Rates are unlikely to rise as aggressively as current market pricing suggests

Inflation is set to rise on the back of higher oil and commodity prices, driven by supply concerns due to the conflict in Ukraine and the recent floods. This has caused pundits to shift their stance to become overly aggressive on rate expectations. However, portfolio manager Anthony Kirkham of Western Asset, a global active fixed-income […]

Inflation is set to rise on the back of higher oil and commodity prices, driven by supply concerns due to the conflict in Ukraine and the recent floods. This has caused pundits to shift their stance to become overly aggressive on rate expectations.

However, portfolio manager Anthony Kirkham of Western Asset, a global active fixed-income manager and part of the Franklin Templeton group, says, “The Reserve Bank of Australia (RBA) is unlikely to tighten monetary policy as aggressively as current market pricing suggests, and investors and borrowers should prepare for a cash rate peak of around 2.5% in this cycle.”

Kirkham expects the “RBA’s cash rate target, which is currently 0.1%, will be at 0.75% by the end of this year and then move towards 1.5% to 2% by the end of 2023. These expectations are predicated on a continued recovery in Australian economic growth, the absence of another COVID variant that challenges vaccination, or a substantial economic shock caused by geopolitical tensions.”

His view is quite conservative when compared to the market’s view. Kirkham says the RBA will not move as aggressively as market pricing suggests due to soaring house prices and housing loan debt.

To add to it, the RBA may not achieve its inflation, employment and wage growth objectives on a sustained basis until second half of 2022, he says. “This contributes to our expectation that the cash rate will peak at around 2.5% in this cycle.”

Kirkham says current market conditions present opportunities for active fixed-income investors. “Overly aggressive pricing and volatility offer scope for active duration and yield curve management, as well as sector and security selection,” he adds, “There are opportunities in high-grade corporate bonds; selective exposure to issuers in sectors that have benefited from supportive policy offer attractive risk-adjusted returns.”

Overall, Western Asset believes that current yields are attractive for existing and prospective bond investors. “Continued volatility is expected to provide ongoing opportunities to generate alpha through active management,” Kirkham says.