The Point

Income and fixed interest wrap: latest outlook for inflation, rates and bonds

The Reserve Bank has revised its end-of-year inflation forecast to 4.5% – where it was in May. Are they right?

Pendal’s income and fixed interest team expects Q4 inflation between 0.7% and 0.8%, meaning the annual figure would be closer to 4.2%.

“If we’re right, then the November rate hike wasn’t needed,” says head of bond strategies Tim Hext.

“More importantly, this makes the chance of a February hike very low.

“Beyond February, inflation should remain sticky around 0.8% to 0.9% a quarter, meaning rate cuts are off the table for most of 2024.”

Pendal roughly agrees with the RBA’s expectation of a 3.6% number by mid-2024.

“By the middle of next year, US rate cuts may well be on the table, helping bonds find more support.”

In Australia, all eyes will be on Santa’s stocking to see the impact of the pre-Christmas hike.

Bond yields remain attractive on a medium-term basis, says Tim.

Moderating inflation is the trend of the year. Here’s what it means for investors 

Moderating inflation is now the trend of the year, says Anna Hong, an assistant PM with Pendal’s income and fixed interest team.

The US CPI increased 3.2% in the year to October – down from 3.7% annualised in September.

While Australia remains higher (we’re probably six months behind the US says Anna), we can see light at the end of the tunnel.

“Across the globe, economies have been seeing inflation come down as the resumption of supply chains eased price pressure on goods.

“This time around the inflation slowdown was much more broad-based, rather than just a goods-fuelled moderation.”

With moderating inflation as the trend of the year, investors can be more assured in their bond allocation, Anna argues.

“On balance, we believe Australian bonds should provide better risk-reward ahead.”

Pendal’s weekly fixed interest wrap

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.

Tim Hext: Australian business remains resilient as we enter spring

Business managers believe the economy remains on a decent footing and has even slightly picked up from July.

That’s the finding from NAB’s latest monthly business survey.

“The soft landing looks on track, at least for now,” says Pendal’s head of bond strategies, Tim Hext

“Businesses are not confident about the future, but still see conditions as favourable and even improving.”

But investors should separate the nominal economy from the real economy (adjusting for inflation), says Tim.

“Nominally, higher population growth has seen some expansion in the economy and increasing demand for goods and services.

“On the real side, inflation and higher rates has meant individuals are tightening their belts.

“Business knows this, and when the population growth falls back next year the nominal economy will also start feeling this.

“For now, though our models show rate hikes are still more likely than cuts, though the RBA looks happy to sit out the next few months.”

The good news? We’re avoiding recession. The bad news? Living standards are going backwards

This week the ABS released our latest national accounts – quarterly estimates of economic flows such as GDP, consumption, investment, income and saving – for the June quarter.

What did we learn?

“First, the good news,” says Pendal head of bond strategies Tim Hext. “We are avoiding a recession.

“GDP is 2.1% higher than a year ago, though slowing. It’s been 0.4% for two quarters now and will likely end the year near 1.2% – slightly higher than the RBA forecast of 0.9%.”

The bad news?

“We’re clearly in a per-capita recession,” says Tim. That means economic growth is not keeping pace with population growth.

Which means the average person is going backwards in their standard of living.

“Our population grew by 0.7% in Q2, the economy only 0.4%. GDP per capita is now 0.3% lower than a year ago and 0.6% lower than six months ago.”

Why is this happening and what’s next?

Inflation back below 5pc – but getting to 2-3pc remains a challenge

Annual inflation fell below 5 per cent in July and looks on track to hit 4 per cent or lower by the end of the year as 2022’s higher numbers drop out.

That reduces any urgency around further rate hikes – particularly since the fixed-rate cliff is now peaking, which effectively increases rates independent of the RBA.

However, the battle to get inflation back into the 2-3% band will still be a challenge next year and rate cuts seem a distance away, says our head of government bond strategies Tim Hext.

When Dr Michele Bullock takes over as RBA governor on September 18 she will be keen to establish her inflation credentials – so any move to a dovish outlook is unlikely, says Tim.

“For now, rates remain range-bound – as do risk markets,” he says.