The Point

Tim 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

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.

Fast 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.”

Fast podcast: Why now could be a good time to lock in 10-year bonds

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: How a weaker China could be good for bonds

China has emerged quickly from zero-Covid, but a property slowdown is holding the economy back.

What does that mean for fixed income investors?

“When the property sector is in a slump, it means that confidence from the private sector generally is in a slump as well,” says Pendal’s head of income strategies Amy Xie Patrick.

“That’s leading to a lot of the recent data showing that the initial momentum from China’s reopening story seems to be petering out.

China’s weaker domestic demand and falling Producer Price Index will continue to drag on the global inflation story, “which is good for bonds”, argues Amy.

“We think there are many strong reasons both cyclically and structurally to be favoring fixed income and bonds in portfolios right now.

“The way the China growth story is shaping up for 2023 presents as one of the top reasons to be buying bonds right now.”