Recently crowned with the Fixed Interest Manager of the Year award by Morningstar, its third such win in four years, Western Asset Management is on the front food when it comes to global government bond markets. The conditions, despite heightened volatility, offer a rare opportunity for active management.
According to Anthony Francis, investment dealer at Western Asset, Australian bond markets lead the world in terms of price volatility, with the 10-year government bond yield moving from 1.44% on 19 February to a two-year high of 1.91% just seven days later. “To put this into context, the yield is back to levels not seen since April 2019,” he says. Similarly, the steepness of the yield curve, which highlights the outlook for interest rate moves, was at a 29-year high. In portfolio terms, the month of February saw the AusBond Composite Index, the benchmark for most long-duration strategies, fall 3.6%, its worst monthly return in history.
Commenting on the month and quarter just past, Francis suggests, like many others, that the “sell-off is overdone.” While “watchful for further volatility,” Western is cautiously “looking to add duration” on the basis that markets may be pricing in too much of a ‘goldilocks’ situation. He suggests that “in order to justify the rapid change in yields to the current elevated levels we would need to see the global recovery play out with minimal setbacks, and at the same time would need to see some broad-based inflation start to come through.” This simply doesn’t seem likely to be the case. And while inflation may present itself, real wage rises will be required before central banks are forced to take action, rather than “pockets of inflation.”
One of the key drivers of the strength of the A$ has been the government bond yield, with Australian yields some 0.25% above their US equivalents, attracting foreign buyers. This is something that gives Western pause to consider adding duration, with the RBA specifically focusing its Yield Curve control and Quantitative Easing program on reducing this costly premium. With central bankers around the world having “expressed a renewed focus on maintaining stimulatory monetary policy settings for as long as necessary” the pressure on yields is likely to remain downward. There were signs of this trend as March came to an end, supported by the RBA’s comments that it remains ‘flexible’ on QE and could increase purchases as required.
Commenting on the recent decision by the Reserve Bank of New Zealand (RBNZ) to reintroduce loan-to-value ratio (LVR) restrictions for the housing market, and the growing headlines about property prices in Australia, Francis notes “there may be some belief that the RBA may have to follow the lead of the RBNZ and focus more sharply on house prices when looking at the cash rate, but we believe they would prefer to leave such responsibility to other regulatory bodies such as APRA, who could re-introduce macro-prudential measures should they feel the need. This would assist the RBA in keeping the cash rate very low which in turn helps to relieve some pressure on an appreciating AUD.
“All told we see the recent price action as overdone, and while short-term volatility is likely to remain while the market adjusts to all the factors mentioned above, the current levels of yields presents an opportunity to tactically add value to portfolios.”
Western Asset Management is a US$484 billion ($628 billion) asset manager and part of the Franklin Templeton Group. The Australian Bond Trust is a $1.4 billion strategy investing into the broad spectrum of investment-grade bonds, carrying duration of six years.