Federal Budget will embolden the RBA on rates — but not as much as you think

Not surprisingly in an election year, the federal government is already spending its recent windfall in the Budget. TIM HEXT explains what that means for rates and bonds

WHETHER you like the federal government or not it’s a fact their time in power has not been a happy one.

Natural disasters and pandemics have defined the past three years.

But some good fortune has finally come their way in the past year as Australia’s terms of trade have boomed.

Even the Ukraine conflict, which of course is a terrible disaster, has seen prices take off for many of our exports.

This has delivered the government a huge windfall via company taxes and some royalties. Added to this is the massive fiscal spending delivering a stronger economy domestically.

Over the course of four months or so, the federal Budget has improved by about $115 billion over the next four years.

Not surprisingly with an election imminent Treasurer Josh Frydenberg (pictured above) has spent $30 billion of it — on top of a previously announced $16 billion in pre-election handouts.

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What it means for rates and bonds

From a bond market perspective this adds further fuel to an already strong economy.

Dealing with supply shocks by subsidising demand only helps keep prices elevated.

But politics trumps economics.

The 22c fuel excise reduction plays to this although I doubt Australia’s reduced demand will impact global prices much.

The RBA is already on the precipice of finally admitting they need higher rates — and this budget will only encourage them more.

But with markets forecasting 2% rates in Australia by early next year — and 3% by the end of next year — there is quite simply too much priced in.

We think the US will get to those levels, but investors assuming Australia must follow are missing a couple of factors.

Firstly, our inflation is significantly lower.

Secondly, our floating rate mortgage market means any rate hikes have more impact sooner.

It may seem strange but when the RBA actually starts to moderately tighten rates, bond markets will likely rally.

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.

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