Tim Hext: How to position portfolios for a falling-rates environment

A gradual rate cut path over 2025 should support economic growth, meaning investors should think carefully about fixed-income positioning. Pendal’s Timothy Hext and ANZ’s Adam Boyton explain in a new webinar

Watch now, on demand: Preparing for rate cuts in a shifting global economy

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THE Australian economy is strongly placed as cost-of-living pressures recede and market expectations grow for a lower-rates environment – setting the stage for an economic rebound from last year’s tougher conditions.

That was the message from Pendal’s head of government bond strategies, Tim Hext, and ANZ’s head of Australian economics, Adam Boyton, at a Pendal webinar: How to prepare for rate cuts in a shifting global economy.

The webinar took place ahead of this week’s Reserve Bank meeting which is expected to start a rate-cutting cycle.

A second cut is expected within the next six months. But Hext and Boyton see the pace of interest rate reductions as gradual due to underlying economic strength.

“The economy isn’t necessarily screaming out for a rate cut the way you typically see when the Reserve Bank starts easing,” says Boyton.

ANZ expects a second 25-basis-point cut in August. Hext says it could come as soon as May.

“We’re looking for just those two rate cuts,” says Boyton.

“The reason being that the economy isn’t collapsing, there are signs of the consumer recovering, the labour market has performed remarkably well over the past 12 months … and inflation has eased more than expected.”

Labour market resilience and RBA caution

One factor behind the RBA’s cautious approach is the remarkable strength of the labour market.

“My best assessment is that full employment in Australia is probably between 3.75 and 4 per cent – so you’re close-ish to it. The most recent published thoughts from the RBA are a bit higher,” says Boyton.

Boyton says employment is being supported by jobs growth in health care, social assistance, public administration, and safety, and there is also evidence that the private sector is picking up as the stage 3 tax cuts wash through.

“This story of a resilient labour market is probably one that will play through for most of this year,” he continues.

“Either way, this is a really interesting cycle. We could end this economic cycle with the peak in the unemployment rate not very far at all away from full employment.

“To me, that says a couple of things – firstly, it’s great news for Australians.

“Secondly, it tells me that this is probably going to be a pretty cautious easing cycle from the Reserve Bank.

“If the unemployment rate is 5 per cent or 6 per cent you can cut much more aggressively, because you’re not going to be stoking inflation with a tight labour market.”

Falling inflation and household incomes

Further buoying the economic outlook is the fall in inflation itself – an often-overlooked factor in the economic outlook that plays an important role supporting household incomes and lifting consumer spending as real-wages improve.

“Inflation is an insidious tax on everyone – you go backwards, even if you get a wage increase, in a period of high inflation,” says Boyton.

“The fact that inflation has come down so much is really helpful for household incomes. Prices aren’t going back to where they were – but what it does mean is the wage increase you get this year isn’t going to be eroded by inflation. That will change the dynamic.”

Productivity challenges and Australia’s economic model

But while the near-term outlook is stable, Australia still faces longer-term headwinds, says Hext.

“We talk about the three Ps – population, productivity, and participation,” says Hext.

“Participation is looking good. Population is looking generally good, as it always does in Australia. But productivity has looked pretty bad for quite some time. It’s been going nowhere for almost a decade.”

Productivity means getting more output from existing resources and has been the key driver of economic growth from the industrial revolution to the IT boom of the 1990s, says Hext.

But the poor recent performance puts Australia in sharp contrast to the US economy, which has seen a very strong 10 per cent lift in productivity over the last seven years.

Hext says part of the explanation for Australia’s poor performance is a drift away from being a US-style, dynamic economy to a more government-centric, European-style economy.

“We’ve made some deliberate choices in the last five years in Australia – partly to strengthen our health care system, the NDIS, education. But there is a productivity cost to that which we’re now bearing the brunt of.

“We hear a lot about US exceptionalism – that term is used for very good reason.”

Investment implications

Hext says investors need to remember that when cash rates come down, floating rate investment returns come down – “it’s a mathematical formula”. That means lower returns on investments like term deposits and cash.

“But with bonds, you’re fixing your return – if you buy something with a yield of 6 per cent, you’re earning that 6 per cent for the life of that security. The comparison to me does look compelling.

“Would you be coming out of other asset classes, like growth assets, at this point in the cycle? I think it’s a bit early for that. Equities look to me quite fully valued, but I don’t see any major sort of trouble brewing there.”

He says bonds can also act as an insurance policy in a portfolio.

“The final thing you’ve got to remember is, as much as Adam and I sit here pontificating about the next 12 months, there’s going to be something coming from left field.

“And what bonds do, by locking in your return, is if there is a crisis that comes that none of us are seeing at the moment, that’s going to provide you insurance as your growth assets collapse.

“The way I like to say it is you’re almost getting free insurance and you’re getting a decent return.

“The two together is quite powerful.”

About Tim Hext and Pendal’s Income & Fixed Interest boutique

Timothy Hext is a portfolio manager and the head of government bond strategies in Pendal's Income & Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal's Income & Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

This article has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426. It is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. You should consider, with a financial adviser, whether the information is suitable for your circumstances.

The views expressed in this article are the opinions of the author as at the time of writing and do not constitute a recommendation to buy, sell, or hold any security. Any views expressed are subject to change at any time.?To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.