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TIM HEXT: Goods prices are peaking but services have a way to go

The RBA’s path back to neutral cash rates this year is on track. The bigger story for long bonds is the US path to potential recession, writes our head of government bonds Tim Hext

UNTIL next year we remain stuck with quarterly Consumer Price Index numbers, meaning they carry huge importance.

(The ABS is planning a monthly CPI indicator — but for now the quarterly data is more important than ever.)

Wednesday’s June quarter CPI numbers landed almost on expectation, bucking the recent global trend of upside surprises.

That doesn’t mean the number wasn’t high — rather it was already factored in, even generating relief that it wasn’t worse.

Headline CPI for Q2 was 1.8%, meaning 6.1% annual.

Underlying inflation (the average rate after trimming away the highest and lowest 15%) was 1.5% or 4.9% annual.

Under the hood there was decent dispersion.

Food prices were up 1.45% — but given the stories and input prices this was a low result. We expected above 2%.

Commodity prices have eased in the past month so the worst of food price inflation — perhaps some vegetables excepted — may not eventuate for now.

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Pendal’s Income and Fixed Interest funds

Housing inflation remains buoyant  (2.5% q/q)  due to the cost of building new homes. Rents remain benign despite mounting signs they are moving higher.

A rare sighting of inflation in clothing and footwear (up 3.5% q/q) and furnishings (up 2.5% q/q) plays into the theme of higher goods prices.

Service prices to rise

We expect goods price inflation to be peaking, but service inflation to pick up in the year ahead.

Services remain contained for now. Health and education costs tend to be seasonal but overall are running closer to 3% than 6% annually.

Labour costs are moving higher. Skilled migration is picking up but it won’t be enough to stop cost-push inflation.

The move lower in goods prices may lead to some short-term easing of concerns overall, but we remain wary of current market pricing.

Expected inflation levels are back below 2.5% beyond 2023.

Inflation bonds are cheap and investors should consider picking them up around these levels as insurance for a decade of higher inflation.

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What it means for investors

The monetary policy implications of this CPI number are not large.

The RBA will be happy its current path and pace back to neutral cash rates this year (2.5% to 3%) seems about right.

The market is still expecting more (3.25% to 3.5%) than the RBA thinks it will have to deliver this year, so there is the chance for a small rally in rates.

The bigger story for long bonds remains the US path to potential recession.

We get a Fed rates update and US GDP number shortly, so on we move.

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

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

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.

Find out more about Pendal’s 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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This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at July 27, 2022. 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

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