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Ongoing demand is blunting the impact of higher rates, argues Oliver Ge, an assistant PM with Pendal’s income and fixed interest team.
“When households are in decent shape, as they are today – when you have wages growth at decade highs, unemployment near record lows, and savings plentiful – you end up with an environment where people are much less sensitive to price changes,” he says.
“As a central banker you see inflation rising and your natural instinct is to raise rates. But the usual transmission mechanism is broken.”
Higher interest rates will eventually impact, but they’re not working just now, argues Oliver.
He believes there could be a breaking point mid-next year, leading to a reversal from the RBA.
That could make bonds even better value than they are today, he says.
The United Arab Emirates was hit badly by Covid, reporting more cases compared to its neighbouring Arabian gulf states.
That caused a drop in tourism, subdued real estate and higher unemployment.
But it’s since made a powerful recovery and undergone structural reforms that make it more attractive to emerging markets investors.
“The significance of the structural reforms has been underestimated,” argues James Syme, a senior PM from Pendal’s EM team.
Foreign nationals can now live and work in the UAE for a decade and buy property there.
Other reforms have developed Abu Dhabi and Dubai into financial centres. In 2022, the region hosted roughly a quarter of all global IPO volume.
“After taking a thorough look at the UAE’s recovering tourism, trade and oil sectors in the context of deep structural reforms, we moved our position to overweight,” says James.
After the GFC, investors generally had to chase greater risk to achieve targeted returns.
A lack of fiscal support from overly austere governments meant monetary policy had to take up the slack via non-conventional tools such as quantitative easing, says Pendal multi-asset PM Alan Polley.
“The resulting wall of money increased valuations, decreased prospective returns and risked asset bubbles,” says Alan. “But that’s now unwinding.”
Post-pandemic governments have realised monetary policy is out of bullets and fiscal policy needs to fire up again, he says.
“The transition to fiscal policy is good for investment returns, because governments will now do some of the work to bolster aggregate demand.
“There’s decent prospective returns for equities and bonds, and that now makes balanced funds more attractive.”
The Reserve Bank has revised its end-of-year inflation forecast to 4.5% – where it was in May. Are they right?
Pendal’s income and fixed interest team expects Q4 inflation between 0.7% and 0.8%, meaning the annual figure would be closer to 4.2%.
“If we’re right, then the November rate hike wasn’t needed,” says head of bond strategies Tim Hext.
“More importantly, this makes the chance of a February hike very low.
“Beyond February, inflation should remain sticky around 0.8% to 0.9% a quarter, meaning rate cuts are off the table for most of 2024.”
Pendal roughly agrees with the RBA’s expectation of a 3.6% number by mid-2024.
“By the middle of next year, US rate cuts may well be on the table, helping bonds find more support.”
In Australia, all eyes will be on Santa’s stocking to see the impact of the pre-Christmas hike.
Bond yields remain attractive on a medium-term basis, says Tim.
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