The Point

US inflation: 4pc on the horizon, but 2pc still a way off

Last night’s US inflation data was “mildly encouraging”, says our head of bond strategies Tim Hext.

The headline monthly (0.4%) and annual (4.9%) numbers were as expected.

The mildly encouraging bit – which saw yields fall and equities rally – comes from excluding rent data, which tends to swamp the US CPI (it accounts for 41 per cent, compared to 25 per cent in Australia).

This measure came in at 0.11% – the smallest monthly increase since July last year. So for the first time there are signs we may settle at a pace closer to the Fed’s 2% target.

“Markets now believe the Fed is done with hiking,” says Tim. “Without a new surge in employment or inflation this looks fair.

“US markets cannot stand still though, so they’ve factored in 75 basis points of cuts.

“This will be a test for the Fed’s resolve on inflation. Even though the pace of inflation will fall soon to around 0.2-0.3% a month, it will still leave inflation above the Fed’s 2% target.”

Budget 2023: Stage 3 tax cuts remain centre stage

The federal budget didn’t contain much to move markets, but investors will be more interested in the impact of next year’s Stage 3 tax cuts, says Pendal’s Tim Hext.

The cuts will cost the government some $243 billion in lost revenue over the next decade, says Tim.

“Though I am less concerned about their affordability – after all, the government via the RBA owns the printing press – than the economic impact,” says Tim.

“The economic backdrop against which they will take place is important. We expect inflation to be nearer 3% and GDP nearer 1% by mid next year.

“This will make the tax cuts economically affordable, since their boost to inflation and activity will be manageable.

“But it means the RBA may be more reluctant and slower to cut rates.”

How Pendal investors helped make the world a better place in 2022

As “stewards of capital”, Pendal undertook 562 ESG-related meetings with investee companies and issuers on behalf of investors in 2022.

These “engagements” – where we seek to influence positive outcomes on ESG matters – are one of the benefits of investing with an “active” investment manager.

Deep, fundamental research capabilities in this area are increasingly important, says Pendal’s Richard Brandweiner in our 2022 stewardship report (which you can find here).

“The challenge for investors is identifying authentic leadership that can leverage non-financial factors to generate real economic value,” Richard says.

“Since many of the basic hygiene factors are already considered, it will become particularly difficult for systematic processes like those used by the mainstream ESG score providers to assess this.”

Tim Hext: Rates are important – but not as much as the Budget

While we all focused on the RBA’s 10th rate rise in a row yesterday, Team Albanese was quietly working on a budget that will deliver hundreds of billions of dollars in spending initiatives and cuts in May.

Monetary policy is in the spotlight 11 times a year, while fiscal policy only has two moments – the annual budget and the mid-year outlook.

But investors would be wise to pay more attention to fiscal policy, says our head of government bonds, Tim Hext.

“Fiscal policy is more likely to determine whether or not Australia is going to have a recession,” says Tim.

“We’ve built a whole system around monetary policy and the wisdom of the independent central bank.

“But fiscal policy doesn’t get enough attention.

“The government spent $250 billion during Covid. Fiscal policy remains the main game for people’s pockets and the economy.

“It explains why the Australian economy is proving more resilient to rate hikes, at least for now.”

Fixed interest: Check your ‘duration’ settings before inflation turns

Fixed interest investors should get their portfolio settings right now, before US inflation tops out and starts falling consistently in the second half, says Pendal’s Tim Hext.

Right now US inflation reports are resetting the mood of investment markets every month, says Tim, who runs government bond strategy at Pendal.

“By the second half of the year, we are going to get a much clearer picture and we are going to see that inflation hasn’t just topped out but is coming down,” he says.

“The big message is that investors have a bit of time on their hands now, but things will start to move quite quickly by the middle of the year. So investors should be getting their duration sorted.”

That means checking the duration of your fixed income investments and their sensitivity to interest rate changes.

“Investors should be getting back to at least where their model portfolios tells them they need to be in the medium-to-long term.”

Investors need two things right now: patience and protection

INVESTORS need two things in 2023 – protection and patience.

Yesterday’s Australian monthly CPI shows the Reserve Bank’s tightening – which started in the second quarter of 2022 – is starting to have an impact.

The monthly CPI indicator rose 7.4% for the year to January – an easing from 8.4% in December.

Monetary policy works with a lag – but it does work.

This can be observed through the two key components of the CPI number: new dwelling prices and rents.