Here are the latest insights on inflation, rates, bond yields and credit from Pendal’s head of government bond strategies TIM HEXT

• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

Another week, another rise in yields; Australia the worst developed market

AT THE time of writing, Australian 10-year bond rates were up another 0.24% for the week – despite little hard data to explain it.

True, the Reserve Bank is expected to hike rates next week. But long bonds have underperformed short rates, which is not what you’d expect.

Interestingly, Australia was by far the worst performer among global markets. Europe was largely unchanged and the US was only 0.05% higher.

So we’re left with various possible explanations — though if truth be told, the scale of the selloff is a surprise to all.

One economic explanation is that our inflation seems to be settling down near 4% while the US is at 3%.

Even though our short rates are lower than the US, markets (for now) do not expect that to last in the medium term.

Maybe it was the avalanche of supply this month finally catching up with markets. 

The Australian government issued $8 billion of 30-year bonds which seemed to fill in all buyers requirements.

Added to this was $13 billion of semi-government issuance this month, nearly all 10-year maturity or longer.

Corporates also issued $11 billion, larger than normal, with no signs of slowing down.

10-year yields knocking on 5%; semi-government bonds above 6%

Markets are now pricing inflation of 2.75% and real yield near 2.25% for the next 10 years.

South Australia on Tuesday today issued a 2038 maturity at 6.15%!

Perhaps term deposits will keep creeping up to 6% and stay there for the next 15 years. But I suspect that will not be the case.

This highlights the increasing hurdle rate for any other investment — be it equities, property or even absolute return strategies.

RBA likely to hike on Tuesday; but probably not beyond

The RBA has cornered itself into a rate hike through overly optimistic inflation assumptions made in August.

Though, we must emphasise the numbers were not that bad.

Market reaction would have you believe inflation is once again accelerating — though it was largely oil based, the price of which has now come back.

Inflation is still too high, but the RBA is not playing catch up.

The Q4 numbers out late January should be in the region of 0.7 to 1%, again confirming a pattern of inflation slowing to under 4%.

This makes a February rate hike, now priced at slightly over 50%, unlikely.

We have therefore tentatively dipped our toes into short-end duration, though saving some firepower for a move closer to 100% priced.

Credit has largely ignored equities this month

Finally, we should note the impressive performance of credit this month.

No, it hasn’t contracted. But it has also barely widened, despite higher yields and weak equities.

Last year those two events would have led to a decent widening in credit. This year the mood is different, since inflation is seen as under control and central banks largely done.

Earnings have also held up well with the stronger-than-expected economy. Liquidity could become more challenged into year end. But for now credit markets are functioning well.

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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

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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.

Contact a Pendal key account manager

Here are the main factors driving the ASX this week according to portfolio manager PETE DAVIDSON. Reported by portfolio specialist Chris Adams

CONCERNS about the Middle East and Ukraine, ongoing tight money conditions and an opaque inflation outlook are weighing on equity markets.

On a positive note, we’ve seen an improvement in US domestic politics with the appointment of a House speaker after a three-week hiatus. Though the underlying US political backdrop remains deeply partisan.  

Oil prices remain elevated but have not spiked despite Middle East mayhem. Crack spreads — the pricing difference between a barrel of crude and all the petroleum products refined from it — are actually pointing to lower oil prices.

Gold and natural gas prices also remain high.

Iron ore prices are up on expectations of a China stimulus package and lower Chinese domestic iron ore production.

In Australia, a September quarter consumer price index (CPI) of 1.2% pointed to a re-acceleration of inflation, with stickiness in rents and services.  

Aussie two-year and 10-year government bond yields were up 10bps and 7bps respectively last week.

The S&P/ASX 300 shed 1.05% for the week, led down by interest-sensitive sectors such as real estate (-4.33%) and technology (-3.60%)

Simply put, higher rates are likely to reduce an already muted earnings growth outlook. 

US macro and policy

Overall, the economic consensus in the US is now the Goldilocks scenario of inflation on a glide-path to 2%, with GDP slowing and a soft landing.

This is what’s currently in the price.

US GDP growth remains strong and US consumers are still spending.

However there are straws in the wind that suggest growth might be slowing — including a plunge in the recent EVRISI homebuilder survey and some softer manufacturing indices.

Labour costs and services inflation remain thorny issues for inflation. However Covid-inspired quit rates are slowing, helping the outlook for slowing labour price gains.

It’s interesting to note the US has a real (inflation-adjusted) cash interest rate of 1%, versus zero for Europe, about -1% for Australia and -3.5% for Japan.

Higher real cash rates help lower inflation. Jamming the Fed funds rate above the inflation rate worked in 1979 for Fed governor Paul Volcker, who broke the back of inflation.

The US yield curve is now much less inverted than it was mid-year. The spread between 10-year and two-year nominal yields has fallen from about -100bps to -20bps.

We continue to watch a number of factors which have driven 10-year yields to 20-year highs. These include:

• Strong Q3 GDP growth of 4.9%
• Increased supply of Treasuries as the fiscal deficit expands
• Reduced demand for US government bonds from global investors. There is also competition from rising yields on offer in Japan
• Reduced demand from the Fed

Looking at the past eight Fed tightening cycles, bond yields fell post the final hike each time by 90bps on average over the following six months — irrespective of whether a recession or soft-landing followed.

However history also shows that sharp rises in 10-year bond yields often culminate in a financial “accident” such as the 2018 global sell-off or the 2013 “taper tantrum”.

We did see the US banking crisis earlier in the year and we remain on watch for other signs of stress.

Australian macro and policy

September’s CPI came in at +1.2% for the quarter, up from a +0.8% rise in the previous quarter.

It was 5.4% year-on-year, down from 6% in the June quarter.

The trimmed means were 1.2% for the quarter and 5.2% for the year.

The devil was in the detail. Food grew only 0.6%, helped by deflation in the fresh food category. Meanwhile subsidies helped rein in growth in the childcare and electricity components.

Services inflation remains elevated, driven by rents and insurance. It’s likely that growth in the rental component is understating the actual state of rents.

An RBA rate hike is now more likely in November.

We do note that accounting software company Xero’s data suggests wages rose just 1.9% in the year to September and averaged 2.7% in the prior three months for Australian small businesses. This is a positive trend for inflation.

Labour cost growth is starting to trend down, according to the latest NAB business survey.

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About Pete Davidson and Pendal Focus Australian Share Fund

Pete is Pendal’s head of listed property and a portfolio manager in our Aussie equities team. For more than 35 years, he has held financial markets roles spanning portfolio management, advisory and treasury markets.

Pendal Focus Australian Share Fund is Crispin Murray’s . Find out more about Pendal Focus Australian Share Fund here.

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

Contact a Pendal key account manager here

The November 7 rates decision rests on the definition of ‘materially higher’ and ‘low tolerance’. Pendal’s head of bond strategies TIM HEXT explains

• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

AUSTRALIA’S latest inflation data was higher than expected.

The September quarter inflation number came out at 1.2% for both headline and underlying (trimmed mean) measures. This was above expectations of 1.1% and 1% respectively.

In terms of headline inflation, it’s now fair to say the current pace is about 4% annually.

Last quarter it was 0.8%, dragged 0.2% lower by fuel prices. This quarter was 1.2%, dragged 0.2% higher by fuel.

The increase in underlying inflation would be of greater concern for the Reserve Bank.

A quarterly rate of 1.2% would not have been welcomed.

Under the hood

Looking under the hood would add to the RBA’s concerns.

Market services remain stubbornly high. Housing inflation remains at over 2% a quarter, driven in part by utilities.

At least rents have now caught up with leading indicators at 8% annually.

Anyone who recently received their council rates will not be surprised by the 4.4% increase there. At least it only happens annually.

Government subsidies once again had an impact.

The government is already suppressing utility prices and now also childcare prices – though the childcare changes are permanent. Childcare costs were down 13%, subtracting 0.1% from this quarter’s CPI.

Here you can see a breakdown of the ABS’s latest inflation data:

What’s material?

Focus now turns to the RBA’s November 7 board meeting.

We have two communications recent communications to consider.

The RBA’s latest minutes mentioned a “low tolerance” to upside inflation surprises.

And in her maiden governor speech, Michelle Bullock mentioned “the board will not hesitate to raise the cash rate further if there is a material revision to the outlook for inflation”.

The question is – what is material?  

In August the RBA forecast year-end inflation to be 4.1% and 3.9% underlying. It’s early days, but Q4 is expected to be around 0.9%.

This would leave headline at 4.3% and underlying at 4.1%.

The RBA will release updated forecasts in its next monetary policy statement on Friday November 10 (though it will reference them in their rate decision beforehand).

Is 0.2% higher “material” or a breach of the “low tolerance”? That will be the big question come November 7.

Markets have 60% chance of a hike in November and a cash rate 0.35% higher by early next year.

At these levels there is no clear trade, since it will be line ball.

If pushed, I think Michelle Bullock will be keen to show her inflation fighting credentials by putting in one hike, even though she was probably hoping today’s number would let her off the hook.

If the market gets close to pricing two hikes in the next few weeks we will go long duration. But until then today’s reaction seems sensible and fair.

Long bond yields largely ignored Wednesday’s moves. Ten-year bonds remain around 4.75%.  

As always, they will rightly or wrongly be more captive to US bond moves and the latest iteration of oil prices.

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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

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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.

Contact a Pendal key account manager

There are signs the global economy is gradually slowing. Pendal’s ANTHONY MORAN explains what that means for Aussie equities portfolios

• Economic slowdown may require portfolio rethink
• Look for companies gaining market share and investing
• Find out about Pendal Focus Australian Share fund
• Watch Crispin Murray’s bi-annual Beyond The Numbers webinar

THE global economy has shown resilience in recent months — but there are now signs it is gradually slowing, along with consumption.

“It doesn’t feel like things are falling off a cliff,” says Pendal equities analyst Anthony Moran.

“But we are moving from single-digit growth to single-digit declines. In this environment investor mindsets change from being comfortable about resilient demand to thinking about downside risks.

“That’s making everyone a bit more wary and it’s a good time to think about your portfolio.”

The shift has been particularly prevalent in industrials, which have underperformed other sectors.

“Investors want a way to offset the risk, particularly because we’re talking about modest and moderate declines, not a full-scale recession.

“Investors don’t need to put all their money into hyper-defensives because things may not be that bad,” Moran says. 

“They should be looking for companies that are going to grow above their category, or are able to grow market share, particularly if they are trading at attractive valuations.”

Example: Aristocrat

One example is Aristocrat Leisure (ASX: ALL), which Pendal owns in several equities funds.

“They are not only exposed to the traditionally resilient category of gaming. Because they’ve invested huge amounts in research and development, it’s allowed them to keep taking market share in slot machines, particularly in North America and in online casinos.

“Companies like Aristocrat should be able to still deliver pretty good earnings growth even if gaming spend declines because of market share gains,” Moran says.

Aristocrat has also recently won a licence to use NFL branding in the US on slot machines, which has the potential to be a long-lasting franchise and deliver a younger demographic into casinos.

Example: James Hardie

Another company that falls into the ‘outperformance’ category is building materials supplier James Hardie (ASX: JHX), which Pendal also owns in several funds.

“They’ve had a double-digit decline in market demand in the US market, but they’ve been able to win market share through refocussing their attentions on the large home builders in the last 12 to 18 months.

“Not only has James Hardie been winning market share in their customer segment, but those large home builders have been winning share themselves within the housing market … benefiting from a lack of existing home inventory.

Focus on longer-term gains

Moran says companies like Aristocrat which make upfront investments can lose in the short term in the hope of longer-term gains.

“That’s as long as they have the people to execute. If they have that, then investing can be a good lead indicator of future performance.

“When you find stocks that invest in the future, grow above their category and are gaining market share, then they are generally going to surprise on the upside and that’s where you want to have your portfolio positioned.”

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About Anthony Moran

Anthony Moran is an analyst with over 15 years of experience covering a range of Australian and international sectors. His sector coverage has included Australian Industrials and Energy, Building Materials, Capital Goods, Engineering & Construction, Transport, Telcos, REITs, Utilities and Infrastructure.

He has previously worked as an equity analyst for AllianceBernstein and Macquarie Group, spending a further two years as a management consultant at Port Jackson Partners and two years as an institutional research sales executive with Deutsche Bank.

Anthony is a CFA Charterholder and holds bachelor’s degrees in Commerce and Law from the University of Sydney.

Find out more about Pendal Focus Australian Share Fund  

Contact a Pendal key account manager

Subdued US imports are weighing on Asian economies such as China. Investors should look instead to countries driven by strong domestic demand, argues Pendal’s JAMES SYME

• Weak growth outlook for China, Korea, Taiwan and Thailand
• Indonesia and India look more promising
• Find out about Pendal Global Emerging Markets Opportunities fund

THE World Bank’s latest economic outlook for east Asia contains some stark views.

Highlighting weakness in China’s economy and an ongoing slowdown in Asian exports, the bank forecasts GDP growth decelerating to 4.5 per cent in the region.

This would be relatively weak growth historically, excluding short-term shocks such as the 1970s oil crisis, the 1990s Asian financial crisis and Covid.

To what extent is this view borne out in other data?

How are Pendal’s emerging markets portfolio managers adjusting their strategy as a result?

Here is the latest update from James Syme, Paul Wimborne and Ada Chan, fund managers for Pendal Global Emerging Markets Opportunities fund:

China’s outlook

We do see continued weak growth in China.

A combination of tighter monetary and fiscal policy, intervention in the private sector and the effects of the pandemic have slowed a number of key Chinese economic metrics.

In the year to August, property investment is down 8.8%, 12-month trailing USD exports have fallen 5.4% and PMI manufacturing data sits just above 50.

Retail sales are ahead 4.6% over the period and industrial production has picked up by 4.5%.

But GDP growth forecasts continue to be downgraded by multi-lateral institutions like the World Bank and the private sector.

Global trade drag

One of the drags on China’s economic growth in China — and Asia more widely — is what’s happening to global trade.

International goods trade has been growing more slowly than industrial production in recent quarters — an unusual pattern which has significant implications for Asia.

This is largely due to increased friction on trade in manufactured goods, due to factors such as tariffs and non-tariff barriers.

(You can read more detail in the World Bank’s September 2023 global update – download PDF here).

China is the world’s biggest exporter — and the US is the world’s biggest importer.

But trade between the two has been under stress since 2018 when the Trump administration first put tariffs on Chinese exports of solar panels and washing machines.

Since then, China’s share of US imports has declined from 21.4% to 14.7% in the five years to July 2023. In absolute value, it’s declined from $47 billion per month to $36 billion.

This loss of market share comes against a backdrop of a lower intensity of trade in the US economy.

Since July 2018, US imports have increased by 17.9% (in USD terms), but the US economy is 31.5% bigger.

With a weaker Chinese economy and a lower intensity of trade in the US economy, major Asian exporters are showing stress.

In the year to August, Korean exports were down 8.4%, Taiwanese exports fell 7.3%, Singapore’s non-oil exports were off 20.1% and Thailand’s exports decline 1.8%.

Much of Asia’s long-term economic success has been built on a manufacturing export-led model. We largely see the traditional Asian export economies as more challenging from an equity investment viewpoint.

We are underweight in China, Korea, Taiwan and Thailand, seeing weak growth in all four.

Where to look for opportunities

However, some Asian economies have pursued different growth paths.

Indonesia is a major exporter of commodities including nickel, coal, oil and gas and food.

India has been succeeding at services exports — its services exports were up 8.4% year-on-year in August.

These big, sub-continental economies are driven more by domestic demand than exports — and domestic demand growth remains robust in both.

Asia’s long-term growth model has largely been built on manufacturing exports, but that is not the only path to growth.

We now see other models creating better growth opportunities — and Indonesia and India are our only overweight country positions in east and south Asia.

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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 aims to add value through a combination of country allocation and individual stock selection.

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

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
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

Pendal’s head of bond strategies TIM HEXT has the latest on rates and bonds

• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

IN her first monetary policy decision two weeks ago, RBA governor Michelle Bullock played a very straight bat, leaving the cash rate unchanged at 4.1 per cent.

This seemed to be an attempt to push the business-as-usual idea — and more particularly the notion that the board, not just the RBA staff, decide monetary policy.

But the meeting minutes released on Tuesday tell a slightly different story.

The RBA takes some liberties with its use of the word “minutes”.

They are workshopped to give an updated message if needed. And this week’s message is that the next few meetings will be close calls.

The RBA now has a “low tolerance for a slower return of inflation to target than currently expected”.

Near term they expect inflation to be at 3.9% by the end of 2023. This was revised down from 4.3% at the last monetary policy statement in August.

Perhaps they should have left it there, since estimates now put CPI around 4.2% by year end.

This could change in the next three months, but the Q3 CPI number (due on October 25) looks like a 1.1% outcome.

To hit 3.9% by year end they would need a 0.6% Q4. That looks unlikely. (Q1 was 1.4% and Q2 was 0.8%).  

Hence, markets are now pricing a 30 per cent chance of a hike in November and almost a 100 per cent chance by March.

Three-year yields are back up above cash at 4.15%.

Government bonds at 5%

If two years ago you told someone you could buy an Australian Government bond at 5% you would likely have been laughed at.

Full disclosure, I would have joined in.

Yet the government’s debt manager, the Australian Office of Financial Management, on Tuesday issued a new 2054 maturity bond at 4.93%.

Given subsequent moves in US bonds, that yield is now around 5%.

If you are 60 years old and contemplating retirement, the chance for an almost risk-free, guaranteed 5% for life seems interesting.

But why stop there?

For minimal extra credit risk, a Northern Territory 2042 bond is yielding around 6%.  

Happy to take a bit more credit risk?

CBA yesterday issued a Tier 2 (subordinated to senior debt) 10-year bond (there is a call at five years) at 6.45%. 

Of course, you can always invest in Pendal funds, where we work to diversify risk and aim to generate even higher returns.

The point is — as low-risk, fixed-interest returns get higher and higher, the hurdle returns for risk assets should also rise.

If you back the RBA to keep inflation at 2.5% over the next decade it’s happy days for investors — who should see their money grow at a much faster rate with little credit risk. Fixed interest is well and truly back.

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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

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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.

Contact a Pendal key account manager

Here are the main factors driving the ASX this week according to portfolio manager RAJINDER SINGH. Reported by portfolio specialist Chris Adams

• Find out about Rajinder’s Pendal Sustainable Australian Share Fund
• Find out about Crispin Murray’s Pendal Focus Australian Share fund
• NEW ON-DEMAND WEBINAR: Watch our bi-annual Beyond The Numbers webinar

CONFLICT in the Middle East has prompted heightened market volatility and rallies in oil and gold prices.

In the US, Fed watchers saw enough rhetoric from committee members last week to suggest the Fed would stay on hold at the next meeting on November 1.

However, slightly stronger-than-expected September consumer and producer price data raised concerns that the Fed might not be able to sit on the sidelines for too long — especially with tailwinds from volatile components such as energy.

There was speculation that China was about to pull the long-awaited stimulus lever to address their economic doldrums — but this was overwhelmed by other events.

Ten-year government bond yield fell 19bps in the US and 8bps in Australia last week. The US dollar was stronger while the AUD was again weaker.

Most commodities apart from energy and gold were weaker.

Equity markets generally managed to finish up for the week. The S&P 500 rose 0.47% and the S&P/ASX 300 gained 1.42%.

US economy and macro

We saw a number of instructive comments from Fed committee members which point to their current thinking.

We also saw the release of the Fed minutes from the previous meeting.

Both indicated the Fed is increasingly comfortable keeping rates unchanged next month.

There is also a developing theme of Fed members explicitly noting that the recent increase in bond yields could substitute for increases in the federal funds rate.

Fed president Raphael Bostic reiterated that he saw no reason for more hikes, saying policy was “sufficiently restrictive” to lower inflation to the 2% target. “I don’t think we need to do anything more,” he said.

This followed similar recent comments from other Fed presidents Philip Jefferson and Lorie Logan.

President Christopher Waller said policymakers could “watch and see” as financial markets tightened and “do some of the work for us”.

The September Fed meeting minutes noted that “almost all” participants judged that it was appropriate to keep the target range for the federal funds rate unchanged.

“The data arriving in coming months” would help clarify the extent of additional tightening needed to return inflation to the Fed’s 2% target.

All participants agreed the rate-setting Federal Open Market Committee “was in a position to proceed carefully” in setting monetary policy at coming meetings.

It was also noted that GDP growth “had been expanding at a solid pace” but real GDP growth was expected to “slow in the near term”.

A survey of US small businesses showed sentiment remained at depressed levels.

Consumers were feeling similarly subdued and inflation expectations remained at elevated levels, according to University of Michigan research.

We saw US inflation data from three other sources last week:

1. Producer Price Index (PPI)

The headline PPI advanced +0.5% in September. This was a touch stronger than expected and put the yearly gain at +2.2% (up from +2% in August).

Energy goods prices rose 3.3% monthly while and food prices grew +0.9%. Though the core PPI measure (which excludes food, energy and trade) matched consensus with a 0.2% monthly gain

2. Consumer Price Index (CPI)

The eagerly awaited CPI report also came in a bit higher than expectations at +0.4% monthly and +3.7% yearly, versus consensus of +0.3% and +3.6% respectively.

Shelter and energy were the key drivers for headline CPI. Core CPI advanced +0.32%, which translated into a +4.1% yearly gain.

The breakdown of the CPI indicates a few noteworthy trends:

• Services inflation remains consistently higher and stronger, though some forward-looking indicators suggest rent should have a moderating effect going forward.
• Commodities and food effects have dampened over the course of the past 12-18 months.
• Energy has a deflationary effect, though this could easily change with base effects and current prices.

Markets didn’t take this CPI too well on Thursday.

It was the third data overshoot for September (after US non-farm payrolls and the PPI), prompting markets to question whether the Fed had indeed finished hiking — and whether rates had seen their highs.

3. Import prices

To cap off the stronger-than-expected inflation numbers, US import prices came in at up +0.1% in September.

The core import price metric (seasonally adjusted) also edged up +0.1%.

Initial jobless claims (a weekly report that measures the number of Americans who filed for unemployment benefits for the first time) continue to remain low at 209,000, indicating that US labour markets are still tight.

China macro and economy

Early indicators following China’s October Golden Week holiday suggest tourism spending in China jumped 130% year on year, but was up only 1.5% from 2019. 

Macau and its casinos benefited during the holiday period, but travel abroad held below pre-Covid levels.

This aligns with views of continued sluggish activity in the Chinese economy, especially on the consumer consumption component.

Credit growth and credit impulse largely stabilised. Chain’s official “Total Social Finance” credit growth — a measure of the total amount of credit provided by the financial system — stabilised at 9% yearly.

Markets were excited by a Bloomberg report that Chinese policymakers were weighing the issuance of at least 1 trillion yuan ($137 billion) of additional sovereign debt for spending on infrastructure such as water conservancy projects.

That could raise this year’s budget deficit to well above the 3% cap set in March, according to one of Bloomberg’s sources.

An announcement could come as early as this month, though deliberations were ongoing and the plans could change.

The discussions underscore mounting concern among China’s top leaders over the trajectory of the world’s second-biggest economy — and how growth compared to the US.

It would also mark a shift in Beijing’s stance.

Beijing has so far avoided broader fiscal stimulus despite a deepening property crisis and rising deflationary pressure which have put its 5% annual growth goal at risk.

Australia macro and economy

There was not much data last week, other than a couple of business and consumers surveys.

NAB’s latest business survey showed easing in conditions in September.

Business conditions fell to +11 in September from an upwardly revised +14 in August (originally reported as +13). That’s still above the long-run average of around +6.

Surveyed business confidence was stable at +1.

Quarterly measures of price pressures also continued to ease, including labour costs (-120bps to +2%), purchase costs (-110bps to +1.8%) and final product prices (-70bps to +1.0%).

Acceleration in inflation following a minimum award wage increase in July now looks to have faded. Though in level terms overall inflation pressures remained elevated (about 4% annualised for final prices).

Australian consumer sentiment rebounded +2.9% to 82 in October, according to a Westpac Melbourne Institute survey. This was driven by improved perceptions of family finances — up from very subdued levels.

That said, in level terms sentiment was still tracking around 20% below the longer-term average.

On the housing market, the “time to buy a dwelling” index rebounded 4.8% monthly from very subdued levels, while the house price expectations index rose +3.8% to a new cycle high of 160.4.

Some 70% of respondents expected house prices to rise over the next 12 months.

Oil and energy

The market is watching to see whether the Israel-Hamas conflict stays contained, or spills into other oil-producing countries nearby.

Spiking energy prices have historically caused damage to the global economy, though we note that the “oil intensity” of GDP growth in the US, EU and China has fallen materially over time.

All eyes remain on Saudi Arabia and Iran and how they respond.

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About Rajinder Singh and Pendal’s responsible investing strategies

Rajinder is a portfolio manager with Pendal’s Australian equities team. He has more than 18 years of experience in Australian equities.

Rajinder manages Pendal sustainable and ethical funds including Pendal Sustainable Australian Share Fund.

Pendal offers a range of responsible investing strategies including:

• Pendal Sustainable Australian Share Fund
• Crispin Murray’s Pendal Horizon Fund
• Pendal Sustainable Australian Fixed Interest Fund
• Pendal Sustainable Balanced Fund
• Regnan Credit Impact Trust
• Regnan Global Equity Impact Solutions Fund

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

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The United Arab Emirates is enjoying an economic boom and should be on the radar of emerging markets investors, argues Pendal’s JAMES SYME

• Government reforms leave UAE booming
• Find out about Pendal Global Emerging Markets Opportunities fund
• Watch a recent Emerging Markets overview webinar with James Syme

MANY of us give little thought to the United Arab Emirates unless we’re stopping over briefly on the way to Europe.

But led by Abu Dhabi and Dubai, the UAE is fast emerging as an attractive destination for investment, not just tourism.

“Since Covid, the UAE has staged a really powerful comeback,” says James Syme, who co-manages the Pendal Global Emerging Markets Opportunities fund.

Syme and his team follow a top-down, country-level approach to emerging markets, believing that investment analysis should start at a national level in this asset class.

You can read James’s recent views on Brazil here and Indonesia here.

“In the UAE, we’ve seen a big recovery in overnight visitor numbers,” says Syme. “We’ve also seen a full recovery in oil production which took a big hit during Covid.

“But perhaps more importantly, we’ve seen a number of structural changes that are helping support the recovery.”

The UAE is a union of seven emirates: Abu Dhabi, Dubai, Sharjah, Ajman, Umm Al-Quwain, Fujairah, and Ras Al Khaimah. Each emirate is governed by its own monarch, and one of these monarchs serves as the president of the UAE.

The current president, Abu Dhabi’s Sheikh Mohamed bin Zayed Al Nahyan, has led a series of reforms that have driven an economic boom in the region.

Among the reforms is the creation of a new visa category for non-nationals that allows residency for up to 10 years.

“On that sort of timeframe, people become interested in investing in property and building a stake in the country rather than simply renting, working and moving on,” says Syme.

“That’s really helped support the movement of foreign nationals into the country.

“The UAE is not a democracy, but its leadership is sensitive to the needs of its citizens and has undertaken reforms that have really started to feed growth.”

A regional centre of finance

Other reforms have been aimed at supporting the development of Abu Dhabi and Dubai as financial centres for the region.

“We’ve seen a significant number of listings and IPOs — in 2022, the region had about a quarter of all of global IPO volume.

“As a result, we’ve seen a lot of hedge funds, asset managers and investment banks setting up offices in Abu Dhabi and Dubai, hiring locally, renting offices and buying properties.

“So, there’s a significant boom in it as a financial destination.”

Syme says the Gulf is attractive to the finance industry because it has similar time zone advantages to London — the workday overlaps Asia in the morning and the US in the afternoon.

“Why industrial clusters occur is always a bit of a mystery, but the UAE certainly seems to be the regional winner over Bahrain or Qatar or Riyadh.

“Already having an expat community and strong travel and transport links is a great advantage.”

The two main local carriers, Emirates and Etihad, have also maintained their global routes just as Asian airlines cut back, leaving a significant share of the world’s very-long-haul traffic going through Dubai or Abu Dhabi, says Syme.

And behind it all, oil production is booming – with production back to 3.5 million barrels a day.

“Recovering global tourism, recovering global trade and the recovery in oil production and prices, plus deep structural changes, have driven a boom in the region,” says Syme.

From an investment point of view, Syme says his fund has exposure to domestic sectors in retail, commercial and residential real estate and the commodity side of the economy in both Dubai and Abu Dhabi.

“It remains an active area of search for us. It’s one of our overweights that’s been doing well and which we think is perhaps flying below the radar.”

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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 aims to add value through a combination of country allocation and individual stock selection.

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

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
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 investment analyst ANTHONY MORAN. Reported by portfolio specialist Chris Adams

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THE dominant narrative of resilient global economic momentum and higher-for-longer rates continues.

US 10-year government bond yields rose 7bps last week, driven by higher oil prices, a slightly higher-than-expected inflation print and resilient economic and corporate data.

At the margins there was data suggesting China’s economy is turning a corner.

Commodities were strong overall and US dollar took a breather after its strong rally over the quarter-to-date.

The European Central Bank took a dovish turn after increasing rates last week. President Christine Lagarde indicated the tightening cycle was most likely done. The problem for Europe is they are heading into a recession.

The S&P 500 fell 0.12% and the S&P/ASX 300 gained 1.82% last week.

Oil drives sentiment

Oil continues to be a major driver of sentiment with Brent crude up a further 3.6% last week to $94/bbl. It has risen more than 25% so far this quarter.

This is an upside risk to inflation.

There is an argument oil may be reaching a peak since OPEC supply discipline has driven the rally.

We are now at OPEC’s desired price levels, but we are beginning to see a supply response with US weekly oil production hitting its highest level since Covid.

The long-oil position is crowded. Commodity trading adviser allocations to oil are estimated to be at the highest level since mid-2021.

US economy and macro

In the US, August headline inflation data accelerated to 0.6% month-on-month, primarily due to petrol.

The August core CPI was +0.3% month-on-month, above the 0.2% expected by consensus and the 0.2% print in July.

However, the market wasn’t too worried on the day, since it wasn’t a big miss and showed favourable composition.

The beat in core inflation was primarily driven by higher airline fares (passing through fuel cost increases) and higher car insurance costs.

Car insurance is a lagged flow-through of the Covid surge in car prices. This will roll over as car prices have done, but airline fares should rise next month.

The core deflationary drivers of flat goods inflation and slowing rents remained consistent in August, giving the market some comfort that inflation would continue to slow.

The data can be sliced and diced to support either a hawkish or dovish thesis.

The fact that both can be argued tells us something about the stability of CPI relative to market expectations.

The market was flat on the day of the release. There wasn’t much in there to challenge expectations that the Fed will keep rates on hold this week.

Other economic data supported the “Goldilocks theme” of slowing without a recession.

• Industrial production was +0.4% in August versus +0.1% expected, though mostly driven by oil production. Manufacturing production is flat (excluding autos).
• August US retail sales grew +0.6% versus consensus at +0.2% but the surprise was driven by higher petrol prices. Excluding that, core retail sales growth slowed to +0.2%, which is pretty much in the Goldilocks zone for the deflation trade

Looking ahead, we need to keep an eye on the risks of US government shutdown and the potential impact of the United Auto Worker strikes.

Iron ore

Iron ore rose 7.7% last week and is up 10.5% so far this quarter.

Strength in iron ore is surprising given the depressed state of the Chinese property market. Though this has been offset by steel demand from infrastructure investment and by restocking in low port inventories.

Importantly, Beijing has been happy to let steel production remain strong rather than delivering expected steel production cuts.

This has resulted in Chinese steel exports remaining high (+35% growth yearly) which makes it someone else’s problem and keeps steelworkers employed.

China

Beijing continues to add layers of incremental stimulus.

Last week we saw a 50bps cut in the banking reserve requirement ratio, which should stimulate lending.

There were marginal signs that the economy may be starting to turn less negative.

August economic activity data, while still weak, perhaps indicates a corner has been tuned.

Industrial production was up 4.5% yearly versus +3.7% in July; fixed asset investment gained 2% (prior +1.2%) and retail sales jumped 4.6% (prior +2.5%).

August financing data was much better than expected with total social financing (a broad measure of credit and liquidity) up 9% year-on-year.

Australia

Employment data was strong with +65,000 jobs in August.

But strong labour supply growth from population growth and a lift in participation (a record high of 67%) has kept the unemployment rate flat at 3.7%.

A shift to part-time work potentially reflects growth in second jobs.

Hours worked dipped but the trend has been strong.

Immigration is preventing tightening in the labour market but shifts inflationary pressures from wages to rents and other areas.

Markets

Resources led the equity market last week, driven by stronger iron ore and some China positivity.

Fortescue Metals (FMG, +9.38%), Rio Tinto (RIO, +6.96%) and BHP (BHP, +5.77%) were among the best performers last week in the ASX 100.

Soul Pattinson (SOL, +7.18%) and Whitehaven Coal (WHC, +6.89%) rose on a coking coal supply outage in Queensland.

Financials also outperformed, likely due to firmer bond yields and resilient economic data.

The smaller names such as Bank of Queensland (BOQ, +4.60%) and Virgin Money UK (VUK, +4.49%) did better than the majors.

The market liked Ramsay Health Care’s (RHC, +5.01%) progress on asset sales.

There were positive noise from Malaysian government about potentially working with Lynas (LYC, +4.66%) on investment in downstream rare-earth processing.

Incitec Pivot (IPL, +4.32%) continued its strong run of recent months.

IPL delivered a positive business update as price and cost discipline helped margins in its US explosives business and the Australian explosives business recontracted at better margins. It is still seeing operational issues at Phosphate Hill.

Viva Energy (VEA, -7.64%) was weaker after Vitol sold 16% of the company in a block trade, taking its stake to about 25%. The next major piece of news for VEA will be an ACCC ruling on its proposed purchase of the On The Run chain of petrol stations and convenience stores.

BlueScope Steel (BSL, -6.90%) fell on weaker steel spreads and the US autoworker strike, which will hurt steel demand.James Hardie (JHX, -4.92%) fell on weak sentiment towards homebuilders in the US due to high mortgage rates, despite strong new sales data from the number two national homebuilder Lennar during the week.

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About Anthony Moran

Anthony Moran is an analyst with over 15 years of experience covering a range of Australian and international sectors. His sector coverage has included Australian Industrials and Energy, Building Materials, Capital Goods, Engineering & Construction, Transport, Telcos, REITs, Utilities and Infrastructure.

He has previously worked as an equity analyst for AllianceBernstein and Macquarie Group, spending a further two years as a management consultant at Port Jackson Partners and two years as an institutional research sales executive with Deutsche Bank.

Anthony is a CFA Charterholder and holds bachelor’s degrees in Commerce and Law from the University of Sydney.

Find out more about Pendal Focus Australian Share Fund  

Contact a Pendal key account manager

China’s outlook is one of the most important factors investors need to weigh up right now. Here our head of income strategies AMY XIE PATRICK analyses the latest signals

• New data from China shows positive signs
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

THE latest data shows China’s economic activity starting to stabilise.

Is this a turning point in the economic cycle?

That remains to be seen.

It’s been only a few months since hopes for a re-opening led boom in economic activity were dashed.

We think activity is now stabilising on a cyclical basis, and China’s economy can continue to gradually recover into the end of the year.

But structural drags on the economy are heavy and deep rooted.

In his article we explain how far the current recovery could extend; which structural issues are most limiting; and what are the implications for global growth and investing.

A pick-up in activity

Last week we saw the latest release of hard economic data from China.

As Reuters reports here, monthly industrial output sped up and retail sales grew faster.

By most accounts, the data beat market expectations.

Yes, expectations were fairly low to begin with and therefore easy to beat. But these latest numbers suggest that sequentially, things are improving for the world’s second-biggest economy.

The fixed income team at Pendal thought this would be the case.

Electricity output is a good place to look for how the Chinese economy is going.

Electricity output is driven by energy use in the economy. Although this can fluctuate depending on weather, supply issues and other exogenous factors, a rise in energy use tends to happen when activity levels within the economy are rising.

This is why the Li Keqiang index (a proxy measure for Chinese growth) relies on electricity output as one of its three components to track economic activity.

Electricity output has been rising over the past few months, and points to upside to come in the hard data.

Climbing out of deflation

Another place to look for the health of demand in the Chinese economy is producer prices.

Although they track commodity prices closely, given that China is such a large global consumer of commodities, a falling PPI has usually been synonymous with a slowing of Chinese demand.

China’s Producer Price Index (PPI) – a measure of the change in selling prices received by domestic producers for their output – has been in deflationary territory since October 2022.

But it bottomed in June at -5.4% and has been clawing its way back in the last few months.

This may be good news for the Chinese economy, since generating positive inflation momentum is one way to combat debt-deflation dynamics.

But it has mixed implications for the rest of the world.

As the Bloomberg chart below shows, there has long existed a close relationship between China’s PPI and US inflation.

The relationship was likely solidified after China joined the World Trade Organisation in 2001 and became a heavy-weight influence over most tradeables (goods) inflation.

The dislocation between 2016-2018 was likely as a result of Trump’s trade wars against China. The dislocation since 2022 has been the dominance of services-led inflation in the US.

In fact, China’s deflation has been incredibly helpful for inflation in the developed world in the last 18 months.

Without it, goods inflation would still be high, and the market would not be so sanguine about the future path of the US Fed and other central banks.

The turning point in China’s PPI may signal that the freebie of goods price deflation is coming to an end for the rest of the world.

This may not lead to a big second wave of inflation. But it may mean a stickier path for US and other developed world inflation.

It will put the focus squarely back on local labour market dynamics and whether policy settings have become sufficiently restrictive to slow wage growth.

How meaningful a recovery?

This recovery stands out because the aim of recent piecemeal measures on stimulus was not about starting a new property cycle.

The aim has been to contain the fall-out of the property downturn while finding ways to pivot towards other sources of growth.

To that end, recent measures targeted at relaxing macro-prudential restrictions on home buying are more about easing off on the brakes rather than stepping on the gas pedal.

I would argue these measures have been working.

A huge blockage in the property system formed when property transactions slowed.

Since pre-sale down-payments were a key source of developer funding, it limited the ability of developers to continue or even initiate construction on properties they had pre-sold.

This meant buyers couldn’t take delivery of finished property. But due to the way the mortgage system works in China, they were already on the hook for servicing a part of the mortgages.

This all too easily snowballed into a crisis of confidence, which fed into a further slowdown in property sales, property prices and so on.

A crucial way to alleviate the blockage was to get sufficient funds to developers to finish what they‘d started.

Property completions have been up strongly this year as backlogs of paused works have resumed.

But this is a very different kind of property stimulus compared to the past. It certainly won’t lead to new waves of strong demand anytime soon.

This is why land sales are still contracting.

Developers only buy new plots of land when they see strong demand prospects in the pipe, as you can see in this Bloomberg chart:

Even without a new wave of property demand, it’s a good to see things are moving again in the Chinese property space.

The property sector accounts for more than a quarter of Chinese economic activity, so the flow-through effects will be positive.

Bigger challenges lie ahead

China’s structural problems have not changed.

They centre on an economy that saves too much, causing growth to rely on debt-driven investment rather than by income-led consumption.

China’s national savings rate is over 45%, compared to an OECD average of just over 20%.

The high propensity to save by the private sector in China is partly due to a lack of safety nets.

This increases the burden on the working age population to care for old and young and save for their retirement.

Housing affordability is another issue. Chinese cities have some of the worst housing affordability ratios in the world.

This means parents have to save in anticipation of their offspring one day needing help on a down-payment.

Fiscal measures aimed at easing the burden on households and boosting the social safety net are essential for supporting consumption in China.

Helicopter money is traditionally unacceptable to Chinese socialist principles. It is the main reason why even in the depths of the COVID crisis, the extent of fiscal stimulus unleashed by Beijing paled in comparison to what we saw in the rest of the world.

However, faced with the prospect of a nasty property crisis, fiscal stimulus to the consumer is now being embraced by policy-makers as the lesser of two evils.

Fiscal measures can lead to more near-term upside for the Chinese recovery, but cannot remove a higher-order headwind to consumption.

That headwind is the crowding out of entrepreneurial spirit as President Xi has consolidated his political power in recent years.

Xi’s motives are likely triggered by geopolitical insecurity (including Trump’s anti-China policies).

The outcome is a disruption of incentives for the private sector to borrow, invest and consume.

Investment implications

Against low expectations of any Chinese economic revival priced into Chinese assets, any upside surprise in data in the next few months is likely to have a bigger effect than disappointments.

This limits the ability of bearish China bets to work in Chinese markets, be they rates, currency or equities.

We have closed our short RMB bias now to be neutral, and are short China rates.

It is harder to play for upside in other risky assets though, because not much downside relating to China was priced into those markets in the first place.

Even US companies with big exposures to China’s growth outlook have remained resilient.

However, if Chinese economic momentum is basing here, it reduces the immediacy of tail risks for risk assets more broadly, which is supportive.

A more resilient US economy likely also plays into a supportive backdrop for risky assets ranging from credit to equities.

Our income funds are currently not shying away too much from risky assets, but we are mindful of this being a tactical play.

It is difficult to chart a path of “not too hot, not too cold” growth for the US economy when unemployment is at record lows.

Therefore, it is vital to take the extra risk in the most liquid way so as to preserve the ability to actively de-risk.

When that time comes, bonds will come back into play.

As for currencies, be mindful of a tug-of-war playing out on the US dollar.

It is counter-cyclical in nature, so a stronger global manufacturing cycle should weaken the greenback.

However, if China’s revival causes a sticky inflation headache, the greenback’s ability to weaken will be limited by higher for longer rates in the US.