The Point

Are we getting over-confident on falling inflation? Tim Hext reviews the evidence

Investors have been getting used to good news on inflation.

But does the latest US data suggest we’re getting ahead of ourselves? Pendal’s head of bond strategies Tim Hext reviews the evidence in this week’s fast podcast.

There is still opportunity in government bonds, despite US inflation data surprising to the upside, says Tim.

“People like myself are paid to worry about weekly fluctuations, but I think for investors the trend is still in place.

“We have higher interest rates than we need given the inflation backdrop now, as opposed to 12 months ago.

“Central banks have recognised that and will deliver on cuts. The theme is still lower rates in the US across the year, and Australia will likely follow towards the back after the year.”

Tim expects rates to fall from 4.35% to around 3.6% by the end of this year and possibly lower in 2025.

Amy Xie Patrick: How to manage fixed income portfolios in a turning-point year

A year ago the investment base case was a US recession, an inverting yield curve, an end to the inflation fight and optimism about China reopening.

Now, at the start of 2024, it couldn’t be more different, says Pendal’s head of income strategies Amy Xie Patrick.

“Recession is nobody’s base case. China is the last place people are optimistic about.”

It’s evidence that investors need many levers to pull when navigating the cycle, says Amy.

“Risk number one is that a soft-landing narrative led by the US economic story may not end up being the case.

“The biggest risk is always what’s outside of consensus. It’s not to say that consensus can’t happen, but if the consensus is the case, markets tend to be priced for it.

“Another risk is markets pricing in six Fed cuts, despite data showing resilient growth.

In her new podcast, Amy explains how she’s preparing for risks – and opportunities – the market may not be considering.

Tim Hext: Why bonds still look better than term deposits

Have you missed the boat on bonds? No, says our head of bond strategies Tim Hext.

“Australian 10-year bonds did briefly touch 5% at the end of October. People may look at that and say, ‘Oh, I’ve kind of missed it’.

“But around 4.5% is still very attractive if you believe inflation is going below 3%.

“When I look across the spectrum of what you can buy in bonds, government bonds are around 4.5%, state government bonds 5.25%, and bank debt around 6%.

“On term deposits, my question to investors would be: Okay, let’s assume term deposits are at 5% and you’re locking yourself into those with no liquidity.

“Where do you think on average they’re going to be over the next five or 10 years?

“I think most people would assume they’re going to be a little bit lower, not higher; and that cash rates will come down rather than go up a lot more.

“The other advantage of bonds is that they’re liquid.

“That’s particularly important if you saw a sudden sharp sell-off in equities and you’re wanting to buy them – but your money’s locked up.”

Tim Hext: Bonds offer returns and cheap insurance right now

Bond yields are hitting multi-year highs. Why is it happening and what’s next?

Resilience in the US economy is the main factor, says Pendal’s head of bond strategies Tim Hext.

That’s due to the dominance of fixed-rate loans there and Joe Biden’s big-spending government.

Meanwhile, the Australian economy is holding up better than expected and the fixed-rate cliff hasn’t impacted as much as people thought.

“I think it’s a good time to be buying bonds,” says Tim. “At the moment you can buy state government debt at 6% yields.

“The cash rate is likely going to 4.35%, but I don’t expect it to be well above 5% for the next decade or two.”

Bond investors are rewarded in two ways, argues Tim: the return and the insurance.

“If things were to get out of hand – if you get a collapse in equities, if you see major geopolitical disruptions in this heightened risk environment – then bonds should perform their defensive role. I do think they’re cheap insurance.”

Fast podcast: Why China is hesitating on stimulus – and what’s likely to happen next

Why doesn’t Beijing pump stimulus into the Chinese economy as other countries do?

“We have to remember the Chinese political system is not democratic, and its principles are very socialist at heart,” says Pendal’s head of income strategies, Amy Xie Patrick.

“A very classic characterisation of the Chinese style of socialism is they don’t believe in ‘helicopter money’.

“They believe money going directly into people’s pockets isn’t the way to common prosperity. Instead, everyone should toil in order to achieve that prosperity.”

Even so, the severity of the Chinese property story may prompt action, says Amy.

“Lately we’ve been hearing that some government bodies have been proposing a larger fiscal deficit in 2024.”

Though the amounts aren’t big, it could signal that Beijing is considering more direct-to-consumer stimulus to keep the positive momentum going, says Amy.