Tim Hext: Inflation strengthens but government subsidies keep it in check | Pendal Group
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Tim Hext: Inflation strengthens but government subsidies keep it in check

Here’s our weekly Bond, Income and Defensive Strategies wrap from Pendal portfolio manager Tim Hext.

THE June Quarter CPI numbers were strong but largely as expected. Headline CPI was 0.8% for the quarter buy underlying was a more tepid 0.5%.

The number plays well into the Reserve Bank narrative that inflation is transitory — and helps it maintain a medium-term forecast of 2% annual inflation. Markets have spent the last month taking out rate hikes. If the RBA is right about inflation then rates are here for a long time to come.

But we are not in normal times and the task for statisticians is made difficult by numerous measurement issues.

How do you currently measure international flights or hotel accommodation? How do you measure rents when all kinds of deferrals are taking place?

The main impact comes from government subsidies. CPI is what consumers pay, not what a business charges. Of course normally they are the same thing but a myriad of subsidies means governments are footing part of the bill.

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For example Homebuilder might mean a builder is charging $500,000 for a new home but the consumer is only paying $475,000. In fact new dwelling costs in the CPI (8.5% of the index) have been negative this year despite actual prices going up almost 4%. 

State governments have also been busy subsidising utility bills, restaurant meals, movie tickets and a host of other items.

On our subsidy-adjusted estimate, underlying CPI is now more like 0.7% or around the annual RBA 2.5% target.

Eventually these of course come off but it will be more of an early 2022 story. We remain of the view higher inflation is coming, but it will be services rather than goods leading the way.

Nothing to see from the Fed

Chairman Powell managed to turn the latest Federal Open Market Committee meeting into a non-event, retaining a watching brief on how they may respond to stronger data down the track.

There is nothing to see here for now.

A combination of China wobbles and rising Covid cases kept bond markets generally bid on the week.

Real rates are now at record lows, driven by the weight of money but also growth pessimism. This feeds back into positive news for equities (what isn’t these days) despite being potentially concerning news for the economy.

Asset owners can relax because central banks have your back, and their “put” seems to be a trailing level on the way up.

The chart below shows how the market sees inflation as transitory in the US, with real yields falling to record lows last seen in 2020.

About Tim Hext and Pendal’s Income and Fixed Interest boutique

Tim Hext is a portfolio manager with Pendal’s Income and Fixed Interest team.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.

With the goal of building the most defensive line of funds in Australia, the team oversees A$22 billion invested across income, composite, pure alpha, global and Australian government strategies.

Find out more about Pendal’s Income and Fixed Interest strategies here


About Pendal Group

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

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