As Global Rates Shift, Opportunities Arise for Australian Investors

Against the backdrop of an evolving monetary policy landscape, Australian bonds present a compelling case for investment.

For investors, the evolving monetary policy landscape presents a timely opportunity to review and adjust investment strategies. In a year where some central banks around the world are expected to begin reversing policy and cutting interest rates, investors should be prepared to seize the opportunities presented by these moves. The Australian bond market, in particular, stands out as an area offering attractive prospects for investors.

Central banks in motion: a global overview

Last month saw important shifts in central bank policies globally. The Swiss National Bank's unexpected 25 basis point rate cut signals that its stringent policy settings over the past years have successfully met inflation targets. Meanwhile, the Bank of Japan's (BOJ’s) decision to end its negative interest rate policy and raise rates for the first time since 2007 indicates a re-anchoring of inflation expectations into positive territory. The BOJ’s rate hike has led to a significant milestone: all central bank policy rates and all bonds in the Global Aggregate Treasury Index are now yielding positively. This is a stark contrast to 2019/20, when nearly 40% of global sovereign debt was negative yielding (see chart).

The chart shows the percentage of the Global Aggregate Treasury Index that has been negative yielding since January 2010. It highlights that in 2019/2020 nearly 40% of the Index was negative yielding but since the Bank of Japan’s rate hike, none of the Index is negative yielding.

In our view, the re-pricing in interest rates is largely complete, setting the stage for a new investment environment. As policies and economies diverge, we expect interesting opportunities for active managers to construct diversified portfolios.

While central banks in developed markets adjust to economies that are cooling at different rates, the U.S. economy, in particular, is showing remarkable resilience (as noted in our latest Cyclical Outlook: Diverging Markets, Diversified Portfolios). This strength is attributed to several factors, including fiscal policy support in the lead-up to an election, the prevalence of fixed-rate mortgages insulating borrowers from rising rates, and the country's position as a hub for AI investment. Despite this relative resilience, the U.S. economy is gradually cooling and following its 20 March meeting, the Fed conveyed clear signs that a rate cut is still likely mid-year.

Given these conditions, we see bond markets outside the U.S. representing attractive relative value opportunities. Some of our highest conviction positions are being underweight to Japan, while favouring floating-rate mortgage environments like the UK and Australia.

A closer look at the Australian bond market

Turning our attention to the local scene, our preference for Australian duration has been reinforced by the Reserve Bank of Australia’s (RBA's) shift away from a tightening bias. We have long held the view that policy rates in the low- to mid-4% range would be adequate to decelerate the economy. Rate cuts will hinge on various factors, including the economic tailwinds from population growth and the impact on housing market dynamics, offset by sluggish household spending, and the headwinds from China's growth trajectory and the associated negative impact on iron ore prices.

In this environment, there is no need to wait for the RBA’s first rate cut - the Australian bond market offers ample investment opportunities. Here are four reasons why:

  1. Starting yields are a reliable predictor of expected bond returns. Bonds faced a tough year in 2022, but this was an outlier in the broader context of market history. Investors should base their return expectations for 2024 on the positive 5%-7% that core bonds delivered in 2023, rather than dwell on the rare underperformance of 2022.
  2. The investment grade (IG) credit market is thriving, characterized by strong primary issuance levels and an increasingly diversified issuer base, with yields regularly exceeding 6%.
  3. Bonds are expected to continue to play their role as a diversifier in portfolios, with correlations remaining low, or even negative, to riskier assets.
  4. The cost of de-risking from equities to bonds is low. Investors aren't transitioning from an asset class with double-digit returns to one with zero returns. Instead, they're moving from an asset class with potential double-digit growth to one that could deliver high single-digit returns.

Now is the time to consider investing in bonds

For investors, the evolving monetary policy landscape presents a timely opportunity to reassess investment strategies. The key for investors is to remain agile and ready to capitalise on the opportunities that arise from the actions of central banks both globally and locally.

Australian bonds currently present a compelling case for investment, offering some of the most attractive yields we’ve seen in a decade. In addition, bonds remain a key component of a well-diversified portfolio. We believe now is the moment to look beyond the experience of 2022 and focus on the role bonds can play in achieving financial goals over the long term.

The Author

Robert Mead

Head of Australia, Co-head of Asia-Pacific Portfolio Management

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