Bond markets globally are set for broad-based outperformance, with the potential for monetary policy easings by central banks in the second half of 2024, however, Australian bonds are likely to underperform, according to Kellie Wood, Schroders head of fixed income.
“Bond markets are in a really good position to deliver strong returns to investors in absolute and relative terms in coming months,” Ms Wood said.
“We are seeing a broad-based slowdown in the global economy and the conditions for fixed income to deliver very strong returns are set in place; we’ve got moderating inflation, economic growth is slowing, and central banks globally are cutting interest rates,” Ms Wood said.
“That is exactly the environment where fixed income delivers not only very strong absolute returns, but also very good relative returns compared to other asset classes like cash and equities,” Ms Wood said.
However, Australian government bonds could underperform other bond markets given that Australia faces higher inflation than most other developed nations, according to Ms Wood.
“Australia has been the market we have been more cautious with inflation stickier and the RBA holding policy higher for longer. The Australian economy looks a little stagflationary, with core services inflation is still running at around 5 per cent, but we have seen economic growth starting to slow,” she said.
“That puts the Reserve Bank of Australia (RBA) in a difficult position because that is an environment where it can’t cut interest rates with inflation still too high. We think the Australian economy is about six months behind the US and the rest of the world, as we are still waiting for inflation to moderate.
“We do not expect the RBA to ease monetary policy this year unless we see a collapse in economic growth. We are more likely to see the RBA start to cut rates in 2025. Given this lag, that is an environment where we expect the Australian bond market to underperform bond markets in the US, Europe, the UK and Canada,” she said.
“The labour market also remains relatively tight, with much stronger jobs growth than had been expected. The market is now priced for the RBA to begin the easing cycle in Q4 2024.
“Our valuation and cyclical framework had us preferring credit over government bonds where we have seen very strong performance from Australian credit and mortgages both in the US and Australia.
“As the cycle progresses, we are likely to be leaning against valuations and the strong performance we have seen from credit markets and rotating into government bonds that have lagged. We have already started this transition, reducing exposure to expensive sectors such as US investment grade credit and high yield into US government bonds,” Ms Wood said.
