The Point

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.”

Fixed Interest wrap: Our views on latest inflation data, the RBA review and YFYS reforms

Yesterday’s March-quarter ABS data showed goods inflation almost flat-lining as supply chains return to normal, while services inflation jumped to 6.1%.

Given it’s a one-third / two-thirds split between goods and services, this leaves the medium-term annual inflation pulse near 4%, says our head of bond strategies, Tim Hext.

“The RBA will be encouraged that inflation is falling,” says Tim. “Their 4.75% forecast for 2023 now looks high and will likely be revised down in May.

“This means no more rate hikes, with the fixed-rate cliff doing the work on the domestic economy for the rest of 2023.”

But those looking for rate cuts late this year or early next year will be disappointed, Tim says.

“The easier work on inflation is done. The harder work of reining in services inflation and the domestic economy, is very much a work in progress.

“It will not be smooth or pretty and will require rates stuck here for the rest of this year.”

“Overall the latest data supports our duration-friendly view on markets, but as always levels will determine our risk.”

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.

Hard, fast rates cycle could mean it’s time for long-duration bonds

The RBA’s hawkish tone could mean a hard landing with a fast turnaround on rates later this year.

That means fixed interest investors should be eyeing longer-dated bonds, says Pendal’s Tim Hext.

In a Pendal webinar this week Tim reviewed the latest economic data with Commbank chief economist Stephen Halmarick and outlined how it affected investors.

With higher rates on their minds, Aussies have begun reining in spending in the past two weeks, says Halmarick, who has a real-time view of the spending habits of the bank’s 16 million customers.

That will be good news for the RBA. But it’s unlikely to change their hawkish approach to inflation in coming months, partly due to strong wage growth.

Still, Halmarick reckons the cycle will be short and rates could fall this year.

Tim Hext says it’s time to consider longer-dated bonds as insurance while locking in a decent income.

“Our advice to clients is if you’ve got quite short duration, you should be looking to lengthen that.

“With 10-year bonds around 4 per cent, we don’t think cash rates are going to be able to get that high. If they do, they’ll only be there very briefly.”