Despite tough talk from central bankers, cash rates are likely to sit around 3% next year, writes our head of government bond strategies TIM HEXT
CENTRAL banks have largely abandoned forward-looking monetary policy since Covid.
One wonders why they need big teams of economists if they’re merely responding to the latest prints of often-lagging indicators such as inflation.
This was highlighted again last week at the Jackson Hole central bankers conference in Wyoming.
One cannot blame them for hawkish comments on inflation, including talk of bringing on the pain. After all, their lack of forward-looking policy failed to pick up inflation soon enough in 2021.
In the US there is a risk they will get it wrong again — but in the opposite direction, failing to pick up an imminent fall in inflation led by goods inflation, which forward indicators are showing.
Or maybe they are aware of it are and want to take the credit for falling inflation when it’s already baked in as supply chains and business margins normalise.
Market reaction
Markets this week reacted to the rhetoric by selling off bonds and equities.
July’s rally on hopes of a soft landing is a distant memory. But there are signs the rally, although premature, had the right idea.
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This comes down to the idea that inflation will fall and then stabilise around 4% in the next year.
That’s still too high, meaning rate cuts would be unlikely. But hikes would then stop around neutral and central banks would feel they had time on their side.
Australia is a bit behind the US. Due to the composition of our CPI the moves both up and down will be less dramatic.
We also face a mortgage fixed-rate cliff next year which US 30-year mortgages don’t have.
If the RBA exhibits any patience it is likely to sit at 3% cash rates in 2023.
Falling global inflation should allow our central bankers more confidence that we are not in some 1970s style spiral.
Wages are key
Wages will be key in the medium term.
Our view is that goods inflation will fall before stabilising at about 2%.
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Services inflation will remain elevated around 5%, leading to a 4% CPI.
This assumes wage growth of close to 4% next year. Prime Minister Albanese’s jobs summit this week will bring that all into focus.
We will do a deep dive into wages in our upcoming Australian Investor Quarterly. (Contact us if you’re not on the distribution list).
A little more than 20% of workers are now covered by awards — the main one being the minimum wage set by the Fair Work Commission.
Another 40% of us have individual agreements.
The jobs summit will focus on the remaining 40% covered by collective agreements or enterprise bargaining.
This is where the major battleground over wages will be fought, especially if agreements try to keep pace with the recent 4.6-5.2% minimum wage increase.
Bonds outlook
For now, bonds have once again entered the buy zone.
I will avoid predictions on equities.
But I make the observation the landing in the US may not be as hard as many are predicting.
About Tim Hext and Pendal’s Income & Fixed Interest boutique
Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.
Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
Find out more about Pendal’s fixed interest strategies here
About Pendal
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.
Here are the main factors driving the ASX this week according to our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams.
THE late northern summer repose and the domestic focus on earnings season was dramatically disrupted by Jerome Powell’s short-but-direct speech at the Jackson Hole central bank conference last week.
Powell reminded the market of his singular focus on bringing down inflation, even if it brought “some pain to households and businesses”.
The S&P 500 slumped in response, ending down 4% for the week.
We’ve previously flagged that the market rally was running up against technical resistance and losing steam as the position covering played out.
The S&P is now down 5.5% and the NASDAQ off 7.5% from their Aug 16 highs.
Powell’s message was not so much the need for rates to go higher than markets expect. Rather, rates would need to be sustained at restrictive levels for some time to bring inflation under control.
This is at odds with recent optimism that rates would fall in 2023. This saw US two-year yields rise 17bps and 10-year yields up 7bps to 3.04%.
The Fed’s stance emphasises the importance of the total financial conditions index as a signal. It will not allow this to rise too far.
This means bond yields are underpinned and equities are capped while inflation remains an issue.
Three other developments also weighed on sentiment:
- Oil back above US$100
A week ago the Iran deal looked likely and the market expected oil to drop sub-US$90 on the incremental supply. But on Tuesday we got the “Saudi put” under the oil price. Riyadh’s minister of energy effectively indicated that OPEC+ supply agreements would continue in 2023 and flagged the prospect of supply cuts in response to higher volumes from Iran. He also highlighted a view that there was a disconnection between the physical and paper oil markets. This can be interpreted as a belief that the US is manipulating the oil price down and OPEC will act in response. - European power prices surge higher
We are now at levels where huge swathes of German industry is unviable. This is driven by the inexorable rise of gas prices. Storage levels in Germany are approaching 80% — but this level is required in winter even when flows from Russia are normal. Moscow is now allowing only 20-40% of normal flows. If this continues, no amount of storage will suffice. - US dollar index (DXY) breaks back to 20-year highs
This creates liquidity pressures in many other countries. A return to the trifecta of higher bond yields, oil and US dollar is typically bad for equities. That said, the outlook for oil is still challenged by the potential for weaker demand as the global economy slows.
The petrol price remains a key signal for US inflation expectations — and therefore yields and hawkishness from the Fed.
So there is potential for inflation to resolve itself faster — requiring less policy pain if it comes down.
But for the moment the market is back in a nervous holding pattern with 4000 on the S&P 500 viewed as a key support level.
Australia
Australia enjoyed a short respite from global macro factors. On balance, the busiest week of reporting season delivered a neutral outcome.
Consensus expects FY23 earnings to rise 4%, up from +18% in FY22.
Revisions to earnings expectations are flat for FY22 and -2% for FY23 compared to four weeks ago.
In FY23 resources earnings expectations are now 4% lower and 1% higher for banks, with the rest of the market revised down 2%.
In terms of results, consumer staples disappointed as supermarkets proved less defensive than hoped. Companies delivering capital management — such as Qantas (QAN) and Nine (NEC) — performed better.
Economics and policy
Fed Chair Powell kept his Jackson Hole speech short and narrowly focused for deliberate effect, sending a strong message on inflation.
The odds of a 75bp move higher in September have jumped to about 60 per cent.
The curve of implied hikes is moving back towards its June highs and is a long way above the end of July lows.
The market is divided into two broad camps:
- The Fed will drive the economy into recession as it looks too literally at current data and over-tightens. This triggers a recession and earnings downdraft that takes the market back to the lows.
- The Fed is bluffing. It wants to send a hawkish message to restore credibility, but knows the economy is already slowing rapidly and inflation data will improve. This gives it scope not to push rates too hard. This scenario leads to bond yields falling and is more positive for equities.
The next Federal Open Market Committee meeting concludes on September 21 — so with more employment and inflation data to come the outcome is yet to be determined.
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In terms of inflation, the Core PCE price index rose 0.1% month-on-month — less than expected — and continues a run of incrementally more-positive data.
This may be an unwind following the June spike in core PCE.
Averaging across the two brings it back in line with the run-rate from January to May.
The Core Services PCE price index came in at 4.2% year-on-year. This was also lower than expected and is the lowest print since December 2021.
The Cleveland Fed’s ‘nowcast’ measure of inflation also continues to track lower, as do the Evercore surveys of wage pressure and retail pricing power.
Australian equities
The S&P/ASX 300 finished down 0.6% last week, not capturing Friday night’s slump in US equities.
It held up on the back of reasonable results and better performance from the resource and energy sectors.
Consumer staples underperformed on the back of disappointing results from Coles (COL) and Woolworths (WOW).
Small caps also underperformed, which is a sign that the rally driven by defensive positioning has run out of steam.
Key observations on ASX results so far:
- Pricing power is a key point of differentiation. Disappointing results mostly reflect insufficient moves to offset cost pressure, particularly in the building-related sector and companies with European exposure (eg Dominos Pizza, DMP). Meanwhile companies such as Wisetech (WTC) and Qantas (QAN) showed the value of pricing power.
- Costs are a headwind to some of the defensive stocks, leading to less defensiveness than expected. We saw this in Endeavour (EDC), Coles (COL), Woolworths (WOW) and Ramsay Health Care (RHC).
- Some cyclicals are not experiencing the weakness many feared, eg Nine Entertainment (NEC) and some advertising-related names.
- Companies with cyclical tail winds are performing well. For example the lithium sector remains strong, as does oil refining.
- The market is liking capital return. New buy-backs from NEC and QAN were well received
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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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
Pendal’s head of equities Crispin Murray explains why he is fully supportive of Perpetual’s acquisition of Pendal
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BY NOW you’ll be aware that Pendal has formally joined with Perpetual.
I remain fully supportive of Perpetual’s acquisition of Pendal — completed on January 23, 2023.
It’s the right deal for clients, the business and the team.
It maintains the independence of the Australian equities boutique and strengthens our industry position in the long run — since all senior people of the team are committed to being here for the long term.
The industry is fundamentally changing.
Consolidation is occurring at all levels — super funds, platforms and fund managers. This is an inevitable trend to which we must respond in the most effective way.
When Pendal Group originally floated on the ASX, the goal was to build a diverse multi-boutique business which combined scale for the provision of best services and systems with independence, autonomy and focus for investment teams.
This model has stood the test of time — and has been replicated by others.
It continues to be the right way to run a fund management business.
But we now need greater scale and diversity to build a stronger organisation through which to deliver the best possible services.
This deal enshrines and codifies the independence and autonomy of Pendal’s Australian equities boutique in a way that covers strategy, remuneration, personnel decisions, proxy voting, dealing and service provision.
The Pendal Australian equities team remains unchanged and separately located.
The team is fully supportive of the deal.
We are a separate, independent boutique focused on the job of investing for our clients.
We are protected by strong governance rules and will benefit from being part of a more diverse, larger and stronger group.
Our large and experienced team, our strong performance culture — and a business structure that enables us to focus on investing — provides the critical factors we believe will enable the continuation of the consistent performance we have delivered to our clients for the past 20 years.
Crispin Murray
Head of Equities, Pendal Australia
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 29 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 17-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.
In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s oldest and 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.
Perpetual is a diversified, ASX-listed financial services company providing asset management, private wealth and trustee services to local and international clients in Australia, Asia, Europe, United Kingdom and US.
Central banks are reminding us they’re still hawkish — but they won’t risk sending people broke with a 4% rate, argues Pendal’s head of government bond strategies TIM HEXT
FOR some reason markets spent July ignoring central bank hawkishness.
Recession talk was all the rage, which meant rate hikes were largely discounted.
This was despite central banks keeping their messages hawkish, and seeing little relief on inflation.
Financial conditions — measured by bond rates, credit spreads and equities — eased back to May levels.
Clearly central banks were not impressed. This week they came out swinging, singing from the hymn book of restrictive rates needed to rein in inflation.
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St Louis Fed president Bullard talked of rates needing to go into “higher and restrictive territory”.
Minneapolis Fed’s Neel Kashkari wasn’t sure if inflation could be tamed without a recession.
Reserve Bank of New Zealand governor Adrian Orr wants to see his country’s official cash rate “unambiguously” above neutral.
All of this was lit up by UK inflation pushing through 10% and heading higher.
The playbook from earlier this year is back.
Bonds sell off, credit and equities get hit and cash rates go up.
What does it mean for investors?
In Australia we’re likely to get another 50bp hike in September.
Rates should finish the year around 3%.
Given our high levels of household debt (and in particular the stress on 2020 and 2021 homebuyers) consumers will be hit hard at 3% — let alone higher rates in significantly stricter territory.
While the RBA will remains hawkish I doubt they will risk sending households broke by raising rates to 4% — even if markets are now playing with the idea.
Bonds are now getting more fairly priced in balancing the risks to inflation and growth.
I still prefer inflation bonds for now — but 10-year bonds north of 3.5% are interesting again.
Adviser Sam is invested
in making our world
A better place.
Watch as Sam meets a
mum rebuilding her life
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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
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.
Here are the main factors driving the ASX this week according to portfolio manager Jim Taylor. Reported by portfolio specialist Chris Adams.
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THE US Fed continued to temper expectations around a pivot away from its hawkish stance last week — and US 10-year yields rose 14bps to 2.98% in response.
US economic data continued to paint a mixed picture, while there were some ugly inflationary prints in Europe.
Equity markets were generally quiet last week.
The S&P 500 shed 1.16%, driven by softness late in the week. The S&P/ASX 300 finished up 1.32%.
Commodities were generally weaker, encouraging the view that inflation pressures continue to diminish.
Fed policy
Various Fed spokespeople continued to pour cold water on the notion of an imminent shift to less hawkish policy.
St Louis Fed president James Bullard said the aim was to place “significant downward pressure on inflation” without dragging rate increases into next year. He was leaning to another 75bp hike and pushing the rate “higher and into restrictive territory”.
San Francisco Fed president Mary Daly noted that hiking 50 or 75bps next meeting would be a “reasonable” way to get rates above 3% by the end of 2023 — and a bit higher next year.
Both said the Fed would be unlikely to reverse course quickly, rejecting the notion of a “hump-shaped” path of rate hikes followed by aggressive cuts.
The Fed is grappling with the contradiction of soft headline GDP numbers, strong payroll growth, a weak housing market, uncertainty over the extent and impact of the improving supply-chain story, and still-elevated current inflation.
Hence the repeated focus on data dependency in the eight-week interval between the July and September meetings.
US economy
Retail sales data was solid. The preferred measure of core sales (excluding cars, petrol and food) rose 0.8% in July (and 9.3% annualised for the three months to July) compared to the previous three months.
Higher petrol prices did not have a noticeable effect. US consumers seem happy to run down the mountain of savings they accumulated in the early stages of the pandemic.
On the flip side, there was an unexpected plunge in the NY Empire State Manufacturing Index. This flags further weakness at a national level.
The NAHB housing market index fell to 49 in August, down from 55 in July. All the components — present sales, expected sales, and buyer traffic — fell in August, tracking the steep and sustained decline in mortgage demand, which is yet to find a bottom after a near 30% drop from December’s peak.
July existing home sales fell 5.9% m/m and 20% y/y to 4.81m units, the lowest since June 2020.
The US National Association of Realtors joined the National Association of Home Builders in describing the market as a “housing recession”.
Australian economy
Australia’s Wage Price Index (ex bonuses) increased +0.7% in the second quarter of 2022. This was a bit below the expected +0.8% q/q.
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Annual growth accelerated 20bp to +2.6% year-on-year but remained well below headline CPI inflation (+6.1%y-o-y).
Public sector wages grew 2.4% y-o-y. Annual private-sector wage growth including bonuses rose to 3.3% y-o-y (2.7% ex bonuses).
This is the fastest pace in 10 years.
Private-sector workers receiving wage adjustments in the quarter (most workers only receive adjustments in the September quarter) achieved an average pay increase of 3.8%.
Wage-setting in Australia remains much less responsive to labour market tightness than many countries. This helps reduce the risk of a wage price spiral.
Australia’s unemployment rate fell to a 48-year low of 3.4% in July. Measured employment fell 41k m/m (vs +25k expected).
There was divergence between the full-time component (-87k m/m) and part-time employment (+46k m/m).
Employment again rose solidly for 15-to-24-year-olds (+13.3k m/m) and the youth unemployment rate fell sharply to a new historical low.
China
The People’s Bank of China surprised the market with a 10bp cut in interest rates following weak July economic data and ongoing pressure in housing.
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Like many of Beijing’s recent moves, this seems aimed at stemming further weakness rather than to genuinely stimulate the economy.
China has also had to ration power and water to manufacturers as a result of drought.
ASX reporting season
Earnings per share (EPS) for FY22 continues to beat expectations, with more positive surprises from ASX 100 companies and financials.
Free cash flow has been better than expected, especially in the resources sector.
Capital returns have disappointed, with net dividend misses and fewer buy-backs than expected. Companies seem keen to keep some dry powder on the balance sheet in an uncertain environment.
Inventories are still higher than expected in aggregate, which is a risk to earnings and may signal a slowing cycle.
The number of stocks with disappointing guidance is high. So far twice as many stocks have FY23 earnings and dividend downgrades (28%) relative to upgrades (14%).
Consensus expectations for market FY23 EPS growth have moderated as a result — but remain in the low single digits.
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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
A monthly insight from James Syme, Paul Wimborne and Ada Chan (pictured above), co-managers of Pendal’s Global Emerging Markets Opportunities Fund
WHICH emerging markets look good right now? The clues are in the latest global manufacturing data.
MANY emerging markets display a high sensitivity to global risk appetite — which means the asset class is often regarded as a barometer of investor sentiment.
This can overlook the substantial exposure of some EMs to the strength of the global economy, and the visibility into aggregate demand that these markets can provide.
We believe recent economic data from some of these countries shows very concerning signs.
South Korea and Taiwan
The first and most important countries to consider are the two big East Asian export economies of South Korea and Taiwan.
As exporters of electronic goods, vehicles, and chemicals — as well as providers of airborne and seaborne freight services — these two countries are highly sensitive to the global economic cycle.
(As investment-grade borrowers with large, sustained current account surpluses they have much less sensitivity to risk appetite).
The single most disturbing data point is Taiwan’s July PMI print of 44.6, which suggests a rapid deterioration in business expectations. (Figures above 50 indicate positive expectations; below 50 is negative).
Meanwhile, South Korean manufacturing PMI for July was 49.8 — the lowest since 2020.
South Korean earnings expectations have been drifting lower since they peaked in September 2021, and Taiwanese earnings expectations may also now be declining.
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Central Europe
Things look worse in the European export economies of Central Europe.
Poland shows signs of an accelerating slowdown with manufacturing PMI at 42.1 in July — fully 10 points lower than April.
There is a similar story in the Czech Republic with July PMI down to 46.8 and consumer and business confidence dipping lower.
These results are not a surprise, given collapsing business expectations in the regional heavyweight economy of Germany. But they add to a troubling picture of global demand.
Mexico
The third major cyclical exporter is Mexico.
Mexico’s business survey data is complicated, with two separate time series.
For July the Mexican manufacturing and non-manufacturing PMI surveys were both 52.2 — showing expansion.
But the S&P manufacturing PMI survey came in at 48.5, indicating contraction.
Given the much better net energy trade position of North America compared to Europe and Asia, it may be that Mexico fares much better — and we remain positive on the market.
South Africa
Another market which we are positive on — but where survey data has weakened recently — is South Africa.
There the July manufacturing PMI dropped to 47.6, even if vehicle sales and credit growth remain robust.
We continue to think that very strong commodity exports will support aggregate demand in South Africa. But economic data there will need careful monitoring.
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Finding EM opportunities
We consistently express the view that opportunity within emerging markets is more reliable than the opportunity of the asset class as a whole. In other words there are opportunities in a select handful of EM countries.
There are always economies and markets in upswings. The current environment is no different.
The same commodity export story that is supporting Mexico and South Africa is coming through very strongly elsewhere.
In Brazil the services PMI for July reached the incredibly strong level of 60.8 — a new high. This indicates a full-blown domestic demand boom is underway.
Brazilian earnings estimates have also been rising as strong corporate results come through.
Indonesian GDP growth is expected to exceed 5%, with the July manufacturing PMI at 51.3 and consumer confidence very strong.
Finally in the Gulf, high oil prices are driving intense economic upswings. July PMI survey data for the UAE (one of our preferred markets) was 55.4, while in neighbouring Saudi Arabia it reached 56.3, with Saudi GDP growth for Q2 of 11.8% YoY.
Higher commodity prices act as drags on most global economies, while the strong dollar and higher interest rates are further headwinds.
Right now many commodity economies are experiencing strong growth that’s hard to find anywhere else in the world. We believe this will attract increased interest from global investors.
We remain overweight Mexico, Brazil, South Africa, Indonesia and the UAE.
About Pendal Global Emerging Markets Opportunities Fund
James Symes, Paul Wimborne and Ada Chan are senior portfolio managers and 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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
What does the new monthly CPI indicator mean for investors? Pendal’s TIM HEXT explains
STARTING in October, Australian investors will finally get a monthly snapshot of inflation data.
This is very welcome news to all, particularly the RBA which relies on data to set policy.
The new monthly CPI indicator has a number of shortcomings, which will likely be addressed over the next few years by more budget or better technology.
Some basic facts are:
- Only 43% of the basket is updated live every month. These are items where electronic data points are easily collected such as supermarkets, airlines, rents and home construction costs
- 10% are administrative prices that reset annually – so they are effectively accounted for every month, eg education in February, private health insurance in April and council rates in September.
- The remaining 47% are collected quarterly – but not all in the same month of the quarter. That is, they’re spread across the three months of a quarter. I presume this is a resourcing issue since collection is harder.
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The latter point will make predicting monthly numbers difficult at first.
At Pendal we’re now building out our models to help predict monthly movements, given markets will respond.
For example, utility costs are going up sharply. But they will only be collected in the final month of the quarter – and so will impact at the same time as quarterly numbers.
Restaurant meals though – another inflation pinch point – will appear in the monthly number prior to the quarterly number.
On average, two thirds of the CPI basket is effectively now monthly.
This helps make an already lagging indicator lag less.
It causes issues when the RBA bases policy on data that’s an average three months behind. This was shown late last year when the official quarterly CPI numbers were slow to pick up the rising monthly inflation.
Inflation bonds will continue to index off the quarterly CPI, which is still the ultimate source of truth.
Inflation bonds remain very cheap and despite a likely tailing off in goods inflation in the months ahead.
Services inflation will remain stubbornly higher in the medium term, whether measured monthly or quarterly.
Adviser Sam is invested
in making our world
A better place.
Watch as Sam meets a
mum rebuilding her life
thanks to responsible
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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
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.
In October Australia will move from quarterly to monthly reporting of inflation data. Pendal assistant portfolio manager ANNA HONG explains what that means
AUSTRALIA moves to monthly Consumer Price Index releases in October, bringing us in line with other major developed economies.
The decision, announced by the Australian Bureau of Statistics on Tuesday, heralds a new era for investors.
Why is up-to-date inflation data important?
Price stability is crucial in the allocation of resources.
Prices are economic signals. Large fluctuations change the expectations of businesses and individuals, leading to potential misallocation of resources.
Price stability is therefore one of the core objectives of central banks around the world.
It’s also why most central banks are now taking the full-throttle approach with rate hikes – they want to rein in inflation.
Because the CPI influences monetary policies, financial markets use it as a bellwether for the direction of monetary policy actions.
In 2022 this has led to markets swinging between fears of runaway inflation and fears of recession.
In Australia CPI data is traditionally released quarterly, compared to the US where it is monthly.
Hence, in between quarterly AU CPI releases, financial markets have largely looked to the US CPI numbers as a guide.
Problems arise because the direction of US CPI numbers does not always align with the AU CPI outlook.
This move to fill the calendar gap with timelier AU CPI data will help the RBA with policy decisions and give the markets better direction.
What are the changes?
Same: The new monthly CPI will include all items within the quarterly CPI basket. The weights on each of the categories for the monthly CPI will also align with the quarterly CPI.
Different: Due to the complexities and timing of collecting and collating data, not every item in the CPI basket will be updated every month.
Prices will be carried forward for items without newly collected information — assuming zero change from the last period when the fresh price was collected.
Will it be useful?
There will still be gaps between monthly and quarterly releases.
But the monthly data has been designed to capture the bulk of information within the quarterly data.
Every category of prices will see an update in the monthly releases apart from Communication.
Non-volatile goods prices such as Alcohol and Tobacco and Housing will be fully or mostly accounted for.
Categories with items that experience more volatile price changes – such as Recreation and Culture – will be representative. Though not all series within those categories will get a price refresh in the monthly updates.
What it means for investors
ABS mapping of historical data shows the monthly release will closely track the quarterly.
That is positive news.
This will be a tailwind helping the RBA achieve a soft-landing by providing policymakers with the information needed to identify key inflection points before over-correcting with rate hikes.
It will also give markets better information on potential policy decisions, reducing the need to second-guess the Reserve Bank as demonstrated by aggressive pre-emptive selloffs between Q3 2021 and Q2 2022.
Those circumstances will be supportive of bonds at current levels, allowing them to perform as an income-generating, defensive asset in a balanced portfolio.
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Pendal’s Income and Fixed Interest funds
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. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.
With the goal of building the most defensive line of funds in Australia, the team oversees A$22 billion invested across income, composite, pure alpha, global and Australian government strategies.
Find out more about Pendal’s fixed interest strategies here
About Pendal Group
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
Here are the main factors driving the ASX this week according to our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams.
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THE reluctant rally continues with the S&P 500 up 3.3% last week and the S&P/ASX 300 gaining 1.4%. They are now down 9.3% and 3.7% respectively for 2022.
The US market is now up more than 15% from its low and the rally has lasted 32 days.
Key drivers include:
- Positioning: Systematic and institutional investors have been sitting on their biggest equity underweights in years.
- Lower volatility: This leads to increased participation by systematic investors
- Better sentiment: Job data has helped quell the view that the economy is facing imminent recession.
- Strong US earnings season: Hasn’t validated the pre-season market de-rating
- Lower commodity prices: Particularly in US gas which is helping dampened inflation expectations
- Early signs of goods inflation slowing as supply chains free up
A small shift in fundamental view — that things are not as bad as feared — has prompted a material shift into equities by various systematic approaches. This caught institutional investors off-guard.
This is the nature of bear market rallies — sharp and often short. We now find ourselves at a key point.
In the short term we’re likely to have a quiet couple of weeks ahead of the Jackson Hole central banking conference on August 25-27.
We suspect the market will be range-bound given it is high summer in the north, there are limited new data releases, we are near a large technical resistance level for the S&P 500 and it appears the sharp move in systematic investors has played out.
Beyond that there remains a wide distribution of outcomes:
- Inflation rolls over, the economy has a mild recession at worse, earnings declines are limited and the easing cycle starts at the back-end of 2023. In this scenario the market may consolidate, but ultimately moves higher.
- Inflation proves more persistent, driven by tight labour market and higher energy prices as the economy runs too hot and China re-opens. Central banks need to continue to tighten into the downturn and earnings decline more significantly, taking equities lower.
There is probably enough evidence to indicate the latter scenario does not take us to new lows.
The key to the call remains the main drivers of inflation: the job market (particularly job ads and wage pressures), corporate pricing power and commodity markets.
Economics and policy
US year-on-year CPI (8.5%) and PPI (9.8%) were lower than expected.
But one month does not create a trend — and there was enough in the data for both inflation bulls and bears to validate their outlooks.
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Core CPI (5.9%) was 0.3% month-on-month, a lot lower than recent months. But it is at 0.5% excluding the more idiosyncratic categories such as used cars and airline tickets.
Core goods inflation is falling away reasonably quickly. Energy represents 34% of current inflation and is heading down as petrol prices drop.
Forward indicators of inflation — including the Crude Non-farm Materials ex Energy PPI which is a directional indicator for the Finished Goods (ex-energy and food) PPI — are moving in the right direction.
Freight rates also continue to decline.
All this underpinned more positive sentiment in market last week.
But in the medium term, categories such as direct rent and owner’s equivalent rent become more important. While these have begun to decelerate, it is marginal at this point and is still running above 8%.
Unit labour costs also remain too high, while there is no sign of a turn in the Atlanta wage tracker.
This means the Fed has had to re-iterate its vigilance on inflation.
China
There is some hope that cumulative stimulus measures will begin to drive economic recovery, particularly as we head into Autumn when construction activity should pick up.
We are cautious on calling this too soon. Some key lead indicators remain negative, notably property stock performance.
Credit data continues to be weaker than expected, reflecting low demand given the zero-Covid policy.
Australia
The market continues to grind higher, helped last week by BHP’s (BHP) bid for OzMinerals (OZL) which fired up the resource sector.
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Small caps also continue their recovery, outperforming the S&P/ASX 300 by 8% QTD. This is helped by a combination of short covering and a position squeeze.
There is an emerging view that the government and RBA are looking to deliver a soft landing by allowing inflation to run a bit hotter than normal — on the premise that commodity prices should stop rising, and immigration can ultimately resolve labour shortages.
In this context banks don’t face downside risk on bad debts and some of the consumer-exposed stocks may now be pricing in too much downside.
As in the US, this is contingent on commodity prices staying subdued and labour markets loosening.
Markets
It was interesting that US bond yields couldn’t break the 2.51% low of August 8 in response to the lower CPI number.
June’s hot CPI number coincided with the peak in bond yields (3.5% on June 14). Since then we’ve seen a 100bp move down, before a 33bp rise, closing the week at 2.83%.
Bonds could trade back towards 3% for several reasons:
- Economic data is surprising on the upside. The Fed is likely to be uncomfortable without further slowing, given inflation remains too high.
- The Total Financial Conditions index has begun to loosen, reflecting more confidence in the economy. This works against the Fed’s goals, which may lead them to signal rates stay higher for longer.
- Quantitative tightening beginning to kick in, which will potentially act as a headwind to lower yields.
- Yield curve inversion is implying too quick a reversal in US rates, particularly given economy and FCI trends
Given this, we do not expect to see bond yield moves lower — and they may move higher within a trading band.
This does not necessarily mean bad news for equities, but it makes further moves higher harder.
Given the moves seen so far we expect a period of consolidation coming soon.
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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
Consumers and business can only be out of step for so long — and 2023 will see a reckoning, writes Pendal’s head of government bond strategies TIM HEXT
WE ALL exist in the same economy — but you’d be forgiven for thinking otherwise.
This week we had new consumer and business sentiment data.
Early last year consumer confidence boomed as escaped from lockdowns with money in our pockets.
Sentiment hit an all-time high of 118 in the April 2021 Westpac-Melbourne Institute Consumer Confidence survey.
Now we have resumed our gloomy outlook. Weighed down by rising prices and rate hikes we’ve plunged to 81 — not far off the March 2020 low.
For business, however, it’s hardly looked better.
The NAB Business Survey sees business conditions at 20, not far off the April 2021 high of 30 (it averages around 5).
Business outlook, as measured by confidence, is a more modest 7, nearer the long-term averages.
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What’s going on?
Clearly while we’re worrying about the future we’re still spending our pent-up savings.
Rate hikes of 1.75% to date have been manageable. But the next 1% this year will start to bite — heavily for some.
Tight supply of goods and services means businesses are able to pass on higher costs, maintaining margins and seeing conditions as strong.
Of course, consumers and business can only be out of step for so long — and 2023 will see a reckoning.
For now pessimists are winning the day as markets price in rates topping out early next year.
Growth will slow, but whether the landing is soft or hard is a guessing game that will be heavily debated.
Challenging times for everyone but particularly for central banks trying to bring down inflation without a recession.
However it does mean bonds are back — and their role as insurance in these highly uncertain times should not be underestimated.
About Tim Hext and Pendal’s Income & Fixed Interest boutique
Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.
Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
Find out more about Pendal’s fixed interest strategies here
About Pendal
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.