CIO Ian Martin shares his thoughts for the year ahead 

2017 was a relatively benign year for fixed income. While I hold the view that the RBA is on hold, the market is currently pricing in a full rate hike by December 2018. Although climbing off lows from 2016, YOY Inflation is still below the RBA Target rate of 2%.

We witnessed strong employment data throughout 2017, however wage pressure has still not materialised. This lack of wage pressure is a common problem for most Central Banks and one of the reasons we saw no change by the RBA.

Using futures contracts, we can see the market’s expectation of the future RBA Cash Rate level. This pricing has moved slightly higher although the market is still only pricing one RBA Increase by December 2018. I remain comfortable with no move in 2018 and expect this pricing to be deferred into 2019.

Chart 1: Pricing of future RBA Cash Rates

Yield to maturity (YTM) on 3 year Government Bonds only increased by 0.17% while the YTM on 10 year Government Bonds actually fell in yield by 0.14% thereby creating a flatter yield curve.

The price of credit (or the amount of premium required to hold a corporate bond vs a government bond) tightened, benefiting those who hold corporate bonds instead of government bonds (Table 1).

This is important because government bonds and other similar style of issuers (State Governments of Australia and international government agencies) make up nearly 88% of the Composite Bond Index.

Table 1: Total Return of Bloomberg Indices

Looking at how some of the Sub Indices performed:

• The Composite Bond Index returned 3.66%
• The Credit Index returned 5.09%
• The Floating Rate Index returned 3.45%

Chart 2: Composite, Credit and FRN Index performance

Chart 3: Bonds vs Equities 2017

The stability of bonds helps investors sleep better at night

Sources: ASX, Australian Corporate Bond Company & Bloomberg

Disclaimer

The information in this article is general in nature. It should not be the sole source of information. It does not take into account the investment objectives or circumstances of any particular investor. You should consider, with or without advice from a professional adviser, whether an investment is appropriate to your circumstances. Australian Corporate Bond Company Limited is the Securities Manager of XTBs and will earn fees in connection with an investment in XTBs.