Tim Hext: How far the next rate-hike cycle could go

When rates start going up, how far will they go? It’s a question Pendal’s head of government bond strategies TIM HEXT has been thinking about a lot lately

WE have just released our latest Income and Fixed Interest Quarterly Report (contact a Pendal business manager for a copy) and I have spent my time recently questioning market pricing.

Right now nearly everyone is focused on the timing of RBA rate hikes versus market expectations.

The near-term performance of funds we manage is all about solving that one.

But the issue that’s been occupying my mind — and I write about in the Quarterly — is the long-term question of the terminal rate of a hiking cycle.

In other words, when rates do start going up, how far will they go?

I think rates will move up to 1.5% in 2023. Inflation will peak around 3% in early 2023 before tapering off back to 2.5%, led by modest goods price deflation kicking in.

This will see the RBA happy to leave cash rates there for at least a year or more.

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Consensus is that 1.5% cash rates will see out the rate-hike cycle. The logic is that a 2% rise in mortgage rates would hit the economy hard.

But as the decade unfolds and investment remains strong, real yields could move modestly positive once more.

That would mean cash rates closer to 2.5% than 1.5% and bond rates nearer 3% than 2%.

I doubt markets will factor this in for some time, but it’s a risk to consider for long-term asset allocators.

Of course in the meantime — with cash stuck near zero — it is expensive to be too underweight fixed interest.

Now rates have backed up, fixed interest is once again playing its part as a defensive asset.

For those of us managing portfolios, we must play the short term while keeping in mind the medium term.

We’ll leave long term to the custodians of superannuation funds whose time horizons allow for it.

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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