The recent sharp rise in bond rates may not be a big topic of conversation around the Sunday barbecue, but it has set pulses racing on financial markets amid talk of inflation and what that might mean for investors.
US 10-year government bond yields touched 1.61 per cent in early March after starting the year at 0.9 per cent.i Australian 10-year bonds followed suit, jumping from 0.97 per cent at the start of the year to a recent high of 1.81 per cent.ii
That may not seem like much, but to bond watchers it’s significant. Rates have since settled a little lower, but the market is still jittery.
Why are bond yields rising?
Bond yields have been rising due to concerns that global economic growth, and inflation, may bounce back faster and higher than previously expected.
While a return to more ‘normal’ business activity after the pandemic is a good thing, there are fears that massive government stimulus and central bank bond buying programs may reinflate national economies too quickly.
The risk of inflation
Despite short-term interest rates languishing close to zero, a sharp rise in long-term interest rates indicates investors are readjusting their expectations of future inflation. Australia’s inflation rate currently sits at 0.9 per cent, half the long bond yield.
To quash inflation fears, Reserve Bank of Australia (RBA) Governor Philip Lowe recently repeated his intention to keep interest rates low until 2024. The RBA cut official rates to a record low of 0.1 per cent last year and launched a $200 billion program to buy government bonds with the aim of keeping yields on these bonds at record lows.iii
Governor Lowe said inflation (currently 0.9 per cent) would not be anywhere near the RBA’s target of between 2 and 3 per cent until annual wages growth rises above 3 per cent from 1.4 per cent now. This would require unemployment falling closer to 4 per cent from the current 6.4 per cent.
In other words, there’s some arm wrestling going on between central banks and the market over whose view of inflation and interest rates will prevail, with no clear winner.
What does this mean for investors?
Bond prices have been falling because investors are concerned that rising inflation will erode the value of the yields on their existing bond holdings, so they sell.
For income investors, falling bond prices could mean capital losses as the value of their existing bond holdings is eroded by rising rates, but healthier income in future.
The prospect of higher interest rates also has implications for other investments.
Shares shaken but not stirred
In recent years, low interest rates have sent investors flocking to shares for their dividend yields and capital growth. In 2020, US shares led the charge with the tech-heavy Nasdaq index up 43.6%.iv
It’s these high growth stocks that are most sensitive to rate change. As the debate over inflation raged, the so-called FAANG stocks – Facebook, Amazon, Apple, Netflix and Google – fell nearly 17 per cent from mid to late February and remain volatile.v
That doesn’t mean all shares are vulnerable. Instead, market analysts expect a shift to ‘value’ stocks. These include traditional industrial companies and banks which were sold off during the pandemic but stand to gain from economic recovery.
Property market resilient
Against expectations, the Australian residential property market has also performed strongly despite the pandemic, fuelled by low interest rates.
National housing values rose 4 per cent in the year to February, while total returns including rental yields rose 7.6 per cent. But averages hide a patchy performance, with Darwin leading the pack (up 13.8 per cent) and Melbourne dragging up the rear (down 1.3 per cent).vi
There are concerns that ultra-low interest rates risk fuelling a house price bubble and worsening housing affordability. In answer to these fears, Governor Lowe said he was prepared to tighten lending standards quickly if the market gets out of hand.
Only time will tell who wins the tussle between those who think inflation is a threat and those who think it’s under control. As always, patient investors with a well-diversified portfolio are best placed to weather any short-term market fluctuations.
If you would like to discuss your overall investment strategy, give us a call.
i Trading economics, viewed 11 March 2021, https://tradingeconomics.com/united-states/government-bond-yield
ii Trading economics, viewed 11 March 2021, https://tradingeconomics.com/australia/government-bond-yield
The vaccine rollout continues, restrictions ease, and life is a little closer to normal despite occasional setbacks. There was a raft of positive economic news in March, which should make the Federal Treasurer’s job a little easier when he hands down the Budget on May 11. The Australian economy staged a remarkable V-shaped recovery in 2020, growing 3.1% in the December quarter and 3.4% the previous quarter – the biggest 6-month lift on record – after plunging into recession last calendar year. The contributor to the Federal budget was iron ore, which has doubled in price since March last year.
The NAB Business Confidence Index rose to an 11-year high of +16.4 points in February while the ANZ-Roy Morgan Consumer Confidence rating hit a 7-year high of 124 points in March, up 30% over the year. Confidence is widespread at present as reflected in a recent surge in new vehicle sales, housing construction and property values. It was also boosted by a fall in unemployment from 6.4% to a 13-month low of 5.8% in February. Additionally, Job ads in March have reached a 12 year high. Company profits have remained strong, with 86% of ASX200 companies reporting a profit in the December half-year. Although aggregate earnings fell 17%, dividends were up 5% compared to a year ago with an estimated $26 billion currently flowing to shareholders.
The sugar hit has done its job as it has passed through the system leaving us well placed. Sustaining momentum as the virus and our response evolves will be trickier. We expect the road ahead will be rocky from time to time.
Returns for the Financial Year to date (9 months) are below:
All Ordinaries: 7017, up 1016 points or +16.9%;
Listed Property Accumulation Index 55391, up 9767 or +21.4%;
90 Day Bank Bills 0.034%, down 35%;
AUD vs U.S. Dollar 0.76c, up 6.9 cents or 9.92%;
UK FTSE 100 6,713 points, up 543 points or 8.82%;
Dow Jones Industrial Avg, 32,981 points, up 7,783 points or 28.86%
2021 is shaping up to be a much more positive year than 2020 in so many ways. For people who put holiday plans on hold or those with itchy feet because they haven’t had much of a break for a while, this year is the year to get out and about.
While overseas jaunts are off the table for some time to come, Australia’s management of the pandemic means we are able to head off and explore the local sights, while helping local communities and industries hit hard by 2020.
Recently the Australian Government announced their latest stimulus package for these industries, with $1.2 billion allocated to help our domestic tourism and aviation sectors.i
From 1 April 2021, there will be 800,000 half-priced flights available to 13 key regions which includes the Gold Coast, Cairns, the Whitsundays and Mackay region, the Sunshine Coast, Lasseter and Alice Springs, Launceston, Devonport and Burnie, Broome, Avalon, Merimbula and Kangaroo Island.
It’s also worth keeping your eye out for state run initiatives in the form of travel voucher schemes. While the amounts offered and conditions vary from state to state, they generally enable you to wine, dine or stay the night in a location with part of your bill subsidised.
The importance of R&R
There’s nothing like a holiday to help us feel more relaxed and give us a break from our everyday lives, something we very much need after the year that was.
We know that having a break, whether it be from work or just our regular routines, tends to improve our wellbeing. It can offer a circuit breaker from some of your stressors, give you a new perspective as you take in new surroundings, lighten your mood as you do things you enjoy, give you a chance to spend some quality time with loved ones and simply recharge your batteries by sleeping in and taking it easy.
Perhaps you had to cancel that trip to Paris or have to let go the idea of relaxing on a beach in Bali. Fortunately, we are spoiled for choice when it comes to travelling in Australia, whether it’s a beach holiday you are after, a hike in the mountains, a trip to the snow, a tour of the outback or a foray into a rainforest. We are blessed with a myriad of natural wonders as well as vibrant cities with world class restaurants, attractions and nightlife. Not only will you have a wonderful time, you can also feel good about supporting businesses who need a hand getting back on their feet.
While it can seem like a distant memory due to the COVID-19 outbreak, 2020 was also a hard time for many Australians due to the bushfires that ravaged many parts of the country. As a result, the locations affected are needing to rebuild and welcome tourists back, so why not give them a visit.
Planning your trip
Whether you take advantage of the flight specials or instead travel by bus, train or car, seeing another part of the country will give you something to look forward to.
While we may have become nervous about forward planning due to the uncertainty of 2020, being organised will enable you to make the most of travel deals and plan your itinerary so you can fit in everything you want to do.
If you’re concerned about travelling at the present time, why not take the road less travelled and head to a private spot (perhaps an Airbnb rather than a busy hotel) in a destination that isn’t as well-known. By avoiding popular travel periods such as the school holidays, you will also avoid the crowds.
Wherever you travel in Australia, whether it’s to the other side of the country or just down the road, we hope you enjoy your well-deserved break and are able to recharge your batteries for what is shaping up to be an exciting year ahead.