Australia's biggest investors ramp up bonds in bet on central bank policy

Some of Australia's biggest investors are piling into bonds, in a bet backing central bank Governor Philip Lowe's assessment that a series of robust interest-rate hikes will help get inflation under control next year.

Cbus Super, Melbourne, has been lifting exposure to bonds "across the board" over the past three to six months, according to CEO Justin Arter. Australia's biggest pension fund AustralianSuper, Melbourne, has increased its debt holdings to 10% from just under 6% and Janus Henderson Group's Australian head of fixed income says yields are peaking now as they usually do early in tightening cycles.

"If what Dr. Lowe says is proven to be the case, then bonds at the moment will be very good value," Mr. Arter, the head of the A$73 billion ($49 billion) super fund, said in an interview in Melbourne. "Once that inflation starts to gently come out of the system over the next 18 months, you'll see that bonds will be good value, which is why there's been a reallocation to bonds by a lot of funds."

Australia's 10-year yields spiked to 92 basis points above similar-dated Treasuries last month, the widest gap since January 2015. That sparked a rally that pushed the difference back down to 44 basis points on Monday, a spread that has still more than doubled this year.

The Reserve Bank of Australia has hiked rates by 1.25 percentage points over the past three months to combat the strongest price gains in two decades, surprising economists and traders with the size of the first two moves. While some foreign investors are shying away from bonds after being burned by its failure to provide reliable guidance on inflation and interest rates, locals reckon the central bank is now on the right track.

"We've effectively seen this mini episode's peak in yields," said Jay Sivapalan at Janus Henderson, whose team manages A$15.3 billion. "Bond markets are trying to be forward looking, so it is actually quite common that as you get actual tightening in the cash rate, bond yields can actually go either sideways or go down," he said.

The RBA can be expected to remain hawkish in its rhetoric for some time because it wants consumers to spend less to help cool inflation, but it's unlikely to meet market pricing for a cash rate that peaks at about 3.5% in mid-2023 because that would do too much damage to financial stability, he added.

Cbus and Janus both see a decent chance that the RBA will avoid tipping Australia into recession.

Bonds, "certainly Aussies and semis in Australia – are sending you the signal that maybe things won't be as bad as expected out there," Mr. Arter said. "They now seem to be saying well maybe this tightening cycle will end earlier than we thought."

Bonds worldwide have suffered an unprecedented rout over the past year, with Australian government debt's 11% drop actually outperforming an 18% loss for global sovereign securities.

Janus Henderson's Mr. Sivapalan said that sort of meltdown owed much to the extraordinary pandemic-era switch into and out of massive policy easing and that bonds are offering value now yields have climbed so rapidly.

"Fixed interest is that great diversifying asset class, and against growth assets this time around it's failed in that role," Mr. Sivapalan said. "That's not to say that'll fail in its role again, because the asset class now has yield built into it."