Australian Bond Exchange Weekly Update
Friday 23rd June 2023
Key Points
- Bank of England hikes the cash rate half a percentage point to 5%, to fight sticky 8.7% inflation recorded in the year to April and in the year to May.
- RBA releases the minutes from the June monetary policy meeting, with upside risks to inflation the prominent reason for hiking another 25bps, despite financial pressures.
- Australian and U.S. bond yields are rising in response to ever-increasing interest rates, making equities a less attractive option than the bond yields currently on offer.
- CBA data shows the mortgage cliff has arrived, as over 850,000 Aussies face up to $15,000 more in mortgage payments each year, despite the rising cost of living.
- The Australian bond yield curve returns to positive territory after inverting last week for the first time since the Global Financial Crisis, sparking fears of an imminent recession.
Global Cash Rates & Inflation
- The RBA Cash Rate is currently 4.1%, raised another 25bps in June to fight an inflation rate of 7% in the twelve months to March. The next RBA meeting is in two weeks on Tuesday July 4th.
- The BOE Cash Rate was hiked 50bps points to 5% on Thursday, as new CPI data showed sticky inflation, unchanged at 8.7%. The CPIH inflation indicator, however (including housing costs) rose 7.9% in the year to May, from 7.8% in the twelve months to April.
- The U.S. Federal Reserve cash rate (policy rate) is between 5-5.25% and inflation eased to 4%, as reported last Tuesday by the U.S. Bureau of Labor Statistics.
- The ECB Cash Rate (deposit facility) is at 3.5%, raised 25bps last week to fight an annual inflation rate of 6.1% in the twelve months to May.
Inflation Pressures Drive Rate Hikes
This week, the Bank of England (BOE) responded to sticky inflation with a surprise 50bps cash rate hike. Following Australia’s recent 25bps hike in early June, the UK, Australia, and many other advanced economies just cannot shake this high inflation.
CPI data for the UK drove the BOE’s decision to take the UK cash rate to 5%, as the rate of inflation stayed strong, recording an 8.7% average increase in prices in the year to April and the year to May. Some commentators are even suggesting that the UK cash rate could reach 6.25% by February 2024.
The Reserve Bank of Australia (RBA) is also on a mission to curb inflation by doing what is necessary to return inflation to target. In the minutes of the June monetary policy meeting released this week – where they hiked the cash rate to 4.1% – it was the upside risks (the risks of an increase) to inflation drove the RBA to their June decision, namely:
- Rising house prices – the mean price rose by $8,500 to $896,000 in the year to March
- A tight labour market – 76,000 people gained employment in May
- Rising wages – an increase of 5.75% for award wages and 15% for the aged care sector
- Lack of housing supply – new dwelling approvals fell 24.1% in the year to April
- Services inflation – the “primary source of inflationary pressures across advanced economies”
- Increased demand and strong population growth, mostly due to overseas migration
The RBA remains firm in their forecast that the cash rate will not be returned to target until at least mid-2025 and “reaffirmed their determination” to do “what is necessary to achieve that” target range.
NAB and Westpac took these minutes as a clear signal for more rate hikes, and now predict a 4.6% peak cash rate in August.
As Chief Economist of Westpac Bill Evans states, “As we saw at the June Board meeting, we expect that the July meeting will see these considerations of inflation risks again overriding concerns about the poor growth outlook.”
Australian and U.S. bond yields on the rise
As rising interest rates wreak havoc on equities markets and empty the pockets of Aussie homeowners, fixed-income investors are benefiting from the rise in returns.
According to the RBA, the rate hike contributed to a rise in Australian bond yields “by around 30 basis points over the prior month.” In fact, according the Australian Financial Review, over 25% of investors are confident that bonds will outperform equities this year.
Roy Keenan, the co-head of Australian Fixed Income at Yarra Capital Management, believes the yields are here to stay, “with cash rates going to 4.1%, and three-year bonds recently hitting a 12-year-high, it’s hard to see [the current levels of yield] not being sustained for the next 18 to 24 months.”
With a portfolio spanning 106 securities from 50 issuers, Keenan’s advice to achieve a diversified portfolio is to ensure that the risk taken is relative to the value received.
By investing a higher portion of his portfolio in lower-yield, higher value businesses, and a smaller amount in higher risk and higher yielding securities, Keenan explained to Livewire that his “goal is to get paid for the risk I’m taking.”
“If I’m not getting paid for risk,” he continued, “I won’t invest there.”
When ABE Co-founder Markus Mueller met with Keenan this week, fixed income was on the menu. “We haven’t seen yields like this in a long time,” said Mueller, “bonds are back!”
It’s the same story for our allies over in the U.S., says Luca Paolini, chief strategist at Pictet Asset Management. “For the first time ever the yield on cash, bonds and equities is the same,” she said. “If you are a US investor you should probably buy bonds because in risk-adjusted terms they give you more.”
850,000 Aussies Facing the Mortgage Cliff: From 2% to 6% Interest Rates
Despite commentary that portrayed the move as hawkish (an excessively strict approach to curbing inflation) the minutes released on Tuesday depicted a more balanced decision.
It seemed to be a much closer call for the RBA, as members considered the struggles of families financially, of renters in cities with low vacancy rates, and in particular the looming mortgage cliff.
The cliff, which entails over 850,000 Aussie fixed rate mortgage holders switching from interest rates of around 2% to variable rate mortgages of 6%, could see Aussies paying up to $15,000 more in interest each year.
“The large number of fixed-rate loans scheduled to expire over coming months would see financial conditions tighten further,” the minutes state.
“Based on increases in the cash rate to date, payments were projected to rise to the equivalent of around 10 per cent of household disposable income by the end of 2024.”
Recent Commonwealth Bank home loan data also confirms that for many of their customers, this fixed-rate mortgage cliff has already arrived.
What’s coming up next week:
- Next Wednesday, the Australian Monthly CPI Indicator will be released on the ABS here, which CBA will be reviewing in order to confirm their cash and interest rate forecasts
- Also on Wednesday the U.S. will release the CB Consumer Confidence Report for June here, which will give economists some insight into the impact of rising interest rates.
- Next Thursday the U.S. will also release the annualised change in GDP, the primary gauge of economic health, providing some more insight into the effects of rising rates and high inflation.
The information and data in this article are accurate as at 23.6.2023.
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