ABE Weekly: A war on inflation, or a conflict of interest?

Australian Bond Exchange Weekly Newsletter

Friday 12th May 2023

Key Points

The 2023-2024 Federal Budget released on Tuesday has provided Australia with a surprising surplus, albeit short-lived with large, forecasted deficits for 2023-2024.

The Budget has heralded mixed reviews from economists and market commentators on whether the injection of billions of dollars into the economy will increase inflation.
The “war on inflation” and potential for more cash rate rises suggests defensive assets could provide bond investors with additional returns alongside coupon payments.
The Federal Budget commitment to sustainable finance through creating green government bonds could increase the scale and maturity of these markets in Australia.

Global Cash Rates & Inflation*

The Reserve Bank of Australia (RBA) cash rate is at 3.85%, and inflation is 7%, with new CPI data due for the 27th July. The next RBA cash rate will be delivered on Tuesday 6th June at 2,30pm.
The Bank of England (BOE) raised the UK cash rate to 4.5% on Thursday, in a bid to fight double digit inflation which is sitting at 10.1%. The next rate decision will be Thursday 3rd August.
The US cash rate is 5.08%, and CPI data released Wednesday shows easing inflation, now down from 5% to 4.9%. The next Federal Reserve cash rate decision is due for Wednesday 14th June.
The European Central Bank (ECB) main deposit cash rate is at 3.25%, increased 25bps last week, and inflation is at 6.9%. The next ECB monetary policy review is set for Thursday 15th June.

This week, the Labor Government released the 2023-2024 Federal Budget, which saw them achieve what many commentators thought to be impossible, a budget surplus. 

Although previous treasurers have predicted surpluses that did not eventuate, in comparison to other OECD countries, Australia is seemingly leading the charge in bouncing back from the economic blackout that was the COVID pandemic. However, it’s important to remember that this surplus will be short-lived in the 2022-2023 financial year, returning to a forecasted deficit of over $13 billion in 2023-2024.

The war against inflation

Inflation has been the core focus of major Central Banks around the world, as they continue raising interest rates to achieve global target inflation rates of 2-3%. 

On Thursday, the UK increased their cash rate by 25bps, in lockstep with the RBA, ECB and the Federal Reserve’s recent hikes, and while US commentators are already forecasting 2023 rate cuts, the ECB is likely to continue “to ensure inflation returns to its 2% target over the medium term.”

In his speech, Treasurer Jim Chalmers provided a brief economic outlook outlining that “the global economy is slowing due to persistent inflation, higher interest rates and financial sector strains.” 

This high and potentially “sticky” inflation that countries across the world are currently battling with, has evolved into a global “cost of living” crisis and a war against inflation. But has the budget done enough to fight inflation and reduce the chance of more interest rate hikes?

Conflicting views on how inflation and interest rates will be impacted

There have been mixed opinions on the success of the budget, and whether the injection of billions of dollars into the economy is inflationary. Some commentators believe that it is not enough to have a “material change” on inflation, while others predict it could impact central bank decisions, including how early the RBA can start reducing the cash rate. 

Various other opinions commented on clear winners and losers, an over-reliance on personal income tax, and many were shocked that smokers will contribute over $1 billion more in revenue to the government than the Petroleum Resource Rent Tax (PRRT).

Additionally, at least 80,000 Australians are likely unhappy with the new 30% tax on superannuation funds exceeding $3 million. This is up from the current tax rate of 15%, and will begin on the 1st of July 2025.

So how does the budget impact bond investors?

The war against inflation, rising interest rates and US banking collapses have highlighted the benefits of having defensive assets in your investment portfolio, like bonds and other fixed income securities, to spread risk.

As interest rates increase, the prices of bonds go down, which also allows investors to buy bonds at a lower price than face value. This gives investors an additional return on their investment, if they hold the bond until maturity, as they sell at face value and collect the difference, on top of regular coupon (interest) payments.

It is important to note that when you invest in bonds, it’s best to seek the advice of an experienced professional as there are risks associated with certain types of bonds such as unsecured bonds and there are bonds out there with very high yields, which can come with high risks.

Economist Christopher Joyce suggests “we are entering a new regime where interest rates are likely to remain high for a long time [which] will probably perpetuate a US, European and global recession, which will in turn trigger a very large default cycle in the risky high-yield and private loan debt markets.”

At the Australian Bond Exchange (ABE), our product approval process approves the fixed income products for trading purposes. This process is what ensured ABE did not invest in Virgin Australia bonds on behalf of our clients. This approval process is what continues to protect our clients.

Speak to an adviser today about our approval process by giving us a call on 1800 319 769.

The rise of sustainable finance?

The budget also included information on new green government bonds. As part of their sustainability strategy, outlined on page 26, the government states that “the issuance of sovereign green bonds will support Australia’s broader green capital market to mature and scale.”

“Green bonds form part of the Government’s Sustainable Finance Strategy, which will set out measures to develop transparent and credible green finance markets.”

There could soon be a major shift in bond markets to focus on these sustainable bonds, which in a time when interest rates are high, could see investors investing more sustainably while increasing their bottom line.

If you’re interested in learning more about bonds, and how they can work for you, get in touch with an experienced ABE Investment Adviser.

What’s coming up next week:

RBA Meeting Minutes: The RBA minutes from last week’s monetary policy meeting will be released here next Tuesday 16th May, to discuss the reasoning behind the latest 25bps hike.
The Wage Price Index: The Australian Bureau of Statistics will release the data for the March quarter on Wednesday 17th May, reporting on the changes in the price of labour in the Australian market, which is a major measure of inflationary pressure on wages and salaries, and will be considered by the RBA at their next monetary policy meeting on Tuesday 6th June.
The April Jobs Report (discussing March figures): The Labour Force report from the Australian Bureau of Statistics (ABS) will be released next Thursday 18th May, providing updated figures on employment, that will also inform the RBA’s next cash rate decision.

*Data accurate as at 12.5.2023

Disclaimer: The information and any advice provided in this newsletter has been prepared without considering your objectives, financial situation or needs.  Because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to those things. You should obtain the relevant appropriate document for any product mentioned and consider its contents before making any decision.