Forget the RBA moves, Australia offering compelling bond yields

PIMCO believes the Australian bond market is already offering compelling yields to investors regardless of the next action of the Reserve Bank of Australia (RBA).

The fund management giant believes policy rates between 4 per cent and 4.5 per cent in Australia are adequate to decelerate the economy, with rates currently sitting at 4.35 per cent. 

Any future rate cuts will hinge on economic tailwinds from population growth, the impact on housing market dynamics and headwinds from China’s growth trajectory.

Australia is one of the markets where the firm has its highest conviction as a result of its favourable floating-rate mortgage environment, alongside the UK. Another reason is the desire to look beyond the US, where a rate cut is expected mid-year, to those markets which are offering attractive relative value opportunities, PIMCO said.

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“Despite its relative resilience, the US economy is gradually cooling and following its 20 March meeting, the Fed conveyed clear signs that a rate cut is still likely mid-year. Given these conditions, we see bond markets outside the US representing attractive relative value opportunities. Some of our highest conviction positions are being underweight to Japan, while favouring floating-rate mortgage environments like the UK and Australia.”

Robert Mead, co-head of Asia-Pacific portfolio management, said there are four areas which specifically make Australian bonds attractive regardless of the interest rate path. These areas are as follows: 

• Starting yields are a reliable predictor of expected bond returns. Bonds faced a tough year in 2022, but this was an outlier in the broader context of market history. Investors should base their return expectations for 2024 on the positive 5–7 per cent that core bonds delivered in 2023, rather than dwell on the rare underperformance of 2022.
• The investment grade credit market is thriving, characterised by strong primary issuance levels and an increasingly diversified issuer base, with yields regularly exceeding 6 per cent.
• Bonds are expected to continue to play their role as a diversifier in portfolios, with correlations remaining low, or even negative, to riskier assets.
• The cost of de-risking from equities to bonds is low. Investors aren’t transitioning from an asset class with double-digit returns to one with zero returns. Instead, they are moving from an asset class with potential double-digit growth to one that could deliver high single-digit returns.

However, the firm noted it is important for investors to remain agile with their portfolio construction and ready to capitalise on actions of central banks locally and globally.

Looking at central banks globally, Mead said the repricing in interest rates is “largely complete” and he expected new opportunities to be presented for active managers.