James Maunsell: Welcome to this month's trade floor update. I'm joined by portfolio manager Rachael Boyte.
Rachael, the RBA overshadowed the Melbourne Cup yesterday with its fifth rate hike of the year. For bond investors is this bad news, or is the price in yields becoming more attractive?
Rachael Boyte: Yes, it's starting to offer a pretty compelling opportunity for investors. With yesterday's rate hike, the RBA have taken the cash rate to a 15-year high at 4.85%. That's had an impact across the whole yield curve. So 10-year yields are also at their highest level since 2011, which is just a really attractive opportunity for investors to lock in some income.
And the price action after the RBA yesterday was very interesting. They hiked rates, they revised up their inflation forecast and bonds still rallied. And that's because yesterday's rate hike was really baked in by markets already. Plus markets were pricing a bit more even for the next couple of meetings. And we're now focusing on the negative growth implications for next year instead.
And we're already seeing that in evidence of tighter financial conditions. So the unemployment rate has risen from 4.1% to 4.7% this year. Growth is running at only half the pace of last year. And Sydney house prices are down over 10% from the peak. And that's really important because the RBA have a dual mandate.
And so we saw that in the vote split yesterday, 6-3; three members actually would have preferred to leave the cash rate on hold because while the focus until recently has been on the inflation side of the mandate and the fact inflation is too high, the RBA would also really like to preserve job gains. And so the focus heading into next year looks set to pivot to the negative growth implications and the slowdown there.
James Maunsell: AI has seemed to be a bullet-proof thematic over the past couple of years. More recently we've seen some weakness both domestically and globally. Is that a function of the trade being tested, or is the market getting better at discerning the winners from the losers?
Rachael Boyte:Yes, the AI capex spend has been the major theme of the year, particularly the call on debt markets as companies look to finance that spend. So I'd really split that into two parts – there’s the credit story, there's also the macro implications of that. If we start with the credit story we're definitely seeing cracks.
The Firmus IPO was cancelled last month because of market conditions. We've seen one of the local data centre issuers in the Aussie market, their sub-debt is down over 25% from where it was issued only a couple of months ago.
And AI stocks have suffered, which is because the high borrowing costs we're seeing at the moment, those are starting to have an impact on the actual economics for a lot of businesses, and whether their spending plans still stack up.
So we've been really cautious on AI-related credit for that reason. It's so important to discern between quality issuers and also the structure of the debt, and make sure that you're being compensated for the risk that you're taking.
The second part of the AI story is really the macro side of things. So business investment has been the resilient part of growth this year in Australia. That's been propped up by AI spend. But the AI spend alone is not enough to drive the next cycle of growth. And there's a couple of reasons for that.
Firstly, AI spend does not translate 1 to 1 to GDP growth. So GDP growth is driven by domestic production. And a lot of the tech equipment that's being put into data centres is being imported. So the stronger business investment is largely offset by higher imports as well.
And then the second part of that, we've reached a point in the cycle where the pace of AI growth is starting to moderate because of political frictions. So a lot of people don't want a data centre in their backyard. There's concerns about energy usage of data centres and what that will do to prices. And so we've reached the speed limit of the build out.
And so AI spend alone is just not enough to drive the next cycle of growth. We really need to see stronger household consumption and improvement in the housing market. And both of those areas are still quite weak.
James Maunsell: Thanks, Rachael. It's clear that duration is now looking attractive and high starting yields are providing a good entry point for investors looking for defensiveness and income in portfolios.
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