GLOBAL fixed income markets have been marching to a common theme lately.
Inflation data have been on an upward trend and there seems to be consensus that inflation will climb higher still.
Market pricing for rate rises from major central banks is outpacing what the policy makers themselves are saying.
Inflation will be going higher over the next couple of quarters. That theme is global since the driving forces behind the trend are global.
Supply chain disruptions coupled with higher goods demand have affected us all. As lockdowns lift and consumption normalises, there will be a handover from goods inflation to services inflation.
There is an assumption that rising wage pressures will be an equally global theme.
That is not the case. As RBA Assistant Governor Lucy Ellis pointed out this week, market fixation with labour market patterns offshore is leading to an overly optimistic outlook for wage developments in Australia.
Labour force participation rates in the US have been slow to recover since the depths of the pandemic. That same degree of sluggish return to work need not apply to Australia.
Initiatives such as JobKeeper have been instrumental in maintaining a link between employers and workers.
In the US, the fiscal response was aimed at generous unemployment benefits. So generous at first, in fact, that many workers chose to quit their jobs so they could access a better income stream.
Find out about
Pendal’s Income and Fixed Interest funds
Another difference is the health policy response in handling the pandemic.
In the US, despite attempts at various lockdown measures, Covid has unfortunately run rampant in the community. In Australia, a zero-Covid strategy until very recently has produced a far better population health outcome.
While the US vaccination rate seems to have stalled around the 60% mark, Australia’s vaccination rates continue to climb. New South Wales passed 92% this week.
For the US, this translates to slower re-entry into the labour force by workers who are still legitimately fearful of contracting the virus.
The resulting picture differs for wage pressures in Australia and the US.
Sure, both central banks are willing to let things run hotter for longer. But the heat is far more intense in the US.
Nevertheless, the market prices a matched pace of rate hikes for Australia and the US in 2022. Either the Fed will need outpace the market, or the RBA will prove the market wrong.
Likely driven by the fear of rate hikes translating into higher refinancing rates next year, the pace of corporate issuance has been heavy so far this month, especially offshore.
European and US credit markets have seen higher-than-typical new issuance volumes in the past two weeks.
Despite continued inflows into both sectors, the supply deluge has been weighing on credit spreads — and hence the secondary market performance of many of these new deals.
In Australia the new issue pipeline has also been solid — about $3.5 billion of benchmark deals hit the market this week.
Issuers have ranged from utilities and banks to commercial and industrial real estate investment companies.
Contrary to the offshore credit climate, however, demand appetite remains very robust in Australia. Most deals have been able to price at the tighter end of price guidance and perform well in the secondary market.
The higher yield environment would usually be a particular headache for emerging markets, especially accompanied by a climbing greenback and slowing China.
On the whole, emerging market hard currency sovereign debt has been resilient in the face of yield climbs so far this month, with yield-related widening in spreads broadly in line with global high yield.
This is because most emerging market central banks have been proactive and keenly aware of inflation pressures.
They have no desires to invite an ugly currency-inflation spiral. Moreover, the global economy is still in good shape, in spite of China’s property-driven slow-down.
The key driver of volatility for emerging market sovereign risk has been the volatility in Turkey and in particular around the currency.
This volatility stems from the Turkish’s president’s unorthodox views on the relationship between inflation and interest rates — and hence the high turnover of the leadership of the Turkish central bank.
A noteworthy improvement now versus the last Lira crisis in 2018 is the composition of the country’s external debt rollover risk.
A lot of the maturing debt is held by the government or institutions that have historically exhibited high roll-over rates even in times of crisis.
Our portfolios currently have no exposure to the Turkish Lira — or any other high-beta local emerging market risk.
Our income strategies employ a tactical allocation to the USD emerging market sovereign index. Turkey is a component of that.
We expect political developments in Turkey to continue punctuating sovereign credit spreads with bouts of volatility, but current market pricing is also compensating investors for that volatility.
Our exposure remains highly liquid and our investment process tunes into left-tail risks.
These are aspects of our investment philosophy that will help us to de-risk promptly and efficiently out of emerging markets when warranted.
Amy is Pendal’s Head of Income Strategies. She has extensive experience and expertise in emerging markets, global high yield and investment grade credit and holds an honours degree in economics from Cambridge University.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2021 the team won Lonsec’s Active Fixed Income Fund of the Year Award. In 2020 they won the Australian Fixed Interest category in the Zenith awards.
The team oversees A$22 billion invested across income, composite, pure alpha, global and Australian government strategies.Find out more about Pendal’s fixed interest strategies here
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at November 25, 2021.
PFSL is the responsible entity and issuer of units in the Pendal Monthly Income Plus Fund (ARSN: 137 707 996) and Pendal Dynamic Income Fund (ARSN: 622 750 734) (Funds). A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund.
An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested.
This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation.
The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information.
Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance.
Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections.
For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com