The Point

Pendal’s weekly fixed interest wrap

Another week, another rise in yields; Australia the worst developed market

AT THE time of writing, Australian 10-year bond rates were up another 0.24% for the week – despite little hard data to explain it.

True, the Reserve Bank is expected to hike rates next week. But long bonds have underperformed short rates, which is not what you’d expect.

Interestingly, Australia was by far the worst performer among global markets. Europe was largely unchanged and the US was only 0.05% higher.

So we’re left with various possible explanations — though if truth be told, the scale of the selloff is a surprise to all.

Tim Hext: Inflation is higher. But is it ‘materially’ higher? That’s the big question

After yesterday’s strong inflation numbers, focus now turns to the RBA’s Nov 7 meeting.

The rates decision rests on the RBA’s definition of ‘materially higher’ and ‘low tolerance’, says Pendal’s head of bond strategies Tim Hext.

RBA minutes mention a “low tolerance” to upside inflation surprises. Meanwhile governor Michelle Bullock has said the board won’t hesitate to hike if there’s a “material revision” to the inflation outlook.

“What is material?,” ponders Tim.

Q4 inflation is expected at around 0.9%, leaving headline inflation at 4.3% and underlying at 4.1%, he says. That would be about 0.2% higher than the RBA’s last forecast.

We’ll get a sense of the latest forecast (due Nov 10) with the rates decision.

“At these levels there is no clear trade, since it will be line ball,” says Tim.

“If I’m pushed, I think Bullock will be keen to show her inflation-fighting credentials by putting in one hike, even though she was probably hoping today’s number would let her off the hook.”

Aussie equities: where to hunt for category winners in this economy

THE global economy has shown resilience in recent months – but there are now signs it is gradually slowing, along with consumption.

“We are moving from single-digit growth to single-digit declines,” says Pendal equities analyst Anthony Moran.

“In this environment investor mindsets change from being comfortable about resilient demand to thinking about downside risks.”

The shift has been particularly prevalent in industrials, which have underperformed other sectors, says Anthony.

“Investors don’t need to put all their money into hyper-defensives because things may not be that bad.

“Look for companies that are going to grow above their category, or are able to grow market share, particularly if they are trading at attractive valuations.”

Emerging markets: where else to look in Asia while China remains weak

Subdued US imports are weighing heavily on Asian economies such as China.

Emerging markets investors should look instead to countries driven by strong domestic demand, argues Pendal portfolio manager James Syme.

James points to the World Bank’s latest economic outlook for east Asia, which highlights weakness in China’s economy and an ongoing slowdown in Asian exports.

The bank forecasts GDP growth decelerating to 4.5 per cent in the region – historically weak growth excluding short-term shocks.

“We do see continued weak growth in China,” says James, pointing to tighter monetary and fiscal policy, intervention in the private sector, the effects of the pandemic and a sagging share of US imports.

Instead, James points to Asian economies such as Indonesia and India, which are driven more by robust domestic demand than exports

“Indonesia and India are our only overweight country positions in east and south Asia,” says James.

Weekly fixed interest wrap: close call on next rates decisions; govt bonds at 5pc

Two years ago people would have laughed if you said you could buy an Australian Government bond at 5 per cent, says Pendal’s head of bond strategies Tim Hext.

“Full disclosure, I would have joined in.”

On Tuesday, though, the government’s debt manager, the AOFM, issued a new 2054 maturity bond at 4.93%.

“Given subsequent moves in US bonds, that yield is now around 5%,” says Tim.

Meanwhile a Northern Territory 2042 bond is yielding around 6% and a new CBA 10-year bond is 6.45%.

“As low-risk, fixed-interest returns get higher and higher, the hurdle rate for risk assets should also rise,” says Tim.

“If you back the RBA to keep inflation at 2.5% over the next decade, investors should see their money grow at a faster rate with low credit risk.

“Fixed interest is well and truly back. “