The Point

‘No pre-set path’: What the RBA statement means for investors

Did the RBA this week signal fewer rate hikes ahead? Probably not, says Pendal’s head of government bond strategies Tim Hext.

“We know we’re going to hit neutral this year. Another 1% can be expected, moving the cash rate to 2.85%.

“Whether it’s four lots of 25bp or 50bp at fewer meetings is only of interest to short-end traders. Hence the RBA’s line that it is ‘not on a pre-set path’.

“Sounds like an opportunity for everyone to interpret this with their own confirmation bias — which on Tuesday seemed to be fewer hikes, not more.

“I think that’s reading too much into it.

“As asset owners we must remember the ‘central bank put’ is now also a ‘central bank call’.

“If bonds, equities and credit spreads rally too much without a significant easing in inflation pressures, the RBA will lean against the easing of conditions.

“The rally of the past month suggests this is in danger of happening — so expect more hawkish speeches from officials, especially in the US.”

Fixed interest: why bonds look promising and how to take advantage

A re-assessment of fixed income securities and yields — and their defensive qualities — have recently made bonds attractive again, says Dale Pereira, who heads up client solutions at Pendal.

“Bond returns don’t predict the future — they reflect what’s happened,” says Dale.

“That’s where the opportunity lies: they may be showing negative returns now, but the future looks a lot brighter.”

Bonds typically lead equities in terms of market reaction, says Dale.

“From the end of 2021 and into the first half of 2022, bond yields moved in line with expectations of future rate rises — which in turn reflected inflation expectations.

“But markets often over-react when extrapolating good and bad news. And that’s probably the case now.

“The market has likely priced in too many rate rises. It’s priced in a good chance that central banks won’t be able to control inflation. (Though recently that pricing has started to dissipate, making yields less volatile.)

“This means the bond market is at a much better entry point for investors.”

Crispin Murray’s weekly ASX outlook

When is bad news good news? Right now say some investors — since weaker growth helps drive inflation lower, bringing forward an expected peak in rates and bond yields.

The market is seeing signs of inflation easing, the economy slowing and policy having an effect, says our head of equities Crispin Murray.

“As a result, concerns over the extreme tail risk of substantial central bank overtightening may be receding.”

Though it’s still too early to say whether we are seeing a bottom or another bear market rally, says Crispin.

“Technical measures of market breadth and volumes are not indicating a sustainable turn in sentiment. Seasonally, August and September are typically soft months for equities.

“Bear markets don’t tend to end until policy direction shifts. It would also be unusual to see markets bottom before the extent of any earnings recession is known.”

The average NASDAQ bear market rally since 1985 has been 30% — and the NASDAQ is only up around 10% from its recent low.

Amy Xie Patrick: The value proposition for bonds right now

Investors have been hesitant to include bonds in portfolios in recent years — but that’s changing, says Pendal’s head of income strategies, Amy Xie Patrick.

“The bond story of recent years has been flipped on its head. Buying 10-year government bonds in Australia can get you nearly 4 per cent. At the height of the pandemic, it was 50 basis points.

“Now the credit risk-free rate is 4 per cent, which raises the bar for other asset classes.”

Is 4 per cent a good return, given inflation is currently higher than that?

“Inflation markets infer that over 10 years inflation will average around 2.5 per cent, which is the RBA’s inflation target,” Amy says.

“Ten-year bonds are yielding a nominal rate of 4 per cent. By owning a 10-year Australian bond, you are taking effectively no credit risk, keeping up with the 2.5 per cent long-term rate of inflation and then getting another 1.5 per cent.

“You’re getting paid to own something without credit risk and keep up with inflation.”