Fixed income strategist for APAC, Marie Tsang, believes that with rate cuts looming, investors may be entering a rare “sweet spot” before the cycle turns.
“The longer that cash is expected to stay higher, the more positive in terms of a return perspective for [floating] exposures,” she said.
"The best time to go is when the interest rates are peaking because you get the benefit of a very high yield, you also get a little bit of price return as the interest rates come off,” Tsang told InvestorDaily.
Tsang noted that fixed-rate bonds tend to reflect the interest rate environment more accurately.
“If rates are at 4 per cent and you’ve got a bond that issues with interest at 4 per cent, or a coupon that’s at 4 per cent … when your interest rates move down to say 3 per cent – where does that 1 per cent go? It gets reflected in the price ... the price goes up so new investors of those bonds will roughly get a 3 per cent return based on the cost price when they enter the market,” she said.
Currently, markets are pricing in a 44 per cent chance of a rate cut in November.
“Based on the data that’s available today, we feel like there should be one cut before the end of the year, but expectations, of course, evolve as more data comes out,” Tsang said.
State Street will be closely watching the upcoming quarterly inflation print on 29 October.
“That will give us a clearer inflation picture, especially since the decision to pause in September, inflation was a driving factor in that decision,” Tsang said.
Rather than being detrimental for bond investors, Tsang argued that the rate pause maintains the opportunity to invest at solid yields.
“If all else is equal, if the cash rate remains elevated for longer, what that means is that the yield level for those bonds will remain elevated.
“It extends that window of opportunity,” Tsang said.
She pointed out that inflation continues to erode real returns across all asset classes – including bonds.
“Australian bonds are generally priced to reflect a real rate of returns. That’ll take into account the local rates of inflation,” she said.
Tsang also noted diverging inflation dynamics between regions, highlighting the importance of local factors.
“With different inflation environments [in the US] you could potentially have a scenario where you’ve got higher inflation in Australia compared to what it is [in the US]. We’ve seen that playout ... it becomes a little bit more mismatched.”
Currency considerations are also key for Australian investors evaluating international exposure.
“If you leave your exposure unhedged, then you can leave yourself exposed to more volatility if you’re invested in overseas investments, because the Australian dollar can move against the overseas currency,” Tsang said.
“If you make a decision to hedge, more things are involved there. There could be a cost to the FX hedging. There could alternatively be a benefit, but that is something additional that investors have to take into account as well. Australian assets, especially bonds, reflect more the economic conditions of Australia thinking about things like inflation, but also thinking about things like currency as well."
As a result, State Street is seeing a renewed preference for domestic bonds.
“With the yields being where they are, they are quite attractive. When you look across the landscape, you look at some of the global bonds that are as highly rated as Australian bonds – sometimes the yields are not as high. This is before we consider what happens when you hedge the exposure. We do see a preference from investors for Australian bonds for that sort of simplicity. If you can get reasonable yields from your domestic market, why not?” she said.
In the current environment, domestic core bonds are offering a more compelling investment case, with Australian government bonds remaining a cornerstone of fixed income portfolios.
Tsang noted that Australian Commonwealth government bonds, rated AAA, are more attractive than many developed market sovereign bonds.
“A stable macroeconomic environment, benign inflation outlook and prudent management of government spending contributes to the rating of AAA,” Tsang told InvestorDaily.
She also pointed to strong fundamentals supporting domestic investment-grade corporate bonds.
“Solid fundamentals” – including robust profitability and low debt – make them generally “more attractive than many international peers”, she added.
While overseas bond markets offer scale, liquidity and diversification, Tsang warned of potential currency risks.
“This means the value of that investment can fluctuate significantly due to movements in the exchange rate between the Australian dollar and foreign currencies,” Tsang said.
With rates still near multi-year highs and credit fundamentals intact, Tsang believes local fixed income offers a balanced solution.
A well-balanced Australian bond exchange-traded fund could be a prudent allocation for those seeking income and portfolio resilience.
In a piece published earlier this year, Matthew Macreadie, executive director at Income Asset Management, predicted Australian bonds would outperform in 2025 – especially compared to their US counterparts, which he said may come under pressure from potential Donald Trump policies.
Macreadie also highlighted that the proposed phasing out of listed bank hybrids for retail investors has created new opportunities in the local bond market.
“With stable credit fundamentals and attractive income yields, Australian bonds stand out as a compelling option for investors seeking a balanced portfolio compared to US bonds, which face more risk from rising inflation,” he said.
