Australian Fixed Income – Dislocations and Potential Opportunity

To say the past year been a difficult year for Australian fixed income markets, would be a gross understatement. In fact, February was the worst single month on record for Australian Government bond performance.

For a sense of how challenging things have been, let’s look at two examples from the Australian Government Bond curve: the Australian 3-Year Government Bond Yield has increased from approximately 0.45% in July 2021 to approximately 3.55% as of 22, June 2022, and similarly, the Australian 10-Year Government Bond yield has increased from approximately 1.5% in July 2021 to approximately 4.00% as of 22, June 2022[1].

Australian 10-year Government Bond Yield (May 2021 – Present)

In this article, we’ll briefly review the factors that have driven Australian fixed income performance and why this difficult period may in fact be setting investors up for a more promising return profile in the months and years ahead. 

Factors Driving Australian Fixed Income Performance

While there a many fundamental and technical factors that contributed to last years fixed income returns, two elements stand out for their influence on the performance of the bond market over this period.  

These have been:

1. Inflationary pressure
2. RBA monetary policy related to COVID-19 stimulus

Persistent Inflationary pressure

Inflation and its persistence has been the biggest factor driving both Australian fixed income and global fixed income markets over the past year. Inflation began trending upward as the world emerged from lockdowns and the COVID stimulus began to be absorbed into the economy, but this was expected by many to be temporary.

Since the end of 2021, continued COVID lockdowns in China and the war between Russia and Ukraine have served to exacerbate the underlying inflationary pressure and force central bankers to adjust policy to defend price stability.

The Australian economy has not been immune from this pressure. May’s headline inflation figure represented the highest quarterly and annual increase in Australia since the introduction of the GST in 2000, breaking the 5% year-over-year level.

Australian Consumer Price Inflation YoY % Change (1996 – Present)

This pressure has forced the RBA to both raise the policy rate and forecast further increases to the bond markets.

Yield Curve Control Ends

The other factor that has contributed to the weak performance of fixed income markets was the RBA policy background in which we entered 2021. In 2020, in response to the economic challenges presented by COVID-19, the RBA instituted a “Yield Curve Control Policy”.

This policy targeted a 0.25% yield for three-year government bonds, meaning that the RBA would intervene in fixed income markets by purchasing bonds to try and achieve this level of in-market yields. For this reason, Australian government yields were low, especially by historical standards, just prior to the onset of global and domestic inflationary pressure.

Opportunity Ahead?

The past twelve months have been turbulent for bond markets and investors, so one could be forgiven for being gun-shy about adding to your fixed income allocation. To the contrary, however, the sell-off in the Australian fixed income market over the past year may instead have created substantial opportunity for investors.

This is because for bonds, just as for stocks, all else equal, a lower price and higher yield makes the investment opportunity incrementally more attractive. And, as already discussed, the yields on offer across the Australian government curve and in corporate bonds have all seen material increases over the past year.

Combine these higher yields with the potential for more balanced central bank policy, a more open approach to COVID in China and the even partial resolution of the war in Ukraine, and inventors and Australian fixed income could be both an outright attractive asset class and powerful diversifier. But of course, the world is uncertain, and even an attractive asset class should be integrated into an appropriately diversified portfolio that takes into account your willingness and ability to take risk. 

Building Diversified Portfolios – Understanding the Ingredients

At Partnervest, we create portfolios comprised of multiple index and fund products based on a careful analysis of the underlying exposures within. By doing this, we are able to craft portfolios that have asset allocations that are diversified based on the logic of fundamental risk exposures and correlations, rather than just the whims of market pricing dynamics.

Our online platform is designed to make it easy for you to allocate your cash to a portfolio of carefully selected investment products designed to harness the benefits of diversification, and specified to target risk and volatility levels. In a world of rising uncertainty and fast-moving markets, having a partner that can help you invest your wealth quickly, easily, and intelligently can make all the difference.

To learn more about how you can start building a sound financial future, visit our website at https://partnervest.com.au/.

[1] Source: Franklin Templeton, Morningstar

IMPORTANT INFORMATION

* You also need to maintain a balance of at least $2500 in your Cash Hub at all times.
All investments carry risk. Before deciding to invest, you should consider the following key risks:
• The value of investments will vary. You can lose money as well as make money.
• The level of returns will vary, and future returns will differ from past returns
• Returns are not guaranteed and investors may lose some or all of their money, and
• Laws change.

Important Information

Past performance is not an indicator of future returns. Issued by Partnervest, a division of Franklin Templeton Australia Limited (ABN 76 004 835 849, AFSL 240827).

Before making an investment decision you should read the relevant Product Disclosure Statement (PDS) carefully and you need to consider, with or without the assistance of a financial advisor, whether such an investment is appropriate in light of your particular investment needs, objectives and financial circumstances. The PDS is available and can be obtained by contacting Partnervest on 1800 679 541 or at www.partnervest.com.au.

The information in this presentation is of a general nature only and is not intended to be, and is not, a complete or definitive statement of the matters described in it. The information does not constitute specific investment advice and does not include recommendations on any particular securities. Franklin Templeton Australia Limited nor any of its related parties, guarantee the repayment of capital or performance of any of the Franklin Templeton trusts referred to in this document. Although statements of fact in this presentation have been obtained from and are based upon sources Franklin Templeton Australia Limited believe to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions and estimates included in this communication constitute our judgement as of the date of this communication and are subject to change without notice.