Market review

After an early June rally, a post Consumer Price Index (CPI) selloff in the local bond market saw diverging yields across the curve. The Australian bond market, as measured by the Bloomberg AusBond Composite 0+ Yr Index, rose 0.77%.

The outlook remains complex, amid a myriad of competing pressures in the economy and from geopolitical and structural pressures.

Bond markets rallied over the first half of June, giving most of it back through the second. This was due to continued evolution of central bank easing cycle expectations, and inflation outcomes. Australian three-year government bond yields ended the month 3 basis points (bps) higher at 4.08%, while 10-year government bond yields were 10bps lower at 4.31%. Against the current cash target rate of 4.35%, three-month bank bills ended 10bps higher at 4.45%. Six-month bank bill yields ended 13bps higher at 4.74%.

The commentary for June could almost mirror that of May, with an early rally and late sell-off. Broad global influences continue to be a driver, amid cyclical uncertainty. The European Central Bank, the first of the major global banks, lowered interest rates 25bps, cementing the global easing cycle. A weak US leading indicator, the Institute of Supply Manager’s purchasing manager index (PMI), was also a factor in markets pricing a broader slowdown. However, there were tones of the late 2022 UK debt sell-off, as France declared a snap election, and markets fretted about fiscal profligacy in an already bulging debt environment. This raised yields and highlighted the high debt levels in some advanced economies that will have to be addressed in coming years. The US Federal Reserve have yet to lower interest rates and their cycle may be pushed out after the recent meeting erased hopes of very near-term cuts. There are signs of a weaker US economy, but it is a gradual slowing.

The June Reserve Bank of Australia (RBA) meeting highlighted risks to the outlook centre on inflation, and the RBA are particularly sensitive to upside risks. Cementing this risk was an unexpectedly high May monthly CPI print, raising the potential for a late cycle interest rate hike before the RBA can ease the pressure in 2025. The still solid headline employment data re-iterates these risks. However, weak forward looking employment data, such as job advertisements alongside very poor consumer sentiment, declining business confidence and deteriorating domestic PMIs suggest that real economic growth is slowing.

The months-long global credit rally took a pause as investors re-focused on valuations against a backdrop of slowing growth, stubborn inflation, complex macroeconomic settings and new political risks emanating from France and the UK. Domestically, post a period of exceptionally high new issuance activity across credit sub-sectors, primary markets wound down ahead of the financial year end.

The Australian iTraxx Index ended 6bps wider at 71bps, while the Australian fixed and floating credit indices returned +0.44% and +0.41% respectively.

Market outlook

The outlook remains complex, amid a myriad of competing pressures in the economy and from geopolitical and structural pressures. The Australian economy is slowing gently, and while no recession is forecast, the pressure of higher interest rates is expected to continue to broaden out across sectors of the economy. This is occurring whilst inflation remains sticky and a continued risk to the economy. The RBA needs to balance these risks along their so-called narrow path. An extended period of policy at restrictive levels will further slow growth, rebalance the labour market and subdue inflation over time. The global economic backdrop is slowing, but a growing number of geopolitical and structural concerns, such as elections and government debt concerns, raise market volatility risks.

Our base case is for the RBA to remain on hold at current rates before commencing an easing cycle in Q1 2025. We price a more modest than the historically average easing cycle, of around 175bps, spread over an extended period. There are a myriad of risks to the base case at this stage, with the high case of a late cycle hike in H2 2024, and a slow cycle easing through to 2026. The risks have skewed to this case in the last month. There is a low case of a modestly earlier commencement, which finishes with slightly more easing over the whole cycle.

The market is currently only pricing a low in the cash rate of 4% in 2026, which is still elevated above the RBA’s cyclical neutral rate. We see this as underestimating the risks to the economy after an extended period of policy tightness. We currently consider the Australian yield curve as under-valued at points in the curve. We hold a long duration position and look to adjust it on significant market moves.

In recognition of the complex investment environment, our credit strategy remains skewed towards high-quality, investment grade issuers with resilient business models, solid earnings power, and conservative balance sheets. Conversely, we are avoiding lower credit quality and leveraged sectors where default stress is increasing. While we acknowledge that credit spreads in general are tight, all-in yields, particularly in very low default-risk Australian Investment Grade credit, remain reasonably attractive. We continue to actively and selectively take advantage of these yields in highly-rated corporate bonds and structured credit in both primary and secondary markets, where risk adjusted returns make sense.

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