Australian Bond Exchange Weekly Update
Friday 7th July 2023
Key Points
- RBA pauses one of the most aggressive hiking cycles in history, as supply and demand begin to balance out. Now sitting at 4.1%, it is the highest RBA cash rate we have seen in 11 years.
- An uncertain economic outlook and an inability to accurately forecast is causing major money movers to flock back to bonds, as they capitalise on close to double digit yields.
- Investment firms are concerned that the markets are not accurately pricing in the risks of rising interest rates and inflation, growing global debt levels and a looming recession.
- AustralianSuper is the latest to jump on the bondwagon, shifting $37million over to fixed income after property proved to be the worst performing investment of FY 2023 (down 7%).
Global Cash Rates & Inflation
- The RBA Cash Rate was held at 4.1% on Tuesday, with the next decision due for the 1st August. Annual inflation to the March quarter is 7%, with new CPI data due for release on the 26th July.
- The BOE Cash Rate sits at 5% after being hiked 50 basis points last week in an effort to curb an inflation rate of 8.7%. The next monetary policy meeting is set for Thursday 3rd August.
- The US Federal Reserve cash rate (policy rate) is between 5.25-5.5% and inflation is 4%, making the US the only region of the four mentioned to get the cash rate above inflation.
- The ECB Cash Rate (deposit facility) is 3.5% and inflation is 6.1% in the year to May 2023. Inflation data for June is expected on the 19th July, ahead of the next rate decision on July 27th.
RBA holds at 4.1%, but more hikes to come
This week, the Reserve Bank of Australia (RBA) decided to pause one of their most aggressive hiking cycles in history, leaving the cash rate unchanged at 4.1%. Still a far cry from the 17% interest rates seen in the first quarter of 1990, the cash rate is at the highest level in eleven years.
After raising Australia’s “official interest rate” 4 percentage points since May 2022 to 4.1%, the RBA board noted in their statement that “a more sustainable balance between supply and demand” was in the process of being established, and inflation had passed its peak.
However, the RBA remained firm in its conviction that “further monetary policy tightening” (i.e. more cash rate rises) “may be necessary to ensure that inflation returns to target [2-3%].”
The RBA’s next cash rate decision is on the 1st of August, where the release of the CPI June Quarter data will provide insight into whether inflation is returning to target, or whether more hikes are needed to tame inflation and avoid a recession.
Major money movers exit the “cash trap”
According to the RBA, despite concerns regarding the potential emergence of a “wage price spiral” the recent increases in award wages and the national minimum wage (increased by 5.75% and $1.85/hr respectively), could remain consistent with the inflation target “provided that productivity growth picks up.”
However, the lack of an accompanying figure (how much productivity needs to “pick up” by), and the RBA’s repeated use of the word ‘uncertainty’ throughout the statement, make it difficult for markets to predict what’s next.
This uncertainty is causing major money movers, like JPMorgan, BlackRock and Macquarie, to shift investments into lower-risk assets, like fixed income.
According to Wall Street veteran Bob Michele (head of global fixed income at JPMorgan Asset Management), despite bonds experiencing the “worst start to [last] year for the bond market in history,” 2023 is the time to exit the “cash trap” and switch to fixed income.
In fact, some of these new “bond ambassadors” are claiming that $1 trillion could flow into fixed income over the next year, as investors flock back to bonds to take advantage of predictable, stable returns and yields close to double digits. Others have been waiting patiently for fixed income to return to the spotlight since late last year.
Welcome to the ‘Land of Confusion’
This uncertain economic outlook and lack of predictability, which the RBA made a note to mention in their reasoning for the July pause, has been causing unprecedented confusion in global markets.
As Julia Howard from Zurich-based investment firm GAM investments cleverly puts it, “one of supergroup Genesis’s less-known hits of the 1980s was called ‘Land of Confusion’ which described a world in which people are told nothing is wrong despite evidence to the contrary all around them.”
“For investors today, there is a similar dissonance to contend with,” she continued. “Benign stock markets since October, along with low corporate borrowing costs appear to be disguising a host of ills.”
Basically, Howard is concerned that the markets are not accurately pricing in the risks of rising interest rates and inflation, growing global debt levels and geopolitical tensions (including the protests in France). Chetan Jindal, Chief Investment Officer at Greenwich Ivy Capital LLC, agrees.
“Either the market does not believe the Fed’s going to raise a lot more, or the market is very disconnected from reality,” Jindal said. “Because if the Fed raises, let’s say another 50 basis points, then the probability of a recession increases pretty substantially.”
Though Jindal is referring to the US market, the global dependence on the USD in money markets could see a US recession trigger a global recession, as was the case in the 2008 Global Financial Crisis.
Find out the kind of returns you can get with fixed income investments by giving the ABE team a call on (02) 8076 9343 or request a call back here.
Australia’s largest superfund sees bonds as “a bit of a hiding place”
This economic uncertainty has seen commentators split in their opinions on whether Australia (and major advanced economies) face an imminent, inescapable recession, however the markets do agree on one thing – bonds are back!
Major players in wealth management are now shifting their investment strategies to allocate more of their capital to lower-risk assets like bonds and fixed income.
AustralianSuper (Australia’s biggest super fund) has taken note of the uncertainty, and potential recession, by shifting allocations from higher-risk investments, like property.
For example, the property portfolio was AustralianSuper’s worst performing asset class in FY 22-23, losing a total of 7% into lower-risk assets like bonds.
Mark Delaney, AustralianSuper chief investment officer for more than two decades sees bonds as “a bit of a hiding place” and has now placed an additional $37billion into bonds – a 70% jump since last year.
“Eventually, higher rates will have an impact on the economy and central banks will ease into those higher rates,” he told the Australian Financial Review.
“In that environment, whereby the economy is a bit weaker, earnings are hard to get and central banks are cutting rates, fixed interest will perform well.”
Equities are also coming under fire. Head of portfolio management Jeff Brunton, of industry super fund HESTA, told the Australian Financial Review that due to current equity valuations, he has trimmed some of HESTA’s higher-risk positions to shift into cash and bonds.
If you’d like to learn how investing in fixed income can help you prepare for a potential recession, speak to an investment adviser here.
What’s coming up next week:
- Next Wednesday, the US Bureau of Labor Statistics will release the latest monthly inflation data with the CPI indicator released here.
- The Economic Society of Australia (ESA) Conference is also from 9-12th July next week, with RBA Governor Philip Lowe speaking at the business lunch on Wednesday 12th July.
- Next Thursday, the Office for National Statistics will share national accounts data, reporting the quarterly estimate of GDP growth for the UK here.
- The Melbourne Institute July 2023 Survey of Consumer Inflationary and Wage Expectations will be also released next Thursday 13th July here.
*Data accurate as at 07.07.2023
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