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Australia’s latest GDP figures suggest the door for rate cuts has opened further, writes Pendal’s head of government bond strategies TIM HEXT

Why bonds, why now? Pendal’s income and fixed interest experts explain
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THE Australian economy grew by only 0.3% in the September quarter, once again falling behind population growth.

We managed only 0.8% growth for the year, yet the RBA still thinks demand outstrips supply.

The September quarter GDP numbers were always going to be more interesting than most.

Tax cuts and government subsidies were hitting consumer pockets and the big question was whether they would be spent or saved. For now, it appears consumers have been happy to pocket the extra money.

Spending by business and consumers once again flatlined and per capita consumption fell by 2% over the year.

The only growth we could find was, once again, the government – which now comprises almost 28% of GDP, up from around 23% for most of the past 50 years.

The graph below, courtesy of Westpac, highlights this extraordinary return of big government.

Source: Wages grow 3.5 per cent for the year | Australian Bureau of Statistics

The national accounts also provided more information around wage pressures. As the high wage outcomes of 2022 and 2023 have faded from view, these are easing quickly.

Average earnings per hour moderated to 3.2%yr, from 6.5%yr in the June quarter. This is consistent with recent wage data at 3.5%.

We have weak growth, moderating inflation, wages under control and global easing cycles – so why the hesitation from the RBA?

The central bank remains focused on the idea that the labour market remains too tight, as it believes that 4.5% – not the current 4.1% – to be full employment.

The data is now suggesting otherwise.

Outlook

It will be an interesting few upcoming meetings for the RBA board.

February will likely be the last monetary policy board decision for three of the six independent directors. And March or April will see a split into governance and monetary policy boards.

Whether this influences thinking remains to be seen, but the current spirit of caution may yet stop a rate cut in February.

However, I think the RBA may do a short sharp pivot in the next few months, and view two cuts (in February and May) as still on the cards.

The Q4 inflation data at the end of February will be another low number, with even underlying inflation likely to print 0.6%, or annualised at the RBA midpoint.

While bond investors will be cheering for a cut, the Labour government will be desperate for one ahead of the “cost-of-living” election.

Time will tell if the RBA delivers for them.

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.

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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Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by portfolio specialist Chris Adams

THE market finished November on a high, helped by falling bond yields and a lower US Dollar.

The S&P 500 returned 1.1% for the week and 5.9% for the month, while the S&P/ASX 300 was up 0.6% and 3.7%, respectively.

President-elect Trump’s threat of 25% tariffs on Canada and Mexico as well as 10% on China did not illicit a durable negative reaction in either bonds or equities – probably due to the attached conditionality and a timeframe that is still almost two months away.

The pre-conditions for a continued rally into year-end remain in place, with positive macro data, flows good, confidence high, and the supportive technicals.

There was strong divergence within Australian equities last week; tech and healthcare outperformed while energy and banks lagged.

The market’s favourite high-momentum growth names are melting up, with Life360 (360) up 20.5%, Pro Medicus (PME) up 13.6%, Sigma Healthcare (SIG) up 13.3%, Guzman y Gomez (GYG) up 12.7% and Telix Pharmaceuticals (TLX) up 9.6% week on week, with flows the main driver.

Our broad-cap portfolio positioning is generally skewed to growth, with Technology One (TNE) and Xero (XRO) underpinning performance in November. This was combined with quality industrials such as SGH (SGH) – formerly Seven Group – and James Hardie (JHX), as well as insurers which benefitted from higher bond yields over the month and the rotation to financials.

Pendal Focus Australian Share Fund

Now rated at the highest level by Lonsec, Morningstar and Zenith

US tariffs: hard to know where they land, so not factored in by the market for now

Trump posted that he intends to impose 25% tariffs on Mexico and Canada on day one of his administration.

While these are higher than the market expected, he conditioned them on action relating to immigration and drugs.

We have subsequently seen Mexican President Sheinbaum have a call with Trump, while Canadian Prime Minister Trudeau popped in for dinner at Mar-a-Lago.

Trump also spoke to imposing an additional 10% tariff on China.

The impact, if applied, is material.

The percentage of import value collected as tariffs would rise from low single-digits to roughly 10%, before factoring in anything additional for Europe.

So far, the market is sanguine on this on the belief that they will be watered down in both size and scope.

The other issues to consider with tariffs are:

suppliers absorb part of the impact in their margins
that the inflationary effect is diluted as trade flows adapt to avoid them 
currencies may adjust to dampen down effects (e.g. USD strength reduces the inflationary effect)

US economic outlook: looks fine, persistent inflation is one area to watch

This week’s monthly payroll data is an important signal for the US Federal Reserve.

The signals are constructive, with claims data coming off post the hurricane-induced spike. While continuing claims are picking up, it is gradual and still low in historical context.

Consumer confidence – reflected in the Conference Board Expectations Index – has seen a post-election increase tied to the election outcome.

History indicates that this may not result in higher spending, but it doesn’t hurt and reduces risks to the downside.

An encouraging component of the Conference Board measure is the confidence in jobs, which has improved and is a positive read on the outlook for employment.

Overall, the growth outlook remains encouraging according to the Atlanta Fed GDPNow indicator, which still has Q4 2024 GDP at above 2.5% growth.

There is a concern among some that inflation is not coming down sufficiently for the Fed to cut rates much below 4%.

In this vein, the latest Personal Consumption Expenditures (PCE) data – the Fed’s favoured inflation indicator – saw Core PCE up 0.27% month-on-month, in line with expectations.

However, the three-month annualised rate increased to 2.8% year-on-year.

Some of the services components are proving sticky; the concern is that the PCE won’t be able to break below 2.5% next year before we begin to get the effects of tariff increases and the potential impacts of lower immigration and tax cuts supporting the economy.

This could leave the Fed in a difficult position in terms of predicting the outlook, which may make them more cautious of further rate cuts.

The market is currently pricing 3.3 cuts by the end of CY25.

Australia: inflation data provides no help for case to cut rates

October’s Consumer Price Index (CPI) was lower than expected at 2.1% year-on-year, but this was all down to government subsidies.

Underlying inflation measures remain stubbornly high and the trimmed mean was 3.5% for the 12 months to October, up from 3.2% in September.

This provides no cover for the RBA to cut rates.

Inflation in areas such as rents and new dwelling purchase costs remain high, driven by structural issues in the economy.

We continue to see limited risk of a material slowdown in Australian GDP, but confidence is muted and growth seems likely to remain below trend for the next few quarters.

Markets: short-term signals remain positive

November was a good for equity markets, triggered by the decisive US election outcome.

The S&P 500 returned +5.9% for the month and the S&P/ASX 300 3.7%, with the bulk of the move from valuation re-rating.

Short-term market signals are positive:

The US dollar has not broken above its range and retraced in the last week.
Bonds yields have also rolled over and didn’t get back to the April highs.
Market technicals like breadth and seasonality are positive. For example, 77% of the S&P 500 is trading above its 200-day moving average.
Earnings revisions have been positive. This has been driven by mega-cap tech, where FY25 earnings have been revised up 11% over CY 2024. The rest of the tech sector has been revised down 1.6% and the rest of the S&P 500 down -3.8%. However, this is well within the normal range of zero to -5% earnings downgrades over the course of a year.
Flows into US equities remain strong, with a large spike following the election result.

The challenge is US equity valuations are full. There appears little catalyst to change this currently, but if there was a shift in liquidity or in the economy, then valuations could reset.

The S&P 500 is on the top decile in terms historical market valuation going back to 1999.

There is an argument being made that the market structure is now dominated by mega-cap tech companies which have low capital intensity, high rates of return on investment and incremental return, as well as strong revenue growth rates which may suggest that valuations aren’t as extended as simple historical analysis suggests.

We do note that credit spreads are low by historical standards, which suggests that the liquidity environment remains supportive.

Australia

Information technology (+10.2%), banks (+7.1%), consumer discretionary (+6.6%) and industrials (+5.6%) led the S&P/ASX 300 higher in November. Energy (-0.7%) and resources (-3.4%) lost ground.

Growth momentum performed best; results from TNE, XRO and Block (SQ2) were good, while PME won a key contract.

With limited revisions, the banks’ earnings season was neutral, with CBA performing the best.

Insurers outpaced the banks, helped by bond yields.

Resources continue to fall and have given back more than 50% of their China stimulus rally.

Battery materials remain the worst of the sector, despite lithium prices stabilising. BHP continues to be burdened by the fear of it re-bidding for Anglo American now that the six-month lock period is up. Finally, copper and gold have retreated post the US election.

Portfolio positioning

Generally, across our broad-cap portfolios, we have kept our sector skews relatively limited:

We have been underweight defensives/bond sensitives, though this has been reduced somewhat with the addition of Scentre Group (SCG) in recent months.
We also have a small underweight to resources.
The bank underweight has increased in recent weeks. We see reduced risk of valuations breaking higher for the bank sector given the strong run and current rating. This exposure is also partly offset by the overweight in insurers.
We are underweight consumer defensive – notably supermarkets – which we see as expensive, low-growth stocks.
Against this we are overweight growth, mainly through technology companies where we see earnings growth underpinning the higher valuations.
We have also benefited from an overweight in cyclicals industrials, with stocks in good industries and/or strong market positions such as Aristocrat Leisure (ALL), SGH (SGH), James Hardie (JHX) and Qantas (QAN) all performing well in November.

About Crispin Murray and the Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

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

Find out more about Pendal Focus Australian Share Fund

Contact a Pendal key account manager

Managing portfolios in a Trump era | How the gender pay gap affects investors | China’s property sector improves | How to reduce the impact of inflation

At the end of a year in which almost half the world’s population were eligible to vote, investors can finally look forward to more certainty, says Pendal’s ADA CHAN

End of a huge election year improves certainty for investors
Potential opportunity emerges in China
Find out more about Pendal Global Emerging Markets Opportunities Fund
Watch a Pendal webinar covering the outlook for global equities and emerging markets

IF IT feels like a hectic year for emerging markets investors, you’d be right.

So far 66 national elections have taken place around the world in 2024, according to the International Institute for Democracy and Electoral Assistance, an intergovernmental organisation that supports democracy worldwide.

And another eight or so are still scheduled before the new year.

Just after the US election, Pendal Global Emerging Markets Opportunities fund manager Ada Chan joined Pendal Global Select fund manager Chris Lees in a live webinar to discuss major trends emerging from these polls, along with other issues.

You can watch the full webinar here.

Below are Ada Chan’s key points. Click here for insights from Chris Lees.

A big year for elections

Investors in emerging markets (EM) can expect more certainty after a huge year in national elections, says Pendal emerging markets fund manager Ada Chan.

“We will have to wait and see the details on many Trump Administration policies … and implementation is key from the US.”

But there are already actionable lessons to be drawn from elections in Indonesia, Mexico and India — which all had “very different elections this year”, Chan says.

“In Indonesia, there is continuity and stability and that is viewed positively. It is a market where reforms are [working] and driving the economy. That’s a differentiator among ASEAN markets.”

James Syme, Paul Wimborne and Ada Chan (right) are co-managers of Pendal Global Emerging Market Opportunities Fund

“In Mexico investors expected Claudia Sheinbaum to win, but the surprise was her super majority. There was also an overlap with her predecessor … and that created uncertainty and investors don’t like uncertainty.

“Mexico is a difficult market – which part of a valuation is driven by a carry trade unwinding, which part is driven by local politics and which part is driven by anticipation of what Donald Trump is going to do. We think a lot of the bad news is already in valuations,” she says.

“In India, people expected Narendra Modi to win, and he did. But markets in India are pricing in perfection. In India it isn’t so much about the election as high valuations.”

China

Investors in China should focus on domestic industries, rather than manufacturing exporters, Chan says, ahead of any Trump Administration decision on tariffs.

“The Chinese government wants to stimulate its economy. But I think there is a little bit of wait and see, to make sure they know what Trump is proposing,” Chan says.

“It is a timing issue for China. They want a bit more clarity [on the Trump Administration] before they come up with their stimulus. We do expect there will be more stimulus, but it is a step-by-step process.”

Chinese consumers are changing as well. Previously foreign brands sold better than local products but that is no longer the case.

“Chinese consumers are embracing domestic brands. They can buy better products, with higher average prices, that are a lot cheaper than foreign brands,” Chan says.

Country-first analysis

Chan’s investment process starts with identifying a promising country, based on an outlook and valuation perspective.

Find out about

Pendal Global Emerging Markets Opportunities Fund

“There are opportunities emerging in China. We think people had become too pessimistic and gone too extreme when looking at China.

“We saw Chinese companies report better numbers, raise forward earnings [guidance] and then get sold off.

“There is the opportunity to [invest] in companies that are becoming stronger because management are focusing on what makes the business more efficient, in an environment which is very difficult.”

About Pendal Global Emerging Markets Opportunities Fund

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund’s top-down allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

James, Paul and Ada are senior fund managers at UK-based J O Hambro, which is part of Perpetual Group.

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

Contact a Pendal key account manager here

Here are the main factors driving the ASX this week, according to Pendal portfolio manager JULIA FORREST. Reported by portfolio specialist Chris Adams

EQUITIES continue to grind higher, with the S&P 500 up 1.7% last week and the S&P/ASX 300 up 1.3%.

Safe havens like gold, oil and the Swiss franc caught a bid on the back of rising geopolitical tensions, with outgoing US president Joe Biden giving a final push to resolve the Russia-Ukraine conflict before Donald Trump takes office.

Treasury yields were relatively stable as markets attempt to discern the likely policy mix under a Trump administration, made even more difficult by some interesting cabinet nominees.

US Fed-speak was mixed but on balance more dovish.

Nvidia, the world’s largest company, reported Q3 results with guidance for Q4 sales only beating by $400 million versus the normal $1 billion. Management highlighted some delays and cost pressures around the next-generation AI chip.

In Australia, Reserve Bank minutes noted that easing in the labour market might have begun to stall or modestly reverse. The RBA wants to see two quarters of declining inflation before cutting the cash rate.

US macro and policy

Howard Lutnick, CEO of bond broker Cantor Fitzgerald, was appointed US commerce secretary and hedge fund manager Scott Bessent was announced as Treasury secretary.

Pendal Focus Australian Share Fund

Now rated at the highest level by Lonsec, Morningstar and Zenith

Lutnick advocated for higher tariffs at a recent rally in New York, citing the prosperity of the early 1900s when there was no income tax and all the government had was tariffs. Though he did acknowledge they would raise prices, at least temporarily.

In an interview with the Financial Times, Richmond Fed president Tom Barkin noted the US was more vulnerable to inflationary shocks than in the past, with businesses more readily passing on costs to consumers.

The inflationary effects of potential tariffs and immigration plans under president-elect Donald Trump were a “concern” for businesses, but the Fed shouldn’t adjust monetary policy before possible changes in economic policy, he said.

Elsewhere, US home builder sentiment rose to a seven-month high. The results suggest optimism that high-income households will move forward with home-buying plans, given US personal tax cuts will persist.

While sentiment has been strong actual starts have been softer, with starts and permits declining 4% and 7.7% year-on-year. Mortgage rates have risen 80bp to 6.86% over the past two months.

Walmart reported sales +5.3% with the retailer benefiting from trading down.

Recent surveys suggest US consumers are set to spend 4% more on holiday shopping this year. While consumers may feel fearful of inflation, their balance sheets look good.

Initial jobless claims came in at 213k, better than consensus expectations (220k) with the data showing that the labour market is trending sideways at a healthy level.

The narrative that the US labour market is cooling appears inconsistent with the continued strength in data for above-trend GDP growth, strong retail sales, low jobless claims, and rising average hourly earnings.

In addition, credit spreads continue to be tight, corporate profits and forward profit margins are at all-time highs and US household balance sheets are in very good shape.

In short, the US economy remains very strong.

The market continues to pare back expectations of large Fed Fund rate cuts. Expectations for a December rate cut from the U.S. Federal Reserve have diminished, with the likelihood now at 53%, a sharp drop from 82.5% just a week earlier.

Unsurprisingly the US dollar continues to be very strong.

US inflation and bond rates

The US 10-year bond yield has increased from 3.6% to 4.4% despite the Fed signalling significant rate cuts.

This has not been the case in previous rate cutting cycles where yields have either fallen or gone sideways.

The soft employment print in September prompted a 50 bp cut but was then met by a couple of sticky inflation prints.

Fed funds futures have shifted over the past two months, with the expectation for the end 2025 moving from 2.8% up to 3.8%.

While inflation has been trending down with the core measure at 3.3% year-on-year, it will remain a key concern for financial markets, as well as in the political sphere.

This was the 42nd consecutive month with Core CPI above 3%, the longest period of elevated inflation in the US since the early 1990s.

Find out about

Pendal Property
Securities Fund

Voter perceptions of inflation were important in the recent US elections. The economy was the top concern for Republican voters, and three quarters of US voters felt inflation created hardship for them this year.

Tariffs generally apply to lower frequency consumer durables, with consumers less aware of price changes unlike the hyper awareness of changes in prices at supermarket or petrol stations.

As such tariffs may end up raising inflation with less impact on the politically important perception of inflation.

Europe macro and policy

The European Central Bank’s index for negotiated wages rose to 5.4% year-on-year in Q3, up from 3.5% in Q2, a record lift since the euro area was formed.

A jump had been anticipated after large, negotiated wage rises in Germany for auto and engineering workers.

The ECB expects wage inflation to fall next year to a rate more consistent with the 2% inflation target.

The market’s reaction was limited, with the data playing to the view that the ECB is likely to cut by only 25bps next month.

China macro and policy

China announced some tax reductions for home buyers. This might indirectly support consumer spending, with new home buyers having more spare cash to spend on furniture, for example.

However it is not the degree of consumer support markets really wish to see.

A wide gap has opened between mortgage interest rates and mortgage borrowing, implying that potential homebuyers are unwilling to buy apartments at any level of mortgage rate.

With an estimated 90 million empty apartments and a population expected to fall by roughly 100 million in the next 20-to-30 years, the cyclical and structural headwinds make stimulating this important part of the economy extremely difficult.

Australia macro and policy

Minutes from the RBA’s November meeting noted that easing in the labour market might have begun to stall or modestly reverse.

A breakdown of Australian unemployment by duration shows that short-term unemployment appears to have stabilised below pre-pandemic levels.

The board also highlighted that due to govt subsidy ’noise’ from government subsidies in the December 24 quarter, it wants to see two quarters of declining inflation before cutting the cash rate’.

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Pendal Smaller
Companies Fund

This means that the first rate cut (if any) is likely to occur from May 2025.

Australian housing prices have also hit a historical peak of unaffordability – with the average home now costing eight times the median household income.

The percentage of national median income needed to fund a mortgage on the national median dwelling value has hit 50.6%, according to CoreLogic, versus a 20 year average of 36.6%.

Rental costs are 33%, versus a 20 year average of 29%, by the same measurement.

The Australian Bureau of Statistics considers a household to be in housing stress if it pays more than 30% of income on housing costs.

While first home buyers have benefited from assistance from the Bank of Mum and Dad in recent years. There are warning signs of pressure here.

By one measure, the percentage of households in the 55-64 year age cohort owning a home with no mortgage has fallen from over 70% in 1995 to under 40% today.

Markets

There are some warning signals in US equities, such as historically high valuation levels, insider selling (although there are some seasonal effects here) and Berkshire Hathaway loading up on cash.

However, sentiment remains strong, and earnings growth continues to be supportive.

Market breadth is also improving and favouring small caps which are likely to benefit from US pro-growth policies.

The stock market is the second most expensive for any incoming President (after George W Bush in 2000).

Given Trump’s pro-market tendencies, it is reasonable to expect that he is likely to double down on market friendly policies in the event of a big sell off.

Locally, the ASX unwound some of the recent weak performance in energy and resources with both sectors up strongly at the expense of IT, consumer discretionary stocks and AREITs.

About Julia Forrest and Pendal Property Securities Fund

Julia Forrest is a portfolio manager with Pendal’s Australian Equities team. Julia has managed Pendal’s property trust portfolios for more than a decade and has 25 years of experience in equities research and advisory, initial public offerings and capital raisings.

Pendal Property Securities Fund invests mainly in Australian listed property securities including listed property trusts, developers and infrastructure investments.

About Pendal Group

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

Contact a Pendal key account manager

We have updated and reissued the Product Disclosure Statement (PDS) for the Pendal Australian Long/Short Fund (the Fund) effective on and from Monday, 25 November 2024.

The following is a summary of the key changes reflected in the PDS for the Fund.

Updates to significant risks disclosure

The Fund’s investment strategy involves specific risks.

We have updated the significant risks disclosure applicable to the Fund to ensure that our disclosure continues to align with the nature and risk profile of the Fund and the current economic and operating environment.

Updates to ongoing annual fees and costs disclosure

The estimated ongoing annual fees and costs for the Fund have been updated to reflect financial year 2024 fees and costs. These include changes to estimated management costs and estimated transaction costs.

We now also disclose the maximum management fee we are entitled to charge under the Fund’s constitution.

Updates to restrictions on withdrawals

We have updated the disclosure on restrictions on withdrawals to align closer to what is in the Fund’s constitution.

Additional information on how to apply for direct investors

We have provided additional information for non-advised investors (i.e. investors without a financial adviser) investing directly in the Fund who may also be required to complete a series of questions as part of their online Application, to assist us in understanding whether they are likely to be within the target market for the Fund.

Updates to our complaints handling process

We have provided additional details about our complaints handling process and the Australian Financial Complaints Authority.

Shorting bonds may no longer be the best trade, argues Pendal’s head of income strategies AMY XIE PATRICK

Bonds carry plenty of risk premium for the uncertainty that lies ahead
Hedge funds piling on short US bond bets “like no other time in recorded history”
Find out more about the Pendal Monthly Income Plus Fund

IN the final weeks leading up to the US election, political pollsters said it would be a close call.

Bond markets, on the other hand, traded like a Trump victory was in the bag.

While the market continues to show little love for bonds in the aftermath of the “Red Sweep”, this article looks at whether the bond short remains the correct “Trump trade”.

What’s priced in?

Bonds have had a busy time. For most of the year, US bond yields have danced between large and small rate cut expectations, fuelled by recession fears and resilient data, respectively.

Despite the US Federal Reserve (the Fed) kicking off this easing cycle with a 50 basis point (bp) cut to the Fed Funds Rate in September, bond yields have failed to fall any lower.

The fear of a Trump victory and the anticipation of his economic policies have played a large part in the most recent bond sell-off.

This move has been similar to the post-election bond market reaction in 2016.

After some immediate confusion as to whether a Trump presidency would herald the end of civilisation as the world had known it, bond yields started to take off. This made sense, as tax cuts and corporate repatriation tax breaks were lifting US growth expectations across the board.

The Fed was also engaged in a hiking cycle.

Between the 2016 US election and the middle of 2018, most tax cuts and repatriation flows had already happened. In that same window, US 10-year Treasury yields climbed by nearly 1.00%.

Figure 1: The impact of Trump’s first victory on bond yields — Source: Bloomberg

This time around, bond yields started to move ahead of the US election.

Since the September Fed rate cut (and there has been another cut since then), US 10-year bond yields have climbed by close to 0.9%.

Source: Bloomberg

This latest rise in US bond yields has effectively erased all the market’s anticipation of how the Fed easing cycle would play out on longer-dated bond yields.

It could even be argued that this similar rise in bond yields compares as more extreme than the 2016 experience, which took place against the backdrop of a Fed tightening cycle.

While it’s impossible to say whether the full impact of Trump’s presidency is already in the price, it is certain that bonds already carry plenty of risk premium for the uncertainty that lies ahead.

The real rise in yields

The rise in US bond yields since September is not just about a fear of Trump’s policies being inflationary. Figure 3 shows that both US 10-year breakeven and real yields have marched higher.

Breakeven yields indicate the market’s view on long-term inflation expectations. Since the September FOMC meeting, 10-year breakeven yields have risen by 0.24% to 2.35%.

In other words, the market is having doubts about the Fed being able to maintain inflation at its 2% target in the long run.

Real yields, however, have risen by twice as much in the same period – from below 1.6% in September to nearly 2.1% today.

The prevailing market explanation is that the incoming Trump administration is very likely to see a worsening of the US deficit situation, leading to an increase in US government bond supply.

However, real yields can move due to both the demand for and supply of capital.

An increase in US government bond issuance represents an increase in demand for capital. But existing academic studies have found that the most significant drivers of real yields in the US are demographics and growth.

Source: Bloomberg

Ageing populations lead to higher savings rates, which increase the supply of capital – pushing down real yields.

This long-term trend is unlikely to be suddenly reversed by Trump’s policies and may, in fact, be exacerbated if the working-age population can no longer grow so easily due to more hawkish immigration policies.

GDP growth is positively linked to real yields, because when an economy grows, its need for capital tends to increase. This is why productivity growth is also tied to real yields. Higher productivity is usually a result of investment in technology and innovation – both of which require capital.

The likely effect of tax cuts and tariffs

An expansion and extension of tax cuts under the Tax Cuts and Jobs Act may indeed lift the growth rate of the US economy. But with a real yield rise of over 0.5% since September, a lot of those higher growth expectations have already been baked in.

Figure 4: Fiscal handouts have contributed to US consumer resilience — Source: Bloomberg

Furthermore, tax cuts are unlikely to have the same distributional impact as the post-pandemic fiscal handouts implemented under the Biden Administration.

As illustrated in Figure 4, the poorest half of Americans still have more cash in their pockets than prior to the pandemic. The poorest one-fifth of US households have still experienced significant growth in their ex-real estate wealth since the pandemic.

In addition, trade tariffs tend to have a contractionary effect on demand and global growth.

The US economic slowdown in 2018 was evidence of this during Trump’s tariff wars with China. The deflationary effects were so strong at the time that it forced the Fed into the famous “Powell Pivot”, whereby the hiking cycle was abruptly halted (Figure 5).

Figure 5: Trump’s first trade war was deflationary

Source: Bloomberg

The extent to which Trump’s policies can lift the US economic growth trajectory is uncertain. That the poorest Americans stand to benefit the most is unlikely.

Place your bets

While the US economy has remained resilient, we remind ourselves that only weeks ago recession was the main concern on the supposed breach of the “Sahm rule”. Whether the US labour market will manage to avoid further deterioration remains the main concern.

As Figure 6 highlights, once the unemployment rate starts to turn higher, recession usually follows.

Figure 6: Hoping to avoid the unemployment lift

Source: Bloomberg

In the meantime, global hedge funds have piled on short US bond bets like no other time in recorded history (Figure 7).

Figure 7: Selling bonds like they’re going out of style

Source: Bloomberg

Asset managers’ natural positioning on Treasury futures tends to be long, as often futures will be used to ensure their portfolios’ duration do not fall short of their benchmarks. This creates room to put cash to work on higher-yielding assets like credit.

The most recent rise in the net Treasury futures position among global asset managers may be linked to their chase for credit, rather than an outright desire to extend their US government bond exposures.

Hedge fund positioning, on the other hand, tends to be driven by a direct view of how US Treasuries will fare.

In the low-rates era, hedge funds built up short positions on views that lower rates could not possibly last forever. The pandemic brought in a brief period of even lower rates and forced those hedge fund short positions to be unwound.

Since 2022, however, hedge funds have re-engaged with the short-bond trade because of concerns over inflation, the US deficit situation, and likely a multitude of other factors such as momentum.

The most recent driver of short positioning among global hedge funds seems to be the “Trump trade”. With hedge funds’ short bets on US Treasuries at an all-time high and yields having already risen significantly, the risk is that even hawkish Trump policies fail to push this trade on further.

Market positioning is never the primary driver behind our portfolio positioning decisions. However, it does inform our assessment of the risk-reward dynamic affecting any active decision we make.

If the details of Trump’s economic policies surprise to be more benign or if hawkish policies lead to disappointing market reactions, one expects profit-taking or capitulation to occur among the hedge fund community.

In other words, market positioning points to risk-reward that favours bonds. At the very least, shorting bonds may no longer be the best Trump trade.

About Amy Xie Patrick and Pendal’s Income and Fixed Interest team

Amy is Pendal’s Head of Income Strategies. She has extensive expertise and experience in emerging markets, global high yield and investment grade credit and holds an honours degree in economics from Cambridge University.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia. The team oversees some $20 billion invested across income, composite, pure alpha, global and Australian government strategies.

Find out more about Pendal’s fixed interest strategies here