
“Lately we’ve been hearing that some government bodies have been proposing a larger fiscal deficit in 2024.”
Though the amounts aren’t big, it could signal that Beijing is considering more direct-to-consumer stimulus to keep the positive momentum going, says Amy.
Tim Hext: It’s ‘so far, so good’ on rates and the economy. But what’s next?
Play podcastTim Hext: It’s ‘so far, so good’ on rates and the economy. But what’s next?
After the latest inflation results, you’re probably thinking “so far, so good” on rate rises and the economy.
The worst of inflation at 8-10% appears to be behind us, with numbers heading to 3-4%.
No evidence yet of a sharp slow-down and most fixed mortgage holders seem to be adjusting ok to higher rates, partly due to strong employment.
What’s next for investors? Our head of bond strategies Tim Hext gives his view in our latest fast podcast.
“It’s a very mixed picture and with managing money, you’ve got to respect that for now.
“The mega trends are probably on hold for the next six to 12 months, but we’ll be keeping a very close eye on everything to see what emerges.”
Green bonds: What are they and how do you choose the right ones?
Play podcastGreen bonds: What are they and how do you choose the right ones?
The Albanese government is getting ready to launch Australia’s first sovereign green bonds, which will fund public net-zero projects.
As with all new green bond issuances, investors will be looking to make a good return and a positive impact.
When it comes to impact, investors should be looking for “additionality” in the projects funded by Albo’s green bonds, say Pendal’s head of credit and sustainable strategies George Bishay and ESG credit analyst Murray Ackman in our latest fast podcast.
“In other words, is it actually a step change?,” asks George. “Is it just refinancing an old project or is it a new project?”
Sovereign green bonds should be able to fund bigger, riskier, more interesting projects.
“We’re wanting to see projects that bring about some kind of revolutionary change,” says Murray.
“For example, in the US we’ve seen the Inflation Reduction Act has created a market for hydrogen by subsidising it significantly.”
Tim Hext: Soft landing more likely but don’t hold your breath on rate cuts
Play podcastTim Hext: Soft landing more likely but don’t hold your breath on rate cuts
It looks like RBA boss Phil Lowe’s “got one more hike he’s itching to do” in July or August, says our head of bonds Tim Hext in our latest fast podcast.
Inflation data would then start to turn down and the RBA would likely pause the rest of the year, Tim reckons.
The US could potentially start cutting rates early in 2024, he says.
“With that backdrop, there is a possibility Australia could get lower rates in the second half of next year, even if inflation – and particularly wages – remain a bit sticky.”
Tim argues investors should therefore consider 10-year bonds as they hover around 4%. Australian cash rates will eventually settle down in the 2% to 3% band, he believes.
“It’s a bit like mortgage holders two years ago should have locked in fixed rates for their mortgages.
“Now I reckon investors ought to consider locking in fixed rates for their investments.”
Fast podcast: Three things blunting the impact of rate rises on inflation
Play podcastFast podcast: Three things blunting the impact of rate rises on inflation
Inflation isn’t yet under control and the RBA still has work to do, argues Oliver Ge, an assistant portfolio manager with Pendal’s income and fixed interest team.
“I think at 4.1% we’re still at least a couple of hikes away,” argues Oliver in our latest fast podcast.
“Depending on where wages and inflation land later this month, we possibly could follow the path of New Zealand or the UK into the 5.5%, possibly 6% region.”
Oliver points to three things blunting the impact of rate rises: “Firstly, the Australian economy is demonstrating a level of resilience that’s greatly surpassed most expectations.
“Secondly, there seems to be a wage-price spiral in certain aspects of inflation that continues to channel within the CPI basket, so it persists at a level that warrants concern.
“Thirdly, despite market chatter about the potential fallout from high interest rates – particularly for mortgage holders – our analysis shows that Australians, on aggregate, aren’t as vulnerable as one might assume.”
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