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TIM HEXT: Interest rate pain probably won’t get too bad despite tough talk

Despite tough talk from central bankers, cash rates are likely to sit around 3% next year, writes our head of government bond strategies TIM HEXT

CENTRAL banks have largely abandoned forward-looking monetary policy since Covid.

One wonders why they need big teams of economists if they’re merely responding to the latest prints of often-lagging indicators such as inflation.

This was highlighted again last week at the Jackson Hole central bankers conference in Wyoming.

One cannot blame them for hawkish comments on inflation, including talk of bringing on the pain. After all, their lack of forward-looking policy failed to pick up inflation soon enough in 2021.

In the US there is a risk they will get it wrong again — but in the opposite direction, failing to pick up an imminent fall in inflation led by goods inflation, which forward indicators are showing. 

Or maybe they are aware of it are and want to take the credit for falling inflation when it’s already baked in as supply chains and business margins normalise.

Market reaction

Markets this week reacted to the rhetoric by selling off bonds and equities.

July’s rally on hopes of a soft landing is a distant memory. But there are signs the rally, although premature, had the right idea.

Find out about

Pendal’s Income and Fixed Interest funds

This comes down to the idea that inflation will fall and then stabilise around 4% in the next year.

That’s still too high, meaning rate cuts would be unlikely. But hikes would then stop around neutral and central banks would feel they had time on their side.

Australia is a bit behind the US. Due to the composition of our CPI the moves both up and down will be less dramatic.

We also face a mortgage fixed-rate cliff next year which US 30-year mortgages don’t have.

If the RBA exhibits any patience it is likely to sit at 3% cash rates in 2023.

Falling global inflation should allow our central bankers more confidence that we are not in some 1970s style spiral.

Wages are key

Wages will be key in the medium term.

Our view is that goods inflation will fall before stabilising at about 2%.

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Services inflation will remain elevated around 5%, leading to a 4% CPI.

This assumes wage growth of close to 4% next year. Prime Minister Albanese’s jobs summit this week will bring that all into focus.

We will do a deep dive into wages in our upcoming Australian Investor Quarterly. (Contact us if you’re not on the distribution list).

A little more than 20% of workers are now covered by awards — the main one being the minimum wage set by the Fair Work Commission.

Another 40% of us have individual agreements.

The jobs summit will focus on the remaining 40% covered by collective agreements or enterprise bargaining.

This is where the major battleground over wages will be fought, especially if agreements try to keep pace with the recent 4.6-5.2% minimum wage increase.

Bonds outlook

For now, bonds have once again entered the buy zone.

I will avoid predictions on equities.

But I make the observation the landing in the US may not be as hard as many are predicting.

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 Group

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

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This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at August 30, 2022. PFSL is the responsible entity and issuer of units in the Pendal Monthly Income Plus Fund (ARSN: 137 707 996) and Pendal Dynamic Income Fund (ARSN: 622 750 734) (Funds). A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com

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