Deciphering Australian government bond yields

Deciphering Australian government bond yields

Inside the Enhanced Yield Fund

By Jarod Dawson, PM Capital

With all the talk about higher bond yields relative to where they were trading a few years ago, we thought it prudent to take a close look at how far we have come and what is being priced into the Australian government bond curve.

Bond yield trends

The below table compares the 3-year period from 31 March 2021 to 31 March 2024, and shows how far Australian government bond yields have moved.

It’s evident that bond yields have undergone considerable shifts in recent years.

Rising interest rates, the RBA and economic indicators

While interest rates have moved a long way, the economy however has so far adjusted well to what effectively amounts to higher borrowing costs for consumers and businesses. Additionally, despite bond market pricing, the Reserve Bank of Australia (RBA) has communicated very clearly that it is in no hurry to reduce official interest rates.

Aside from a resilient economy, stubbornly high inflation and a patient RBA, the majority of Australian workers are also scheduled to receive substantial income tax cuts in a few months’ time – with many workers slated to receive thousands of dollars in additional after-tax income. We think this is highly likely to fuel additional consumer spending, and also part of the reason the RBA is currently on its heels.

Looking at the relativities, at the end of March, the yields on the above government bonds were considerably lower than the RBA cash rate of 4.35%:

We infer from this that while rate cuts appear to be far from imminent, markets have taken it upon themselves to price numerous cuts in the official cash rate into the government bond curve.

Portfolio insights

This brings us to the Enhanced Yield Fund’s portfolio and where we believe the best value for money is in the bond market.

To us, investing in government bonds where there are material rate cuts already priced in is fraught with danger. If the RBA does not cut rates over the next few months – which we think is likely – then as a result of the tax cuts, we suspect any cuts to official interest rates will be pushed well into next year at the earliest. In the event this happens, bond yields are likely to move notably higher.

So, what areas of the bond market should investors be concentrating on? The best way for us to answer that question is to highlight where we have been investing the Fund’s capital of late.

As noted in the quarterly report, we recently purchased two new floating rate bonds:

Because of the floating rate nature of these bonds, they have close to zero fixed interest rate risk – and thus have considerable protection from rising bond yields. They also offer considerably higher yields for what we consider to be businesses with very sound balance sheets and earnings profiles.

At yields of approximately 1.5% to 3% higher than the above government bond rates, we think this is a far more lucrative place to be investing the Fund’s capital.

For more details on the Fund’s performance, investment activity and market outlook, watch our quarterly video as at March 2024.

About the Author

Jarod Dawson is the Global Yield Portfolio Manager.

More information on the PM Capital Enhanced Yield Fund is available here. Alternatively, see more insights related to the Enhanced Yield Fund here.

This insight is issued by PM Capital Limited ABN 69 083 644 731 AFSL 230222 as responsible entity for the PM Capital Enhanced Yield Fund (ARSN 099 581 558, the ‘Fund’). It contains summary information only to provide an insight into how we make our investment decisions. This information does not constitute advice or a recommendation, and is subject to change without notice. It does not take into account the objectives, financial situation or needs of any investor which should be considered before investing. Investors should consider the Target Market Determinations and the current Product Disclosure Statement (which are available from us), and obtain their own financial advice, prior to making an investment. The PDS explains how the Fund’s Net Asset Value is calculated. Past performance is not a reliable guide to future performance and the capital and income of any investment may go down as well as up.