Should investors be thinking about government bonds now, given what they’re yielding?
Market pricing – as in what you can achieve by buying securities – has three-year rates in Australia up through 3%.
If you buy a three-year bond today, you are going to get a 3% return for the next three years.
Forget where your term deposit or cash rates are today. The market is already factoring in 3% cash rates and believes we’re going to get there almost by the end of this year.
I think they’re probably going to end up closer to 2% than 3%, but the point is the market pricing.
So if you buy a bond today, you are buying the expected interest rates in the future, which are quite high.
A 10-year bond is now 3.5%.
Last time we spoke we were heading through 2.5%. I said then, if you are underweight bonds, you might want to start thinking about getting back to neutral.
I think they’re starting to get into the territory where you could even look at going overweight bonds.
I do believe inflation eventually heads back 2.5% to 3%. And I believe real interest rates – in other words the return you get above inflation – shouldn’t move a lot higher than where they are now, which is around about 1% for 10 years.
In other words, if you give the government your money today, you are in a sense locking in an inflation rate, somewhere around 2.5%, plus an extra 1% return on top, which in my mind for a risk-free asset is quite a good return.
(We’re not trying to compare it to equities because they’ve got very different characteristics.)
My advice now is people should be thinking in the medium-to-long term about bonds starting to represent good value.
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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.
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