Australian Bond Exchange

ABE Weekly: Equities get the boot as billions flow into fixed income

Australian Bond Exchange Weekly Update

Friday 14th July 2023

Key Points

  • Billions of dollars are flowing into fixed income (and billions are being pulled from equities), as major money movers including super fund managers and Wall Street veterans reallocate assets in response to rising cash rates and high inflation. 
  • ANZ Consumer Confidence Report shows homeowners impacted by rising rates are feeling the pinch, as confidence drops to the lowest level since the report began.     
  • U.S. CPI data shows inflation easing to 3%, but core inflation remains sticky at 4.8% suggesting despite getting inflation below the cash rate, the Fed may hike rates again. 
  • The war against inflation has highlighted the benefits of having defensive assets in your investment portfolio, like bonds and other fixed income securities, to spread risk.    
  • RBA Deputy Governor Michele Bullock will take the reigns as Australia’s first ever female RBA Governor when Lowe’s term expires in September. The RBA will also make 10 key changes to their monetary policy processes and frameworks, including moving from 11 to 8 meetings a year. 

Global Cash Rates & Inflation

Billions of dollars shift into fixed income 

This week, the hype around fixed income continued to gain traction.  

Following AustralianSuper’s reallocation of $37biillion into bonds just last week, this week inflows into exchange traded funds (ETFs) surpassed the $150 billion mark.  

Simultaneously, Australians are rethinking their love of stocks, pulling $2.8billion out of equities in the second quarter of 2023 as a potential recession looms. 

For months now, major money movers like Wall Street veteran Bob Michele and BlackRock’s Larry Fink, have been reevaluating their investment strategies, and shifting billions of dollars into to lower-risk assets like bonds and fixed income. 

In fact, Vanguard head Balaji Gopal told the Australian Financial Review this week that in June alone, ASX-listed fixed income ETFs reported almost $700million in inflows.   

“Fixed income continues to play an important role,” he said, “with 2023, we’re starting to see a return to fixed income being seen as an asset class.” 

For those already investing in fixed income, you’re likely feeling chuffed with your decision to invest in ‘defensive assets’ with predictable and stable returns, whilst also taking advantage of the close to double digit yields, that have emerged in response to rising cash rates. 

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Confidence drops as the mortgage cliff arrives 

The mortgage cliff has now arrived, as the bulk of 880,000 homeowners this year (and another 450,000 next year) who locked in a near-zero fixed rate in 2020-2021, see home loan rates increase by around 3-4%.  

Some homeowners have used this ‘grace period’ – hidden from the 400-basis point hiking cycle – to build substantial savings buffers, but not all have been so lucky.  

In fact, 5.5% of all loss-making sales in the last year were from houses owned for less than a year, suggesting that some have chosen to “cut their losses” rather than face the switch from 2% home loan rates to 6-7%.  

The impact of this jump in rates on consumer confidence can be seen in the ANZ Roy Morgan Consumer Confidence Report, with the ‘time to buy a major household item’ subindex dropping 3.4 points (for the homeowners’ cohort) to the lowest level on record since the report began.   

Source: RBA Bulletin: Wage-price Dynamics in a High-inflation Environment: The International Evidence 

U.S. inflation eases to 3%, but rate hikes still a possibility 

This week, the US Bureau of Labor Statistics (BLS) released the CPI data for June, which saw inflation drop to 3%, just 100 basis points away from the Fed’s target of 2%. This new CPI data shows that the U.S. is the closest to reaching their inflation target.  

This has prompted some to suggest the U.S. hiking cycle is almost over, forecasting one more hike in July.  However, what’s important to note is that the core inflation figure, that excludes volatile items like food and energy, is still at 4.8%. 

As you can see in the graph below from the BLS, the volatility of energy prices (that dropped 16.7% in the year to June) had a significant impact on the 3% headline inflation figure, suggesting that 4.8% may be the more accurate indicator.

Defensive assets spread risk in the war against inflation 

This global war against inflation has highlighted the benefits of having defensive assets in your investment portfolio, like bonds and other fixed income securities, to spread risk.  

Though inflation rates in the single digits may seem menial in comparison to Türkiye (Turkey)’s shocking 38.21% annual inflation, the “stickiness” of inflation rates and slow growth across major western markets, according to the IMF and the World Bank’s recent reports, is pushing us closer to a global recession. 

The strange combination of two typically conflicting economic conditions at once (slow growth and high inflation) is also seeing fixed income investors benefit from both high coupon (interest) payments and low bond prices, increasing overall yields on what are historically low return investments.  

The UK and Australia are facing similar issues with a lack of supply, rising mortgage rates, and increase in demand – rising wages and a tight labour market. This is keeping inflation high and causing commentators to speculate on whether a recession is imminent or if a wage price spiral will emerge. 

China, on the other hand, is fighting deflation as the economy recovers much slower than originally predicted, with producer prices falling despite cutting the cash rate and appointing a new central bank governor, Pan Gonsheng.  

Australia’s first female RBA Governor is appointed

This morning, the Labor Government decided to promote RBA Deputy Governor Michele Bullock, making her Australia’s first ever female RBA Governor.

Bullock will take the reins when Lowe’s term expires on September 18, after the government made the decision not to extend Philip Lowe’s term and saw Bullock as the best candidate.  

The choice of who to place in the top job is not the only change to Australia’s central bank however, as RBA shakes up their meeting schedule to allow for more timely decisions, based around quarterly CPI data releases, and improves their communications to the public.  

Speaking at the Economic Society of Australia business lunch in Brisbane on Wednesday, the (soon to be former) RBA Governor Philip Lowe outlined 10 key changes to their monetary policy processes and frameworks.  

The first, that will begin in early 2024, will see the RBA switch from the schedule of meeting on the first Tuesday of every month (excluding January), to 8 meetings a year based on key CPI data releases, that will provide more in-depth analysis and clearer explanations of their decisions. 

What’s coming up next week: 

 

*Data accurate as at 14.07.2023 

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