Fixed income: the likely impact of rates, inflation and a Trump presidency

Pendal

July 2024

THE services side of the economy - particularly wages and rental inflation - have held up prices in recent times.

But forward indicators monitored by Pendal's income and fixed interest team show the drivers of these two factors weakening.

That means inflation in developed markets should continue to fall, allowing central banks globally to start cutting rates, argues Pendal's head of credit and sustainable strategies, George Bishay.

"That means central banks globally can start cutting rates," he says.

"My view is that central banks will cut rates because inflation is coming down -- not because we are going into recession."

It's an important distinction, because when an economy goes into recession, bonds usually perform well, while credit and equity markets can underperform.

"If inflation is falls, that's a bullish environment for bonds as central banks will cut cash rates and interest rates in general should come down.

"This is also bullish for credit and equity markets."

What a Trump White House means

The key risks to this view is if oil prices rise or if Donald Trump beats presumptive Democratic nominee Kamala Harris in the US presidential election later in the year, Bishay says.

"If Trump wins the election, will he have the ability to change policy? Will he have a majority in both houses of Congress? 

"If he does, then that's problematic for bonds because ultimately that's likely to be inflationary," Bishay says, nominating tax, immigration and trade as key areas of policy to watch.

The impact of a Trump Presidency is more skewed towards longer-term bonds because his policies would likely have a medium-term impact on inflation, he says.

"The short end continues to perform because central banks will be easing rates as current inflation comes down."

Active management remains important for fixed income

With so much uncertainty in the market, active management of credit portfolios is critical.

"Most credit managers in Australia are buy-and-hold managers. In periods such as Covid, performance of those strategies can get hammered before eventually recovering.

"Volatility of their returns can be quite high.

"We prefer to actively de-risk and re-risk our credit exposures, based on a top-down process.

"If we have concerns about the macro environment, we will reduce risk across the board on credit exposures. That tends to support outperformance because it minimises downside risk.

"When we have more confidence in the market, we re-risk and participate in the upside benefit."

The three main pillars of Pendal's top-down process are a qualitative view, quantitative models and technical analysis.

"When the three pillars line up, we de-risk or re-risk the portfolios and that's been incredibly powerful."

Author: George Bishay

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