Rethinking Bonds: Why Fixed Income Should Be on Your Radar Today
The Reserve Bank of Australia (RBA) kept policy rates on hold at 4.35% in June, a level PIMCO believes to be materially tight. This tightness is evident in the percentage of household income allocated to mortgage payments, which has significantly slowed economic growth. The labour market is gradually loosening, wage growth is slowing, and first quarter GDP grew by just 0.1%, suggesting the economy is teetering on the edge of a recession. Over time, this tight policy should pull inflation back down to the RBA's target range and allow the RBA to begin its easing cycle.
The market is pricing in the first rate cut for next year, but we believe that waiting for that to happen before moving out of cash and into fixed income could mean missing out on potential gains. With the challenges bonds faced in 2022 still fresh in many investors' minds, it's essential to separate myths from reality and recognise the opportunities that bonds offer in the years ahead.
Global easing cycle has begun: Why waiting for the RBA to cut rates might not be prudent
Several central banks, including those in Canada, Europe, Sweden and Switzerland, have already started cutting rates, indicating that the global easing cycle has begun. When it comes to duration positioning or exposure to interest rates, at this point in the cycle PIMCO prefers economies where borrowers have been subject to floating-rate loans and there is a faster pass-through of tighter monetary policy. Sharp increases in policy rates mean these borrowers face rapidly increasing interest payments and this, in turn, directly impacts spending and activity across the broader economy. So we expect it is only a matter of time before countries like the UK, Australia and New Zealand also begin easing cycles.
However, investors waiting for the first RBA rate cut risk missing out on the period of strongest performance for bonds. Historical trends indicate that the most significant gains in fixed income markets often occur before, not after, interest rates have peaked (see chart).
Bond returns begin to outperform cash before cash rates peak
Hiking cycles are defined as periods where the Reserve Bank of Australia embarks on a sustained path of increasing the target cash rate. We define the end of a hiking cycle as the month where the RBA reaches its peak policy rate for that cycle (ie, it either pauses rate hikes or cuts). Hiking cycles include (start to peak) 2001 (Dec '98 to Jan '01), 2008 (Oct '01 to Aug '08), 2011 (Apr '09 to Oct '11), 2024 (Jun 22 to May 24). This chart includes data for the most recent hiking cycle, ending May 2024, for the periods -12 to -24mos prior to peak, defining May 2024 as the peak policy rate.
Starting yields matter: Why 2022 was an outlier for bonds
One of the most critical aspects of fixed income investing is the starting yield. The starting yield on your portfolio today is a strong indicator of the return you can expect on that portfolio over the next three to five years.
In 2022, starting yields were low, leading to less attractive returns. However, 2023 saw positive returns for bonds, reflecting the higher starting yields.
Looking at historical trends, 2022 was an anomaly in the bond market's history. With rates now having reset higher, expected returns going forward are also higher, presenting a compelling income proposition.
It’s worth noting that although the bond market has undergone this repricing with yields resetting higher, other asset classes have not yet followed. Equities are still near their highs, credit spreads remain reasonably tight, and commodities have been strong for some time. This makes bonds a compelling option for de-risking portfolios as the economy starts to slow.
Now is the time to lock in fixed income returns
The fixed income market today offers compelling opportunities for investors willing to look beyond recent volatility. Rather than basing bond return expectations on the anomalous experience of 2022, investors should consider 2023 bond returns as more reflective of performance when starting yields are already elevated.
The current environment offers a unique opportunity for bond investors to capitalise on higher yields and lower volatility, making fixed income a compelling choice for de-risking portfolios.
Find out more about how to access today’s attractive opportunities in bonds here.
Disclosures
IMPORTANT INFORMATION
Past performance is not a reliable indicator of future results. This publication is issued by PIMCO Australia Management Limited ABN 37 611 709 507, AFSL 487 505 of which PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246 862 is the investment manager (together PIMCO Australia). This publication has been distributed for informational purposes only. This publication has been prepared without taking into account the objectives, financial situation or needs of investors. Before making an investment decision investors should obtain professional advice and consider whether the information contained herein is appropriate having regard to their objectives, financial situation and needs. This publication may include economic and market commentaries based on proprietary research, which are for general information only. PIMCO Australia believes the information contained in this publication to be reliable, however its accuracy, reliability or completeness is not guaranteed. Any opinions or forecasts reflect the judgment and assumptions of PIMCO Australia on the basis of information at the date of publication and may later change without notice. These should not be taken as a recommendation of any particular security, strategy or investment product. All investments carry risk and may lose value. To the maximum extent permitted by law, PIMCO Australia and each of their directors, employees, agents, representatives and advisers disclaim all liability to any person for any loss arising, directly or indirectly, from the information in this publication. No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission of PIMCO Australia. PIMCO is a trademark of Allianz Asset Management of America LLC in the United States and throughout the world. © PIMCO, 2024.