The Point

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.”

Tim Hext: Powell gives the green light after smaller rate rise

Last week US inflation rose at a slower-than-expected rate, leading to a surge in stocks.

Are sunnier days ahead? Or will this month’s data join earlier false dawns such as July?

“Although not entirely unexpected, lower inflation will continue to provide encouragement to markets that the Fed can slow the pace of hikes (likely 0.5 percentage points in December),” says our head of government bonds Tim Hext.

“Investors should view any decent rallies as an opportunity to de-risk portfolios for the challenges ahead.”

The super-high inflation battle of 2022 may be won. But the outcome of the war is still uncertain, says Tim.

Getting from 9% to 4% next year will be “the easy part”, he says. Commodity shocks from Russia and tight labour markets will likely see inflation get sticky around 4%.

“Unless we tip into a steep recession the US Fed will remain wary about calling victory on inflation soon.”

TIM HEXT: Inflation will test Fed’s patience, but RBA has cards up its sleeve

US rates are headed for 4% or more after inflation remained high in August.

But the RBA may have more patience, says Pendal’s Tim Hext.

“We still expect goods deflation in the months ahead,” says Tim, who manages our government bond strategies.

“But US wage growth is spreading inflation wider into services. Services inflation is now the battleground.

“As always, Australian bonds will follow the US. But the RBA seems prepared to show a bit more patience due to factors such as wages and our floating-rate mortgage market.

“The RBA remain on course for 3% cash rates by year end (either 2.85% or 3.1%).

“Credit and equity markets were hit by the high inflation numbers, but for now look to be range-trading rather than breaking down.”

TIM HEXT: Interest rate pain probably won’t get too bad despite tough talk

Despite hawkish words from central bankers, cash rates are likely to sit around 3% next year, says our head of government bond strategies Tim Hext.

“One cannot blame them for hawkish comments on inflation, including talk of bringing on the pain,” says Tim.

“After all, their lack of forward-looking policy failed to pick up inflation soon enough in 2021.”

July’s rally — now a distant memory — comes down to the idea that inflation will fall and then stabilise around 4% in the next year.

That’s still too high, meaning rate cuts would be unlikely. But hikes would then stop around neutral and central banks would feel they had time on their side.

If Australia’s central bankers exhibit any patience our cash rates are likely to sit at 3% in 2023, says Tim.

Falling global inflation should allow our central bankers more confidence that we are not in some 1970s style spiral.

“For now, bonds have once again entered the buy zone. I’ll avoid predictions on equities. But I make the observation the landing in the US may not be as hard as many are predicting.”

Tim Hext: Hawkish central banks are telling markets to pay attention

Markets ignored central bank hawkishness in July, says head of government bond strategies Tim Hext.

“Recession talk was all the rage, which meant rate hikes were largely discounted. Financial conditions — measured by bond rates, credit spreads and equities — eased back to May levels.

“Clearly central banks were not impressed. This week they came out swinging, evangelising restrictive rates needed to rein in inflation.

“In Australia we’re likely to get another 50bp hike in September.

“Rates should finish the year around 3%. High levels of household debt (and heavy stress on 2020 and 2021 buyers) means consumers will be hit hard at that level — let alone at higher rates.

“While the RBA will remains hawkish I doubt they will risk sending households broke by raising rates to 4% — even if markets are now playing with the idea.

“I still prefer inflation bonds for now — but 10-year bonds north of 3.5% are interesting again.