Tim Hext: 2024 inflation outlook is positive for bond investors

Where are we on inflation at the start of 2024? And how is Pendal’s team positioned? Here’s a quick overview from our head of government bond strategies TIM HEXT

• Inflation on track in the US
• Australian inflation still above target
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

WELCOME back to those returning from a summer break.

If you’ve been off since mid-December you could be forgiven for thinking nothing happened — since bond rates are largely unchanged.

Though there was some year-end excitement as the “everything rally” pushed yields lower and risk markets higher.

A notion of lower inflation potentially allowing US rate cuts seemed to change into a stronger narrative of imminent big cuts.

The new year has now sorted that one out.

Inflation outlook in the US

As always, the main market driver in 2024 will be inflation. Here’s a brief insight into where we are now.

I will talk more about the current pulse than just annual rates — since annual rates are quite backward-looking and take longer to reflect current conditions.

In the US the Fed’s preferred inflation measure is the core PCE (personal consumption expenditure) price index. This excludes food and energy.

The Fed prefers this measure over CPI because it better reflects changes in consumer spending — instead of relying on fixed weights that only change periodically.

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It also relies on business surveys which are more reliable than consumer surveys. And it has less exposure to rents (CPI includes the notion of owner-equivalent rents, which makes up 25% of the basket).

The good news is that in the US core PCE pulse is now running at 2%.

In other words Q4 — similar to Q3 (see below) — is expected to show the three-month annualised core PCE at 2%. That’s bang on the Fed target.

It was 5% in Q1 and 3.7% in Q2.

The main reason for this move is falling margins, as now fully-open goods and services markets see businesses become more competitive again.

The final impact of the pandemic is washing through the system.

US core CPI is now moving between 0.2% and 0.3% per month, indicative of a 3% annual rate.

This should also settle lower as leading indicators on rents suggest lower levels ahead.

Inflation Outlook – Australia

Australia’s fourth-quarter CPI will be released on January 31.

Thanks to monthly data we already know roughly two-thirds of the number. Expectations are for a 0.7% headline and 0.8% underlying quarterly outcome.

Three-month annualised this would see inflation near 3% as well, though rents in Australia are unlikely to provide the same relief as in the US.

Electricity subsidies (if and when they come off) are an added uncertainty in Australia. These softened the 20% price hikes down to only 10% in recent CPI numbers.

The hope is that falling wholesale prices might offset any removal of subsidies.

The RBA forecast of 3.5% inflation by mid-2024 looks reasonable.

Unlike the US, this would leave inflation still 1% above target, making the case for rate cuts more difficult.

But if inflation can stabilise closer to 3% in the medium term — as the current pulse suggests — then the need for tight monetary policy would lessen.

The hope would be wage outcomes could then moderate from the current 4% levels.

Portfolio positioning

Growth, labour markets, geopolitical events and the usual mix of factors will, as always, be in play in 2024.

For bond markets though, inflation outcomes are now on the “good news” side of the ledger for the first time since Covid.

We are running our portfolios from the long-duration side, though adjusting positions depending on market levels and probabilities of cuts priced into markets.

It also makes us favourably disposed to risk markets.

Though we note — and caution — that the long and variable lags of monetary policy will see a slower economy and more pressure on earnings than in 2023.

About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.

Find out more about Pendal’s fixed interest strategies here

About Pendal

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

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