We are moving through an interesting period for fixed income markets. Despite the strong macro-economic backdrop and the rise in equities, bond yields have fallen over the past month – likely due to the softer inflation prints recently and dovish commentary from the European Central Bank and Bank of England. Australian yields have also fallen with 10-year bond yields falling back down to around 2.55 per cent per annum. The market appears to now be accepting that the next move in Australian cash rates is up once unemployment falls to around the low 5 per cent level (from around 5.5 per cent currently) – a level that the RBA considers to be full employment below which they believe that wages and inflation begin to accelerate.
I am cautious investing in both domestic and global fixed income at the moment as I expect bond yields to rise modestly in most of the major economies even if inflation remains below target levels set by most central banks. If this eventuates, you will see downward pressure of capital values. The general theme is one where central bankers want to normalise interest rates in an environment of solid economic growth so that they can have ammunition to cut interest rates if faced with another downturn. In addition, policymakers are concerned that the build-up of debt and rise in asset prices could create risks of financial instability down the track. Although, I am holding a modestly lower overall weighting in fixed income assets, it is mostly held in shorter dated fixed-rate assets rather than floating rate bonds given floating rate bonds provide much smaller portfolio diversification benefits in any risk-off scenario. In the short term I am using a mix of investment grade and high yield credit as they are still offering reasonable value given low default rates.
- This article does not take into account the investment objectives, financial situation or particular needs of any particular person. Accordingly, before acting on any advice contained in this article, you should assess whether it is appropriate in light of your own financial circumstances or contact your financial adviser.
The market appears to now be accepting that the next move in Australian cash rates is up once unemployment falls to around the low 5 per cent level.