THE Reserve Bank of Australia held its final 2021 board meeting this week, sticking to its view that a rise in the official cash rate is some time away.
But there’s enough in the RBA commentary, and the response of financial markets in recent months, for investors to consider cash and short-term fixed income assets, says Steve Campbell, head of cash strategies at Pendal Group.
And the credit market is creating opportunities.
“Margins are moving wider on credit securities. For those worried about the rising interest rate environment, we are starting to get higher margins through longer-dated credit securities.
“Enhanced cash products benefit from that type of environment. You are getting better returns without taking more interest rate risk on.
“If you think we’re in for a more benign economic recovery, and too much upside has already been priced in, then shorter-dated bonds can rally from here even though we are looking at an environment where cash rates will eventually move higher,” Campbell says. “There are too many hikes priced in here over the next two years.
“There’s a fair amount of shape coming into the shorter part of the curve and bonds can provide defensiveness for investors who want to look at short-dated cash funds and bond funds.
“They can provide a degree of protection that we didn’t see at the beginning of 2021.”
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For cash and short-term securities investors, the Reserve Bank commented this week that it would keep a watch on what was happening overseas.
“We’ve had the Federal Reserve in November starting to taper the purchase of Treasuries and agencies,” Campbell says. “And we expect that could go further in December. “
The Fed has also noted greater concerns around inflation.
“That could mean rate rises happening in the US sooner rather than later,” Campbell says.
“The Bank of Canada is looking at lifting interest rates early next year. The Reserve Bank of New Zealand has already hiked by 50 basis points. It’s a situation where a rising tide might lift all boats,” Campbell says.
There’s a risk that if the Reserve Bank of Australia decides to stay on hold and be one of the last central banks to move, it may have to eventually lift rates more quickly.
“They may have to play catch up, and hit the brakes harder,” Campbell says.
Another factor affecting the bond market is the cessation of the Reserve Bank’s term funding facility for the banks, which ended in June.
As lenders start to replace the facility with longer-dated debt, the cost of accessing funds will be higher.
“Where they were accessing funding at 10 basis points, a major bank issuing five-year debt would be paying closer to 65 to 70 basis points over swap currently.
“That’s a lot more expensive so it’s not unreasonable to expect that both variable and fixed rate mortgages will move higher.
“When that happens, the market will be doing some of the Reserve Bank’s work for it.
“Also, we have a bond purchase program going on. That expires in February. The next big decision is whether the Reserve Bank extends the program or just calls time on it.”
Steve Campbell is Pendal’s head of cash strategies. With a background in cash and dealing, Steve brings more than 20 years of financial markets experience to our institutional managed cash portfolio.
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Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.
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