Australia’s rate-cutting cycle will be shallow. Here's what it means for investors

Note: This interview was recorded on 22 October 2024.

There’s a lot of investors banking on rate cuts in 2025, and some are even more hopeful, crying for an RBA rate cut this year. But how excited should investors get?

Anthony Kirkham, Portfolio Manager and Head of Asia Pacific Investment Management for Western Asset Management, believes we should temper our expectations.

“We think the early part of 2025 will see the RBA in a position to actually start easing. But, we do still think it will be a relatively shallow easing programme because I think the economy is feeling some pain at the moment. As we move through 2025, we believe the economy will start to feel a little bit better,” Kirkham says.

Unsurprisingly, duration management is increasingly critical, with Kirkham shifting up and down to factor when markets become “a little carried away in terms of their expectations”.

Where he is seeing the best opportunities is in corporate debt. Corporates reduced their leverage during the COVID pandemic and were able to manage interest rates better.

“The yield that you’re getting on corporates is actually, I would say, quite generous based on those fundamentals,” he says.

In this episode of The Pitch, Kirkham discusses the macro environment and his expectations for the coming year, how his portfolio is positioned and why his highest conviction is in corporate credit.

Edited transcript

The portfolio invests mainly in government, semi-corporate, and supranational bonds. Are these allocations targeted or are they based on how you see the world at any given point in time?

The positioning in terms of the different sectors is very fluid. It's an active bond fund and we are trying to maximise the return for our investors.

We definitely rotate through the sectors based on the economic environment that we're in at the time, and also just based on where we see the best value within those sectors. So that's a big part of what we do.

The key to the fund though, is remembering it is meant to be a defensive part of your portfolio, so we want to make sure that behaves like a bond fund should. The key for us is to have a minimum investment within government and semis, and that gives certainly our investors some comfort that that's there. That is going to be the balance that you're looking for within the fund. And then after that, it's just finding the right balance between the different sectors within it where we see the best value. That's the key for our focus alongside trying to generate income, it wants to be defensive. We want to generate income for our investors and it does pay monthly. So that is an important part of investing in the bond fund.

What's the highest allocation you've got at this point?

Obviously, the benchmark is what we're managing against, and it's fascinating to see how benchmarks have changed over the years. With government debt going up considerably, it's really crowded out a lot of the other sectors within it, and we saw that certainly post-pandemic with all that issuance by the government. We just don't believe we need to hold that level of allocation to the government. 

We've got to find the right balance, and therefore, we do have an allocation to government [bonds], but it's going to be out in the backend of the curve because that'll provide the best sort of hard duration, that defensive aspect that we're looking for the fund. And then it's looking at where we can find the best return for investors. So, we'll have an allocation to SSAS. They're solid AAA issuers that we really want to have as part of the fund. Semi-governments have been issuing a lot more lately too, as you probably well know, wherever you drive, whichever state, there's a lot of work going on, but therefore they're issuing a lot more bonds.

We've been underweight semi-governments because we expected those spreads would widen. And then really our largest conviction would be in credit where we just think the fundamentals are very sound. The actual spread that you're getting or the yield that you're getting on corporates is actually, I would say, quite generous based on those fundamentals. Therefore we do have an overweight to credit, but it's very much a short [term] focus. We are capturing the yield without taking a lot of risk within the companies that we're investing in. That's the balance that we have in the fund. You could say it's sort of a bit of a barbell. You've got that defence, but you've also got some good allocation to income-generating assets.

Let's talk about how you're seeing the world today, inflation, interest rates, and corporate health. It's a big question, but what's your take on the macro backdrop?

It's been a tough one.

Obviously on the inflation side, generated by that super-easy monetary policy, the super-easy fiscal that we had through the pandemic. And then out the other side, inflation was there as a big risk factor, and central banks clearly had to tighten monetary policy to bring that down. And the only way to do that is obviously, to bring activity down. We're seeing that occur across the globe. And inflation now is coming down in Australia, a little bit more challenged, a bit more nuanced if you want, partly because we do have this services inflation that is running a little higher than most. Everyone's had a similar environment, but in Australia, it's just hanging on a little bit longer.

A bit is going on at the government level and there's a lot of spending going on there. We mentioned already that there's clearly a lot of expenditure going into infrastructure and the like, and so that is generating a bit more activity and therefore it's a bit more of a challenge for the RBA at this time. In terms of that easing that's going on elsewhere, we've got to wait a little bit longer, but we think basically early part of 2025, we'll see the RBA in a position to actually start easing. But we do still think it'll be a relatively shallow easing programme because I think the economy's feeling some pain at the moment, but as we move through 2025, we believe that the economy will start to feel a little bit better.

How has the portfolio changed over the past 24 months and as it stands today, where are you seeing the best opportunities?

As I mentioned, we still see those best opportunities within the corporate sector. I think the good thing about what the corporations did through the pandemic was they actually got their leverage down. They got themselves in a safe position from that perspective, and they've pretty much maintained that since the pandemic. And so, as interest rates rose, they were in a position where they weren't really harmed by high leverage and those higher rates. 

Therefore, fundamentally, just because the type of corporates that do issue into our market, which are definitely more of a high-grade nature, they're obviously got a position where generally they're monopolistic, dualistic type companies. 

We do have a lot of infrastructure and utilities that actually issue into our market. They are very much defensive in nature, and so, once again, feel comfortable having an overweight to them, just keeping it short. That brings in that income.

Then it's really just, as I said, looking at markets, seeing where they're moving. For us, duration management has become very important, partly because of the volatility we've seen in markets that uncertainty about whether the economy's going to have a soft landing or a hard landing. Those factors certainly drive the volatility within interest rates, and we are trying to actively take advantage of that. And when markets seem to be getting a little carried away in terms of their expectations, then we can move duration up and down on that basis and take advantage of that volatility, which has really added quite a bit of value for the portfolio as well this year.

Learn more

Anthony's fund is designed to be an active core fixed income allocation with a mandate to provide both defensive exposure and disciplined alpha generation. Learn more via the fund profile below, or visit the Franklin Templeton website for more information.

Managed Fund

Western Asset Australian Bond Fund

Australian Fixed Income

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