The mortgage cliff may not yet have appeared, but we’re only halfway through the roll-off of Covid-era fixed-rate loans, points out Pendal assistant PM ANNA HONG

• Why bonds, why now? Find out more from Pendal’s income and fixed interest team

AUSTRALIAN house prices look to have turned the corner.

But what about mortgage stress?

We’ve repeatedly heard the mortgage cliff warnings since the Reserve Bank started hiking rates.

Yet the cliff doesn’t appear to have appeared.

It’s bank reporting season and the latest updates show mortgage arrears remaining relatively stable, only picking up slightly in the June quarter.

Delinquencies have hardly budged.

It appears that the system is coping just fine. Of course, this does not mean that everyone is.

Despite the positive picture, we are by no means out of the woods.

Most Aussie borrowers who fix their mortgage do so for three years or less.

This means 85 per cent of pandemic-era fixed-rate loans are set to expire by the end of 2024.

As you can see in the graph below, we’re only half-way through the roll-off.

We are at the peak and will remain here into year-end.

The true test of the Australian residential mortgage resilience will only come if significant increases in unemployment collide with repayment stress.

For now, the path to expected higher unemployment is due more to immigration lifting labour supply above demand.

Importantly though, this does not mean people losing their jobs.

For some, the stress is and will be very real.

But for the system, higher rates will be more of a speed bump than a cliff.

What does this mean for investors?

Perhaps, the RBA may yet achieve the narrow path they set out on.

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About Anna Hong and Pendal’s Income and Fixed Interest team

Anna Hong is an assistant portfolio manager with Pendal’s Income and Fixed Interest team.

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

With the goal of building the most defensive line of funds 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

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About Pendal Group

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

A long-awaited and bigger-than-expected rate cut in Brazil could usher in a positive cycle of growth for Latin America’s biggest economy. JAMES SYME explains

• Brazil cuts rates
• Positive cycle ahead
• Find out about Pendal Global Emerging Markets Opportunities fund
• Watch a recent Emerging Markets overview webinar with James Syme

INVESTORS are underplaying the likelihood of further rate cuts in Brazil, which is showing signs of entering a classic emerging markets virtuous cycle of capital inflows, strengthening growth and rising markets.

That’s the view of James Syme, who co-manages Pendal Global Emerging Markets Opportunities fund.

Brazil cut its key interest rate by a larger-than-expected 50 basis points in its August meeting.

The central bank took the rate from 13.75 per cent to 13.25 per cent, ending eight months of keeping borrowing costs on hold.

Markets expect further cuts to 12 per cent by the end of the year and 9.25 per cent by the end of next year.

But Syme says those expectations are likely short of the mark and a positive cycle of rate cuts and economic growth lies ahead.

“Emerging markets tend to overshoot to the downside and then to upside.

“We think Brazil is setting up to be in a cycle of much more positive news, and that should be reflected in equity prices as well.

“We’ve been talking about rate cuts coming in Brazil for a couple of years and they have now surprised markets with the size of the first cut.

“We don’t think this is the last of those surprises.”

Self-reinforcing cycles

Emerging markets tend to move in self-reinforcing cycles of rate cuts and economic growth attracting capital flows, which strengthen the currency, allowing for reduced inflation and further rate cuts, says Syme.

“There’s a traditional view among investors that markets reflect the real world.

“You have a set of fundamental conditions and the output of them is what happens in markets, whether it’s exchange rates or stock markets or individual share prices, or bond yields.

“But we think what happens in markets also drives what happens in the real world.

“That means what happens with currencies, interest rates and bond yields has a real world effect.

“We think we’re heading to a point where we’re going to see that in Brazil, where a stronger currency, a stronger equity market, and declining bond yields feed back into the Brazilian economy.

“In these kinds of emerging markets, these are very positive, self-reinforcing cycles.”

Domestic demand stocks to benefit

Syme says investors can best take advantage of the rosy outlook by focusing on companies exposed to domestic demand.

“It’s going to be about banks and other financials, consumer durables and autos, services and leisure, construction and capital investment, and real estate,” he says.

“Now, that doesn’t mean we’re going to end up with exposure to all those sectors because we need to be selective at a sector and stock level as well. But those are the main beneficiaries.”

A rising level of new stock issuance is also a vote of confidence in Brazil’s outlook.

“Companies are raising capital to take advantage of the improving economic situation. We see that as a statement of a positive intent by corporate Brazil.

“One of our newer holdings in the fund is the company that operates the Brazilian stock market, which is a business that could really benefit from this.”

More rate cuts likely

Syme says the opportunity for rate cuts in Brazil is illustrated by the gap between its interest rates and inflation measures compared to other economies.

“Brazil’s inflation level is about the same as the US — but US rates are at 5.5 per cent.

“That’s a nearly eight percentage point gap so just the carry alone should attract lots of capital into Brazil.

“We think that economic data should pick up quite strongly as rate cuts come through.

“This is how emerging markets investing works — the bad times are bad, and the good times are good.

“A lot of the markets we like are doing very well right now including Mexico, India and Indonesia.”

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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 our head of equities CRISPIN MURRAY. Reported by portfolio specialist Chris Adams

• LIVE WEBINAR SEP 7: Register for Crispin Murray’s bi-annual Beyond The Numbers webinar
• Find out about Pendal Focus Australian Share fund

A COMBINATION of northern hemisphere summer doldrums and limited data is keeping news-flow reasonably quiet.

US and Australian bond yields are both re-testing cycle highs, capturing a lot of attention.

Rising bond yields and a stronger US dollar saw equities fall last week, continuing their consolidation from the end of July. The S&P 500 fell 2.05% and the S&P/ASX 300 lost 2.34%.

The market is also focused on weakness in China’s economy.

Along with talk of inventory reductions, this encouraged a continued sell-off in the lithium complex. Though iron ore miners maintained their remarkable resilience.

Softer Australian employment data helped drive our dollar lower versus the USD.

In local ASX results, season operational performance has largely been solid. But there have been concerns about debt costs for the more leveraged companies.

China

The Chinese economy remains under intense scrutiny.

This was maintained last week by concern of the imminent default of property developer Country Garden, missed payments from investment company Zhongrong Trust and a continuation of weak economic data.

The challenges are symbolised by Beijing’s decision to stop publishing data on youth unemployment — which stands at about 21 per cent.

Data on land sale volumes and consumer confidence are also suspended in the name of maintaining confidence.

Confidence is the key issue:

• High youth unemployment deters consumer spending
• Fears about the solvency of private developers discourage new home purchases, due to the risk that dwellings may not be completed
• Investment trust defaults such as Zhongrong’s may trigger redemption requests, leading to a liquidity squeeze

This lack of confidence can be seen in a lack of private investment, which is down 7 per cent in the first seven months of 2023, versus state-owned-enterprise investment up 12 per cent. 

Concern over property lies at the heart of the confidence problem. New housing starts are down more than 60 per cent from the 2019 peak.

There was a widely-held expectation that the market would stabilise following such a dramatic decline.

But July data indicates the weakness continues.

Goldman Sachs cut its forecast for 2023 new housing starts from -10% to -20% on the previous year and expects the property sector to detract 1.5% from GDP growth.

Beijing’s 2023 GDP target of 5% was initially seen as something of a low-ball target which could be exceeded.

Now the market is cutting GDP forecasts to sub-5% as we see recent trends in retail sales, auto sales and other indicators start to slow.

There have been a number of policy initiatives, including some interest rate easing and bringing forward some spending by local governments.

But these measures have been incremental and unable to reverse deteriorating sentiment.

While this is a bearish portrait, some China-related stocks and sectors on the ASX have held up — notably the miners.

The bulls are taking the view that things are so bad, they’re good — which would increase the chance of a more convincing policy response such as the one we saw in 2015.

They are drawing a comparison with the period prior to the reversal of the Zero-covid policy, where there were incremental signals before the major policy change.

There’s also a theory that Beijing is biding its time, reasoning there would be no point launching an initiative in high summer as it wouldn’t get traction. Beijing may be waiting until September, the theory goes.

If a major policy response doesn’t materialise, we see some risk around bulk commodity producers at these levels.

US macro outlook

US GDP surprised to the upside with 5.8% growth in the second quarter.

The market is trying to understand how this can happen.

Some relates to higher investment.

It’s too early for the Inflation Reduction Act (IRA) to be felt, but the 2022 CHIPs and Science Act (CHIPS stands for Creating Helpful Incentives to Produce Semiconductors) of 2022 is having some effect.

Consumption, however, is the main driver.

One observation is that business tax refunds have surged since March, adding an additional $100 billion in potential spending power.

A lot of this relates to small business and is tied to the Covid-era policy of employment-retention tax credits.

This policy, which remains in place until 2025, is seeing business tax refunds run at four times pre-pandemic levels.

The policy’s original costing was US$85 billion over 10 years. It has cost US$150 billion in the past 12 months alone. 

This is a good example of how some stimulative fiscal settings have become entrenched and are helping the economy outperform expectations.

The stronger economic outlook can also be seen in the Atlanta Fed’s GDP NOW measure, which is indicating an almost 6% growth in GDP for the third quarter.

We suspect this is overstated. But it still retains a healthy buffer over the 1& to 2.5% range of forecasts from consensus.

The New York and Philadelphia Fed regional manufacturing surveys appear to be bottoming, reinforcing the soft-landing case.

They are also signalling a pick-up in prices received, which may give the Fed some pause for thought.

This more resilient economy means markets are expecting interest rates to stay higher for longer, and reinforce the view that real rates need to stay higher for this cycle.

Combined with structural pressure on the government budget deficit from funding costs and more legislated spending — plus extra supply and lower offshore demand for treasuries — this helps explain the increase in bond yields. 

It also suggests that while the market is bearish on bonds — allowing potential for a near-term reprieve — we should not expect a sustained reversal in yields. 

Markets

Australian equities were down last week, in line with the US.

Only REITs (+1.27%) held up, largely due to the influence of Goodman Group.

Lithium names were weak on a macro trade against them.

Domestic high-yield names were also soft, partly due to the realisation that bond yields were staying higher.

 

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About Crispin Murray and 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

Pendal’s head of government bond strategies TIM HEXT explains the latest wage data and what it means for rates and bonds

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

WAGE growth – a key indicator that the Reserve Bank monitors when weighing up rates decisions – was surprisingly benign in the June quarter.

The Bureau of Statistics published the latest Wage Price Index on Tuesday.

The index, which measures changes in salary across 18 industries, showed overall wages grew by only 0.8% in the period.

We’ve now had three quarters in a row of 0.8%.

This indicates an annual rate of only 3.2%. Though a 1.1% number last September gives us an annual rate of 3.6% with rounding.

More surprising is that public sector wages grew only 0.7% in the quarter.

This remains below private sector wages — mostly because three-year agreements in the public sector are slower to respond to changing dynamics.

The opposite was true as wage growth fell across most of the last decade — as you can see in the ABS graph below.

This lower public sector result comes despite a trend for public sector workers to get at least 4% in agreements.

The federal government is now offering 4% next year to unions (and 3.5% and 3% the following years).

Unions have rejected this.

The NSW government has agreed to 4% from July for more than 80,000 workers covered by the Public Service Association.

Teachers and nurses across a number of states have received 4% wage increases over the past 12 months.

Governments offered additional incentives and payments to avoid higher increases given the inflation backdrop.

Wages across the economy are likely to settle on 4% rises for several years yet.

Actual inflation is going to be around 4% and unless unemployment has a very large rise employees will maintain a level of bargaining power.

This 4% is the new 2.5% that we got used to last decade.

GDP data shows a different story

Note that the Wage Price Index is but one measure of renumeration.

It measures salary across 18 industries on a like-for-like jobs basis through time.  

It does not account for overtime, bonuses, shifts across industries or the extra 0.5% of super paid each year as we move from 9.5% to 12%.

During strong job markets the index underestimates the total renumeration employees are receiving.

When measuring total compensation of employees we rely on GDP data.

This points to total compensation growing closer to 6%, which partly explains the resilience of the economy.

Since even this data lags by three months, Pendal also tracks data from a number of business liaison surveys to create our own diffusion index.  

This currently points to wages being a touch above 4%, in line with the RBA forecast for year end.

What it means for rates and bonds

Overall, the wages number continues to buy the RBA time, with steady cash rates for now.

The market now has a bit less than one hike priced in – and that’s towards year-end or early 2024, so there’s no clear opportunity around mispricing.

Short-ends should remain rangebound for now.

Longer bonds remain vulnerable to higher long-end rates globally.

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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.

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

Find out more about Pendal’s fixed interest strategies here

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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 our head of equities CRISPIN MURRAY. Reported by portfolio specialist Chris Adams

• LIVE WEBINAR SEP 7: Register for Crispin Murray’s bi-annual Beyond The Numbers webinar
• Find out about Pendal Focus Australian Share fund

THE US equity market is catching its breath, down 0.27% last week (S&P 500) with limited news-flow and waning recession fears.

JP Morgan joined Morgan Stanley and Bank of America in removing their recession forecasts.

Meanwhile, US post-result earnings revisions continue to come in better than expected.

Offshore bond yields moved higher, despite US CPI coming in slightly softer than expected. US 10-year government bond yields rose 12bps and two-year yields 13bps last week.

This led to some rotation away from tech towards healthcare in the US, exacerbated by a market that has been generally long the former and short the latter.

This may signal some mean reversion with a 33% relative outperformance in tech so far in 2023.

Energy was also stronger on fears of union-led strikes at three Australian LNG projects. European gas prices are up 30% this month.

Chinese CPI and PPI both went negative year-on-year for only the second time since 2009 (the other time was during Covid). Concerns around China’s economic outlook continue to grow.

Australian equities were also flat (S&P/ASX 300 +0.26%). Early results from reporting season are slightly favourable in aggregate.

Commonwealth Bank’s (CBA, +2.48%) result eased fears on bank margins while Suncorp (SUN, -5.02%) and QBE Insurance (QBE, -3.52%) flagged higher near-term claims inflation in Australia.

In combination, this led to some reversal in performance between banks and insurers. We don’t believe this will last too long.

James Hardie (JHX, +13.37%) and Nick Scali (NCK, +13.59%) were the pick of the results last week. Both these cyclicals are doing better than feared, with margins helped by lower input costs.

Finally, the Aussie economy has found another way to defy doomsayers with payments platform Airwallex estimating a $7.6 billion economic boost from the FIFA Women’s World Cup.

And that was before Saturday night’s result.

US inflation and the effect on interest rates

Core July CPI rose 0.16% for the second consecutive month, which was seen as slightly better than consensus expectations.

The breadth of inflation also continues to fall –‑ the percentage of CPI components with deflation has now increased to 25%.

Annualised headline CPI ticked a little higher –- largely the result of energy deflation starting to reverse.

If core CPI is adjusted for observed rents and the volatile component of used autos is removed, it is running at a three-month annualised rate of 2.2%, which is back towards the Fed’s target.

All this is positive and we are likely to see lowish CPI prints in September and October.

This view is expected to let the Fed hold rates steady in their September meeting. The question remains whether this is enough to remove the last hike they still currently predict.

Lower inflation reduces the risk of the Fed being forced to drive the economy into recession, since it suggests there needs to be less of a rise in unemployment to bring inflation back to target.

One caveat is that three current tailwinds are unlikely to be sustained:

1. Airfares are running at -8% and are likely to normalise
2. Used car prices are set to fall for a couple more months, but then stabilise
3. The medical care service component is falling 4%. This is an imputed number, which will be reset for the October CPI (released in November). It relates to health insurance and will start rising — though we note this component is not included in the PCE Deflator measure favoured by the Fed.

On this basis, we could be back to 28-30bp monthly increases in inflation come the December quarter.

This would probably deter the Fed from cutting rates in the first quarter of 2024.

Inflation hawks are concerned that the recent easing of pressure has been exaggerated by the reversal of Covid-related distortions.

Wage pressure remains a key signal for Fed intentions.

While this is a lagging indicator, the employment gap continues to rise. This is not consistent with wages dropping enough to satisfy the Fed.

At this point it would probably take a much weaker US economy in early 2024 to change the view that the Fed does not starting cutting rates in Q1.

There is still a view that we could see a recession, with some pointing to the shift upwards in real rates, which can more than offset the recovery in real wages.

Bond yields – what’s driving the rise in long-end rates?

The US 10-year government bond yield has backed up and is approaching the 4.2% highs of last October and November.

This is interesting because inflation data has improved and the short end of the yield curve is also holding in.

This suggests yields are not being driven higher by an expectation of higher interest rates.

There are several theories on what is driving this move:

1. Some see the economy’s resilience despite higher interest rates as a signal that real rates need to remain higher for longer.
2. Potential concerns over the long-term fiscal position of the US, given the rise in debt / GDP at a time when fiscal spending growth and interest costs remains high. If real rates need to remain higher for longer to contain inflation, this becomes more of an issue for the sustainability of the US fiscal position.
3. The US sovereign credit rating downgrades from Fitch, which is a symptom of the above two points.
4. Japanese Government Bonds (JGB) act as something of an anchor for world rates and the recent change in strategy by the Bank of Japan has seen JGB yields rise –- though they stabilised at below 60bps last week. 
5. Supply and demand can also be a nearer-term factor, but one that historically does not add much to bond yields. Foreign central banks have reduced demand of US treasuries for a variety of reasons. US banks –- another historically large buyer –- have less liquidity as money supply falls. At the same time, Treasury supply is high given deficits and fiscal spending.

Whatever the reason, this remains an important issue to watch.

The risk is that if bond yields continue to break higher it may start to weigh on equity markets as the relative appeal of the two assets shifts.

There is no sign of this yet, although it may have acted as a drag on technology stocks in the last two weeks. 

China deflation and property developer concerns

Last week we saw both Chinese annualised CPI and PPI turn negative for only the second time since 2009 (the other occasion was during the Covid lockdown).

This has coincided with weak export data (-14.5% in July).

At the same time China’s biggest private property developer Country Garden is warning of big first-half losses triggered by high levels of debt and continued weakness in Chinese property sales.

This is raising concerns over refinancing risks, potential default and the need to restructure debt.

This is not having the same contagion effect of last year’s Evergrande issues. But the combination of these signals reinforces concerns that structural factors are overwhelming Beijing’s ability to stem poor confidence affecting the economy.

The risk here to Australian equities in around commodity prices, which have so far held up on the expectation of policy support.

If confidence in a policy response wanes, this could see weakness in the Australian resource sector.

On the other side, there is still the possibility that policy makers change tack, launching a massive program to reflate the economy.

Potential Australian LNG strike

The price of gas inEurope moved 30% higher last week to about EUR37 per megawatt hour (mwh) on fears of a potential strike at Chevron’s Wheatstone and Gorgon facilities and Woodside’s North West Shelf –- all in Western Australia.

Combined, they represent 10 per cent of the global seaborne LNG market –- a reminder of the importance of Australian supply to global markets.

There are signals the strike may be a bargaining tactic rather than a true threat, but it does highlight the way gas markets pricing works.

In the event this supply is removed, that energy has to be substituted.

The first substitute is coal, which would require gas prices of EUR40-50/mwh.

If this was insufficient -– for example if we saw a cold Northern hemisphere winter -– oil would need to be priced as an alternative which implies EUR70-100/mwh.

This equates to an LNG price of US$20-30 per metric million British thermal units (MMBtu) as opposed to the recent price range of US$9-10 MMBtu.

Gas prices have remained lower than market expectations this year due to a lack of recovery in industrial demand — particularly in Europe -– due to ongoing inventory run-downs.

This boosted the European and global economy as it helps inflation and keeps power prices lower, supporting consumption.

Any disruption to this risks reducing growth expectations.

Markets

The market looks to be consolidating, with no major change in sentiment other than the liquidity overhang and a seasonally weaker time of year for equities.

One interesting sectoral point is the strong outperformance early cyclicals, driven by tech and homebuilders. This has left the sector near extremes in terms of historical outperformance of defensives. 

The risk of some reversal here is high, given the shift in sentiment on the US economy has largely played out.

In Australia, performance was largely driven by results so far. 

Retailers did better on more positive anecdotes, notably from Nick Scali.

Banks outperformed on CBA’s message that margin pressure has eased.

Insurers noted claims inflation in Australia remained very high –- running at about 15% in motor insurance due partly to higher repair costs.

The early theme in reporting season was a bounce among cyclical stocks with low expectations when market fears weren’t realised. 

 

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About Crispin Murray and 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

China’s property sector woes continued this week as another big property developer found itself in trouble. AMY XIE PATRICK explains

• Take caution with China’s latest property signal
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

China’s property sector woes continued this week as another big property developer found itself in trouble.

Privately-owned Country Garden — China’s biggest property developer based on last year’s contracted sales — missed US$22.5 million in payments on two bonds.

The company is described as facing “periodic liquidity stress” in a Reuters report. In other words, it’s running out of money.

The bonds now enter a 30-day grace period. To avoid a default, Country Garden must find enough funds to meet coupon payments before the grace period expires.

The market has been bracing for more trouble since a spate of property sector defaults in China during 2022 — including the high-profile default of Evergrande.

At the end of July, Country Garden’s US dollar bonds were trading at 20% to 25% of face value. A high risk of default had been priced in.

Now that two coupon payments have been missed, the probability of default has skyrocketed, causing bonds to dip further to 8c on the dollar, closing in on all-time lows seen last November.

The market values these bonds at such low recovery rates because of rules in China that restrict foreigners from owning physical assets onshore.

If Country Garden defaults on the bonds, it’s likely creditors on their US dollar denominated senior unsecured bonds would stand behind onshore equity holders in the queue to get their money back.

What’s next?

On this occasion, Country Garden will probably find enough money to pay the coupon within the 30-day grace period.

The company’s chairwoman holds stakes in Country Garden Services, an affiliated entity and is expecting a dividend payment of around US$60 million this month.

One could speculate that some of those funds are already slated for curing the missed coupon payments.

But this doesn’t solve the “periodic liquidity stresses”.

For the remainder of the year, Country Garden needs to find US$2 billion of funds to satisfy other payments of principal and coupon on outstanding US dollar denominated bonds.

On top of this, the company needs ongoing cash to complete projects already pre-sold to customers.

As the confidence crisis in the property sector deepens in China, the feedback loop has been vicious.

Levered property developers need strong and sustained momentum in new pre-sales to fund the completion of older pre-sales.

In Country Garden’s case, a minimum of monthly contracted sales of RMB 28-30 is needed to complete a pipeline of earlier pre-sold homes.

In 2021, monthly sales averaged around RMB 40-45 billion. Today monthly sales are down to around RMB 12 billion and falling.

This is what is causing the “periodic liquidity stress” — though I would describe it as existential rather than periodic.

An end to endless demand

The breadth of Country Garden’s operations is vast.

Many of its unfinished projects are in China’s third-tier (or lower) cities.

When the population thought property prices could only go up, these cities benefited from endless demand. But the current crisis has turned everything on its head.

Populations in these less prosperous are in net outflow. These are not the cities that first-time buyers are rushing to anymore.

The company considered an equity raise, but decided to scrap the idea at the end of last month, likely as a result of “no takers” after testing the waters for indications of interest.

The only hope left is help from the government. So far, Beijing is not rushing to their “model” developer’s aid.

Hundreds of thousands of buyers waiting on delivery of Country Garden homes could be affected if the company goes to the wall.

Half-finished building projects would freeze while assets were sold, haircuts negotiated, and left-over funds paid out.

But it is one way to break the vicious cycle between defaulting developers and plummeting buyer confidence.

With the right haircut, the assets of Country Garden are attractive to other developers in a stronger liquidity position.

A default at Country Garden forces the company to take these inevitable haircuts, and lets stronger companies resume the completion of unfinished projects.

Once buyers started getting delivery of finished homes, the urgency to dump these homes at fire sale prices in the secondary market would start to reduce, allowing home prices to stabilise.

Stable house prices then lead to a more stable confidence around the sector and the economy more broadly.

This is not the sugar hit the market has hoped for. But it is likely the structural change that is badly needed in the Chinese economic growth model.

In the meantime, we expect a slight loosening of restrictions on developer access to funding, to prevent a domino effect of Country Garden’s current cash crunch on the rest of the sector.

What it means for global growth

The investment implications from the latest casualty in China’s property crash are fairly straightforward.

China’s weight on the global growth picture will become more apparent as the rest of the world burns through its buffers.

That means being more overweight in duration of developed markets than through China bonds directly.

As China tries to pull other levers to lessen the pain, a weaker currency becomes the easiest release valve. Buy US dollars against the yuan on dips in the pair.

And as China races ahead on electric vehicle production, tread with caution on traditional autos sector exposures.

Most are finding it hard to keep up with the fast-growing Chinese alternatives.

Here Pendal’s head of government bond strategies TIM HEXT points out what to pay attention to in the RBA’s latest monetary policy statement

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

WHEN the Reserve Bank releases its quarterly monetary policy statement I look for two things.

Firstly, what are the forecasts?

There’s usually new information there, though often the preceding monetary policy decision mentions them earlier.

The second thing I look for are the two blue breakout boxes usually featured in the statement.

“Box A” and “Box B” are typically special interest topics – importantly, topics of special interest to the RBA.

They offer an insight into what topics our central bankers are discussing and investigating internally.

Sometimes there are clues as to what may follow.

In the latest statement released on Friday, Box A contains a rather technical article titled The Bond-Overnight Index Swap Spread and Asset Scarcity in Government Bond Markets.

Box B’sarticle is Insights from Liaison, which summarises discussions with 230 Australian businesses, industry bodies, government agencies and community organisations between May and August.

The first would appear to be of interest to very few, outside of bond geeks like me.  

Clearly though, the RBA is looking at the pros and cons of quantitative tightening, which should be of interest to investors. More on this another time.

The business liaison box is significant. The RBA has often referred to this extensive program, but has only recently started sharing specific data.  

Box B reveals a growing view that businesses are seeing an easing in both demand and costs, consistent with an increasingly neutral RBA.

Of particular interest is the graph below:

This graph shows an easing of expectation for wage rises in the year ahead.

Perhaps this is not surprising as actual inflation falls to 4%.

But the most popular indicator of wages, the Wage Price Index, is not forecast to peak until the end of this year at slightly above 4%.

This liaison shows the RBA will likely stare down commentators who talk about higher wages meaning further rate hikes.

Overall, the RBA’s August monetary policy statement should be reassuring for Australian bond investors.

However, a recent US fiscal surge seems to be weighing on US bonds and therefore curbing gains here.

But let’s save that topic for next time.

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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.

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

Find out more about Pendal’s fixed interest strategies here

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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 investment analyst JACK GABB. Reported by portfolio specialist Chris Adams

• Find out about Pendal Focus Australian Share fund

THE biggest down day for the S&P 500 since May set the mood last week, triggered in part by credit rating agency Fitch downgrading the US to AA+.

Stronger-than-expected employment data, higher upcoming US debt issuance and further gains in Japanese yields added fuel to the flames.

Treasuries and equities sold off, with stock-bond correlation the highest it’s been since the 1990s. 

The US 10-year yield rose 8bps and the yield curve steepened. The S&P 500 ended the week down 2.26% despite 79% of companies beating consensus estimates in the first week of reporting season.

In Australia, the RBA held rates steady. This surprised most economists but was largely in line with the market, which was pricing in a 30 per cent chance of a hike.

In contrast, the Bank of England raised rates another 25bps to 5.25% and signalled rates were likely to stay higher for longer.

Australia equities fell (S&P/ASX 300 -1.17%), but less than most overseas markets.

Overall, data for the week was generally consistent with slowing inflation, despite continued earnings and jobs strength.

Central banks remain concerned around the stickiness of services inflation, but expectations for further hikes continue to fall.

Arguably, the key debate around central banks is how long rates stay elevated.

Oil is also worth watching. Brent crude is now up 15% and West Texas Intermediate (WTI) is ahead 17% for the quarter to date.

This is driven by a record drop in US stockpiles and a decision by Saudi Arabia and Russia to extend production cuts.

Gasoline is the sixth-biggest component of US CPI.   

US economics and policy

The data last week was generally consistent with slowing inflation and a soft landing. Two Fed members pointed to the labour market coming into better balance.

Despite uncertainty about a potential lagged impact of rate hikes and whether a recession can be avoided, expectations for further hikes continue to come down.

The market is pricing the probability of another Fed hike by November at just 18%, versus 32% in Australia.

Still, at least one Fed member still sees the need for further hikes. Governor Michelle Bowman said “additional rate increases will likely be needed to get inflation on a path down to the FOMC’s 2% target”.

Labour market data remains solid.

Non-farm payrolls came in at 187k new jobs, versus 200k expected, and the prior two months were revised down 49k. 

Employment data has shown increasing signs of cooling this year, though 200k jobs per month is still strong by historical standards.

On the other hand, wages rose more than expected with average earnings +4.4% year-on-year versus 4.2% expected.

Along with a low unemployment rate (3.5% vs 3.6% expected), this suggests the labour market remains tight and inconsistent with a 2% inflation target.

We will get two more inflation prints (the first this Thursday) before the next Fed meeting in September.

Consensus is forecasting headline CPI at 3.3% versus 3% prior. Excluding food and energy, the forecast is 4.8%, unchanged from prior.

Assuming no surprise — and the CPI prints confirm the June trend, hike expectations likely remain low.

Soft landing odds rising, bears capitulating

The bears have continued to capitulate, with Bank of America the first of the major US banks to officially reverse its recession call.

Bears now forecast US GDP growth of 0.7% in 2024 — 0.7 percentage points higher than was previously assumed.

However, inflation expectations have been revised to 2.8% in 2024 (+0.4 points) and 2.2% in 2025 (+0.1 points).

Unemployment is seen peaking at 4.3% in Q1 2025 versus the prior expectation of a peak at 4.7% in Q4 2024.

Soft landings are uncommon, with only three in the eleven recessions since World War II.

Concern remains over the lagged impact of rate hikes. While the US yield curve has steepened materially (and Australia is now back in positive territory), it has now been inverted for 13 months.

Ultimately, interest rates are coming down — the important factor will be why.

If it’s in response to a recession, the precedent for equities is not positive based on historical patterns.

US earnings season

Some 422 S&P 500 companies had reported Q2 earnings by the end of last week — with 79% beating analyst expectations.

This is more a function of low expectations rather than stellar corporate performance.

Based on Goldman Sachs data:

• 55% of companies have beaten consensus estimates by at least one standard deviation, versus historical average of 48%.
• Only 12% of companies have missed consensus estimates by at least one standard deviation, versus historical average of 13%. 
• EPS growth has been tracking at -6% versus -9% expected.

A few noteworthy results:

• Apple (-7.1%) — Now well below its historic $3 trillion market cap after reporting a third straight quarter of declining sales and guiding to a similar performance in Q4
• Amazon (+5.6%) — Q2 beat and guidance across retail and AWS (cloud) was strong
• Uber (-6.1%) — Reported its first-ever operating profit, but shares declined on slower growth
• PayPal (-15.2%) — Declined on lower transaction take rates and margins
• Caterpillar (+6.1%) — reported a big earnings beat, but noted Chinese demand was worse than was forecast only three months ago
• Starbucks (-0.6%) — Better margins offset lower comparable sales
• Expedia (-14.1%) — Q2 gross bookings missed expectations
• Booking (+1.7%) — Revenue and profits beat. FY booking growth guidance raised to >20% from low-teens
• Atlassian (+14.1%) — Reported better guidance. Cloud revenue growth seen +25-27% YoY

UK and Europe

The BoE hiked 25bps, as expected.

Rates are now seen as “restrictive” — though not necessarily “sufficiently restrictive” with markets pricing in another 50bps before the year’s end.

Doing less than that would likely require a big negative surprise in wages, employment and services inflation.

Commentary was perceived as more realistic on inflation than past optimism.

The statement and the press conference both sent a strong signal that the monetary policy committee had a preference for rate smoothing, ie maintaining higher rates for longer rather than pushing for higher peaks. 

In Europe, the ECB reported that underlying inflation had probably peaked.

Recent easing has been driven by non-energy industrial goods, while a decline in services also appears to have started.

China

Incremental policy announcements continue in the wake of the recent Politburo meeting.

There is still scarce detail, but three announcements caught our eye:

• China’s state planner released a policy document focused on removing government restrictions on consumption and improving infrastructure.
• The People’s Bank of China announced it would “guide” commercial banks to adjust mortgages interest rates lower, step up its monetary support for the economy and help banks control liability costs.
• Local governments are under pressure to use up this year’s quota of special-purchase bonds by the end of September. The question remains whether they will be allowed to pull forward 2024 issuance into this year, which could have a meaningful impact on spending.

Beijing has stopped short of providing major monetary or fiscal stimulus and uncertainty remains whether the measures will be enough.

The challenge was highlighted again last week with data showing continued weakness in manufacturing and property sectors.

• Manufacturing PMI remained below 50 in July, though slightly better at 49.3 versus 49 in June.
• New home sales among the 100 biggest real estate developers fell 33% year-on-year in July, down 33.5% month-on-month

Still, the Politburo has acknowledged the problem and Chinese stocks were the best performers last week.

Australia economics and policy

The RBA held rates at 4.1%, in-line with market expectations but contrary to most economists who had forecast a 25bp hike.

The commentary was on the dovish side, omitting a previous statement that “the path to deliver 2-3% target while the economy still grows is a narrow one”.

However growth expectations moderated.

GDP is now seen at a trough of 0.9% this year, down from 1.2% previously. GDP is expected to be 1.6% in 2024. 

CPI is forecast to decline to around 3.25% at the end of 2024, returning to the 2-3% target in late 2025, suggesting interest rates may remain elevated for longer.

Further easing in goods inflation is expected to drive the decline.

Key risks include services inflation, which remains strong amid rising labour costs. Rent inflation has also increased.

Energy prices are forecast to add significantly to inflationary pressures in coming years with electricity prices forecast to add 0.25% to headline inflation in FY24.

The RBA continues to see a “high degree of uncertainty around the speed and extent of the decline in inflation expected in the period ahead”. 

Four key domestic uncertainties were detailed:

• The outlook for China remains uncertain
• The outlook for household consumption is subject to competing forces
• Inflation could be more persistent than expected
• Goods prices could decline significantly

Consensus is pricing one more hike, then a steep drop-off in rates in 2024.

Australian Equities

Nearly all sectors ended in the red last week, led by utilities, real estate and financials.

This echoed similar moves in the US. Energy and consumer discretionary were the best sectors.

Energy was comfortably the strongest so far this quarter in Australia and the US on the oil price rebound.   

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About Jack Gabb and Pendal Focus Australian Share Fund

Jack is an investment analyst with Pendal’s Australian equities team. He has more than 14 years of industry experience across European, Canadian and Australian markets.

Prior to joining Pendal, Jack worked at Bank of America Merrill Lynch where he co-led the firm’s research coverage of Australian mining companies.

Pendal’s Focus Australian Share Fund has an 18-year track record across varying market conditions. It features our highest conviction ideas and drives alpha from stock insight over style or thematic exposures.

The fund is led by Pendal’s head of equities, Crispin Murray. Crispin has more than 27 years of investment experience and leads one of the largest equities teams in Australia.

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.

Find out more about Pendal Focus Australian Share Fund  

Contact a Pendal key account manager

 

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Full-year reporting season is underway for 2023. Here Pendal investment analyst ELISE MCKAY explains the questions investors should be asking

• Earnings season about more than revenue and margins
• Look for macro impacts, pricing power and AI
• Find out about Pendal Focus Australian Share fund

AUSSIE equities earnings season kicks off this week.

What should investors be looking for in full-year results?

Look beyond revenue and profit margins to how companies are managing the macro-environment, says Pendal investment analyst Elise McKay.

“Have companies maintained the ability to pass through higher prices? What’s happening to wages? Are further cost reduction programs announced?”

“On the revenue side we are looking for the ability of companies to continue to pass through cost inflation, in a slowing economic environment,” McKay says.

“We are also looking for any forward demand indicators – any key performance indicators that will show how the business might perform in future years.

“What will drive revenue? For example, at [milk and infant formula group] A2, what is the birth rate in China doing?

Look at labour

“A key theme over the past 12 months has been availability of labour. We will be looking closely at headcount trends and wage inflation,” McKay says.

“The recent Fair Work Commission decision to lift wages 5.75 per cent highlights the wage inflation issue that we have in the economy.

“We’ve had a number of businesses across the tech sector announce headcount reductions and it will be interesting to see what sectors and companies follow in their footsteps to address their cost bases.

“And then more broadly, how will higher interest rates impact on earnings per share.”

Macro-environment is key

Similar to the June quarterly earnings season on Wall Street, the macro-environment will play an important role, McKay says.

“On Wall Street, up until 28 July, 48 per cent of companies had reported with a better than average result, 55 per cent were ahead of expectations and only 13 per cent missed.

“Yet despite this, the average ‘beat’ has only resulted in the stock going up 28 basis points, versus the average of one per cent.

“So even though companies are delivering better earnings, their share prices aren’t going up on the news.

“The recent market outperformance has been driven by the macro environment, not the earnings. We are still very much in a macro-driven market.”

Keep an eye on AI

McKay says another theme on Wall Street has been artificial intelligence, and she will be watching closely to see how local companies respond.

“You presume locally most companies are thinking about it. It would be a massive red flag if they’re not. You want to understand how companies are thinking about AI as both an opportunity and a threat.”

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About Elise McKay and Pendal Australian share funds

Elise is an investment analyst and portfolio manager with Pendal’s Australian equities team. Elise previously worked as an investment analyst for US fund manager Cartica where she covered a variety of emerging market companies.

She has also worked in investment banking and corporate finance at JP Morgan and Ernst & Young.

Pendal Horizon Sustainable Australian Share Fund is a concentrated portfolio aligned with the transition to a more sustainable, future economy.

Pendal Focus Australian Share Fund is a high-conviction equity fund with a 16-year track record of strong performance in a range of market conditions. The Fund is rated at the highest level by Lonsec, Morningstar and Zenith.

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

Despite higher-than-expected monthly data, the outlook for inflation should be mildly friendly over the next few months, says Pendal’s TIM HEXT

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

THE RBA will be encouraged things are moving in the right direction on the inflation front.

The June quarter inflation numbers came in this week at 0.8% for the quarter, or 6% annual.

Underlying inflation (the trimmed mean where they remove the highest and lowest 15%) came in at 0.9%, or 5.9%. 

These outcomes were both 0.2% lower than expected.

The RBA is now forecasting 4.5% by year end. Given we are at 2.2% for the first six months of 2023 this seems a little high if anything.

We forecast 4.2% by year end, unchanged from before.

We last saw a 0.8% result in Q3 2021, just before the very large numbers kicked in.

However this may prove to be a low point for the quarterly number this year as utility prices kick in again in Q3 and Q4.

We expect 1.1% in Q3 and 0.9% in Q4 as goods prices moderate but services remain elevated.  

The high and lows of these numbers

Let’s start with the items that are accelerating.

Rents are finally kicking in, up 2.5% for the quarter and 7.3% for the year. They are finally catching up with other rental indicators and should remain at 2.5% a quarter for a while yet.

Insurance was up 5.3% for the quarter – no surprise for anyone who has received a payment notice recently.

International travel was up 6.5% in the quarter, again of little surprise.

On the high, but moderating side was new home dwellings.

They rose by 1% in the quarter, though that’s a long way down from the peak. The supply side issues in building seem to be finally working their way through.

On the low side, five of the 11 categories actually saw prices slightly fall.

Most of these were due to government subsidies, highlighting the impact both federal and state governments are having on dampening inflation.

Health, education, electricity and gas were impacted by government subsidies, highlighting the impact governments are having on dampening inflation. Q3 and Q4 will see utilities rebound sharply.

More genuine were falls in motor vehicles, telecommunications and domestic holiday travel as supply constraints ease.  

Goods versus Services

Services inflation is finally higher than goods.

The ABS provided us with this graph below, which highlights services inflation above 6% — not seen since GST started in 2000.

Given the strong link to wages this highlights the RBA point that wage growth above 4% with no productivity is not consistent with target inflation.

The RBA

Despite strong employment data this number should continue to provide the RBA headroom to stay on hold.

August will be Dr Lowe’s second last meeting in charge and having moved 4% in a little over 12 months there is room for further patience.

It will be interesting to see if the inflation forecasts are lowered again, although they lowered them in May and hiked anyway so perhaps it doesn’t matter too much.

Three-year swap is now around 4.25%, and the market has one more hike priced in.

I suspect the RBA will keep one more hike up its sleeve and if unemployment has not risen by October they may execute.

This would be Michele Bullock’s first meeting in charge where she may choose to stamp her mark as an inflation-fighting governor.

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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.

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

Find out more about Pendal’s fixed interest strategies here

---

About Pendal

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

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

Contact a Pendal key account manager