Tim Hext: What job and inflation numbers mean for investors

Portfolio manager Timothy Hext from Pendal's Bond, Income and Defensive Strategies team.

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

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THIS week we saw strong economic numbers — here and in the US — turbo-charged by fiscal stimulus.

Australia’s May employment update reported 115,000 new jobs created, including 97,000 full-time. Jobs are now 1% higher than before the pandemic.

Unemployment fell from 5.5% to 5.1% despite a rise in participation. Importantly underemployment (part-time workers looking for full time hours) fell to 7.4%. This level was last seen in January 2014.

Underemployment has had a stronger correlation to wages in recent times so it lifts the chances of decent wage gains.

On the topic of wages the Fair Work Commission this week passed down a 2.5% increase to the minimum wage —from $19.84 an hour to $20.33 an hour.

This affects about 2.2 million workers. They must have gotten the decision about right as employer groups and unions seemed as unhappy as each other. There was a tip of the hat to Covid impacts with delays on the increase until November for some industries.

The pace of the recovery continues to catch the RBA by surprise.

In February the Reserve forecast unemployment to reach 5.25% by June 2023. Given an opportunity for revision in May they predicted 5% by December 2021. They effectively reached it in the same month as the re-rating.

While forecasts are playing catch up the RBA seems more than happy to leave the narrative way behind. In a speech this week From Recovery to Expansion, Governor Philip Lowe noted the improvements but held the line that “inflation pressures remain subdued and are likely to remain so”.

Time will tell, but after hearing the central bank tell me consistently for 30 years that inflation has a long lag to activity it’s hard to see how today’s low inflation is a good predictor of inflation a year from now.

Pendal named 2020 Fund Manager of the Year in Zenith Awards.

Strong US inflation numbers

Late last week the US printed another series of strong inflation numbers.

Year on year CPI is now 5% and 3.8% ex food and energy. There are some base effects from this time last year but the moves were broad-based and finally seemed to catch the Feds’ attention.

The previous set of numbers brought out a round of Federal Reserve speakers talking about “transitory” inflation.

This time the Fed seemed to be paying attention.

In a press conference Fed chairman Jerome Powell said: “as the reopening continues, shifts in demand can be large and rapid, and bottlenecks, hiring difficulties and other constraints could continue to limit how quickly supply can adjust, raising the possibility that inflation could turn out to higher and more persistent than we expect”.

To paraphrase, as we said earlier “transitory” will be measured in years, not months.

Markets were quick to price in earlier rate hikes in the US, helped by the Fed dots predicting earlier hikes.

Terminal rates were less affected as the yield curve flattened. It seems the Fed narrative has changed from being way behind the curve to maybe keeping up with it — limiting the chance of a major policy mistake unleashing longer-term inflation.

For now the US dollar is rallying because it seems the Fed may be well ahead of the rest of the world in tightening. Only New Zealand might beat them to it in the developed world.

The RBA has a chance for a reset in early July, although the capping of Yield Curve Control at April 2024 now seems a foregone conclusion.

Overall it is negative for bonds, but February saw the major re-rating and the surprise factor is diminishing.

We expect rates to gradually climb while not moving higher than what we saw in late February.

 

 

Tim Hext is a portfolio manager with Pendal’s Bond, Income and Defensive Strategies (BIDS) team.

Led by Vimal Gor, Pendal’s BIDS 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.

The team oversees $22 billion invested across income, composite, pure alpha, global and Australian government strategies with the goal of building Australia’s most defensive line of funds.

Find out more about Pendal’s fixed interest strategies here

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