Cuts are coming, equities are full, and Trump is being underestimated by everyone

From investing his paper route money in term deposits when he was nine years old, to racing the two kilometres from one end of Collins Street to the other to submit a handwritten RBA bond tender, to running a market-beating income fund for more than 20 years, Yarra Capital Management’s Roy Keenan has seen it all in his 40 years in fixed income.

It is this broad experience and love for markets that makes Keenan such an interesting person to talk to, particularly given the world as we find it today.

There’s a new regime taking shape in the US - the promises of which will need to be funded by new paper, locally we have state governments in trouble (none more so than Victoria, where Keenan was at the coalface last time it was broke), whilst the energy transition and other major investment themes are creating opportunities.

Making sense of it all is always the key but when you have four decades of experience, you have learnt when to use your head and when to pay attention to your gut.

"I think that the head tells you to put the trade on. I think the gut is the warning signal that something doesn't feel right and therefore instead of taking that trade off quickly, you might just let it run a little bit longer to see how it will play out," he says.

So, which themes are dominating Keenan’s head space and innards today?

The bond market and Trump’s influence

When talking about the most important factor in today’s market, Keenan doesn’t pull any punches:

"If I summed it up in three words, it'd be Trump, Trump and Trump."

As a card player of the game "500", Keenan quips, "No Trumps would be much better for markets", highlighting the uncertainty surrounding US fiscal policies.

Trump's tariff strategies and tax cuts are crucial drivers of bond markets. If tariffs increase, it supports fixed income markets, but if they are reduced, a large supply of bonds will flood the market.

"Ultimately, it comes back to how he's going to fund his tax cuts," Keenan noted.

This dynamic will continue to shape interest rates and yield curves globally.

Australian interest rates: expect three cuts

Keenan and Yarra Capital Management believe the Reserve Bank of Australia is behind on rate cuts.

"We think the RBA will cut at least three times, beginning in February," he stated before adding that they probably should have started cutting last year.

Keenan also foresees a steepening yield curve, with the long-term rates influenced by U.S. policies.

“The long end of the yield curve in Australia will be driven by US government policy and what Trump implements.

"Our feeling is that the yield curve will steepen. Today, the spread between the 3 and 10-year bond, is around 62 basis points. My head tells me it probably goes to 85, my gut tells me it probably goes 100+”, says Keenan

Corporate Australia: strong balance sheets but consumer risks

Despite economic pressures, Keenan remains confident in the strength of Australian corporate balance sheets.

"We are still very confident of the state of Australian corporate balance sheets, particularly investment-grade credit," he asserted.

However, he is closely monitoring consumer resilience amid prolonged high interest rates.

"Victoria’s not performing as well as we would expect," he observed, noting rising mortgage arrears in the state.

With much of Yarra’s exposure in banks and financials, Keenan sees stability in the sector but remains watchful of potential stress in consumer lending.

The bond market as an equity signal

Keenan suggests that current bond market conditions indicate equity valuations may be stretched.

"My belief is long-term interest rates are rising despite inflation falling," he said, which could put pressure on equity markets.

However, Australia may benefit from a relatively weaker currency.

"The Aussie dollar is cheap, the US dollar is expensive. We could be a net beneficiary," he argued, indicating potential opportunities in Australian fixed income and equities relative to global markets.

Listen to the podcast

Be sure to listen to the podcast or read the transcript below to get more insights on the world's biggest and most liquid markets, as well as some more war stories from Keenan’s 40 years in the market. 

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Edited Transcript

Please note that because of prohibitive length, this is not the full transcript - it focuses on the first half of the podcast where Keenan shares his insights on current market conditions. 

Chris Conway: Roy, let's start big. The bond market is the deepest and most liquid market in the world and a barometer for what's going on economically and in other markets. What are you seeing and can you translate what's happening for those of us who aren't so close to it?

Roy Keenan: Yeah, it's a really interesting period for markets generally, not just fixed income markets and if I summed it up in three words, it'd be “Trump, Trump and Trump”. As a card player and 500 player, I'd say “no Trumps” would be much better for markets. But look, for us it's a daily watch and see what he's delivering. Obviously he's talking about his tariffs and policies, and that's a really important driver for bond markets in the near term. 

What that means is that potentially whatever he finally settles on, whether it's a full blown tariff attack or he uses a strategy to wind back, ultimately it comes back to how's he going to fund his tax cuts? The more he raises tariffs and gets tariff policy through, the more favourable for fixed income markets. If he winds back tariffs, then we know there's going to be a supply of bonds out into the marketplace, and quite a large supply of bonds to fund his planned tax cuts and all his policies that he got elected on. 

So it's going to be a really important time. What it means for us is that what we need to think about interest rates and curves and where we translate across our portfolios. And unfortunately, it feels like we've gone back in time to nearly eight years ago when Trump first got elected and that's the state of play, but he's going to be a really important driver of what fixed income markets are doing.

Chris Conway: Roy, just to follow up there and take it back to what you said right at the top, you're sort of in watch and wait mode and you're waiting for the final thing that Trump decides upon. Is there ever a final word with Trump, or can you get close enough to it so that you can make some intelligent decisions in your portfolio?

Roy Keenan: Yeah, I think it's just too early. Once he does settle down and we do get an inkling of what policy's going to look like, we then can make forecasts; “what's the impact on growth, what's the impact on inflation and ultimately what does that mean for the level of interest rates and, more importantly, the shape of the yield curve?” 

And when I talk about the shape of yield curve, we talk about the monetary policy, which is short end, but we are then also talking about the long end of the yield curve. And why is that really important? Because what's interesting about Trump's policy is that on one hand, he's implementing tariffs with the people who buy his bonds. 

So whether there's going to be a buyers strike and avoiding US dollar debt, it's going to be really interesting how this plays out. And we all know that there's a motive in what he's trying to do, but ultimately I think once we do settle down, like I said earlier, we'll then be able to go ahead and forecast what the outlook looks like, and therefore then also look at where we think interest rates will head to.

Chris Conway: Roy, you touched on it just there - interest rates. Let's zoom in, particularly with an Australian lens. What's the Yarra house view on Australian interest rates over the year ahead and how might that impact how you invest?

Roy Keenan: Across all our funds we're running, we're what we call long duration, long interest rates, and that's with the expectation and most of that long positioning is in the front end of the yield curve. And the reason why we're positioned in the front end of the yield curve is that we think the RBA will cut at least three times beginning in February. 

We think they should have probably been doing it back in 2024 and they're a bit late to the party, but ultimately we think there's three there, potentially a fourth one. So what's really important about that, bringing that back to Australia and what I mentioned earlier with Trump's policies, we're of the view that we will see steeper yield curves in action. 

And what will happen, we think, is that the front end of the yield curve - three years and short - will be dictated by RBA policy, slowing economy, inflation falling, all those things will be driving that and the long end of the yield curve in Australia will be driven by, essentially, what US government policy is going to be and what Trump implements. 

And our feeling is that the yield curve will steepen. Today, what we call between the 3 and 10 year bond, is around 62 basis points. My head tells me it probably goes to 85, my gut tells me it probably goes 100+.

And that's ultimately driven by the fact that we think longer term interest rates rise, given the amount of supply that's going to be coming to finance the US fiscal position, the tax cuts, vice versa, essentially the lack of buyers to do that, and also the US government has a problem with what we call the duration of their debt. 

It's very short historically, and so therefore they need to pump out more long dated bonds. We really haven't seen supply problems in the market for a long time and I think that's what is driving my stomach to feel like we're going to see a much steeper yield curve than what my head even tells me.

Chris Conway: I've got to ask the follow-up question, Roy, do you go with your head or your gut, or somewhere in the middle.

Roy Keenan: Yeah, it's a really good question. I think that the head basically tells you to put the trade on. I think the gut is the warning signal that something doesn't feel right here and therefore instead of taking that trade off quickly, you might just let it run a little bit long to see how it will play out. History tells you that markets always overact to things and I think this might be one of those examples, in 2025-26.

Chris Conway: Ladies and gentlemen, that's the art versus science from someone who's been doing it for nearly 40 years. So Roy, thank you for those insights. Let's talk about now the health of corporate Australia and the companies that you are buying bonds from. We're in the middle of earning season and things could prove to be tough. From an earnings perspective, how is Aussie corporate health and what impact is that having on new issuance?

Roy Keenan: I think one of those things that we felt coming, even when the pandemic hit five years ago, which is quite remarkable that it’s five years ago now, is that I was really confident about credit and corporate Australia because balance sheets were in really good shape. Probably the biggest risk we saw through higher interest rate cycles, that might see some deterioration in the balance sheets, is particularly people who lent to consumers or were dealing with consumers. 

Obviously, higher interest rates, less discretionary income, less ability to spend on those discretionary items. So for us, the key thing when we come to this period is we're not an equity investor - we're not going to be feeling disappointed. We're looking at the shape and quality of the balance sheet. And in some ways going into this, we're still very confident of the state of Australian corporate balance sheet, particularly investment grade credit, which has that ability versus what we call lower grade high yield credit that doesn't have that ability to adjust to higher interest rates. 

And what we've seen through this period and what I'll be watching for again, is how is the consumer standing up, because it's been a prolonged period now of higher interest rates. A lot of my exposure in the funds we run are in banks and financials, so that's probably going to be the one key focus area. Commonwealth Bank reported today, we didn't see any alarming trends in the bank's balance sheet. The only thing that I did notice in some of the data that we did see was that Victoria's not performing as well as what we would expect - it's noticeable that arrears in Victoria are starting to tick up.

Chris Conway: I have a feeling when be talking about Victoria a little bit later in this podcast Roy, so we'll park that for the moment. I just want follow up there in terms of credit spreads and what they tell investors about the confidence or otherwise in a borrower's ability to repay. What have you been seeing lately and are they appropriate at current levels based on what you've seen throughout your career?

Roy Keenan: Yeah, it's a good question. Most of my clients ask me that pretty much at every meeting. I think that credit spreads, if you compare them over a shorter term period, they're a lot tighter today than where they were probably two, three years ago. 

But if you only take that sort of period in time, then you are getting the wrong picture of what history tells you. And I think credit spreads today are indicating that balance sheets are in really good shape in the investment grade credit market that we focus on. I think there's other pockets of the credit markets that are actually experiencing, if you've got property lending, etc. - there's pockets that are really struggling. 

But credit spreads are telling us that essentially things are in pretty good shape, but you've always got to be worried about what the future holds. And if we compare where we are against the US, we use an example that a 10-year credit spread in investment grade credit in the US is comparable to a 5-year credit spread in Australia, plus 30 basis points we get extra - so we get paid more in return for less credit exposure than what you would do for investing in the US. 

And that tells me the Australia looks pretty attractive relative to the US but also, if I go through looking at bank senior debt or bank Tier 2 - I've got a big database of 25 years of history - both those indicators tell me that both credit spreads and yields are pretty much bang on 25-year averages. So it's neither cheap nor expensive and in some ways, that reflects our positioning.

Chris Conway: One of the points of difference for Yarra is that the firm is multi-asset, but even within the fixed income bracket you cover the entire spectrum. Can you just take us inside the Yarra war room? So what I really want to know, when managers from other asset classes ask you about the signals coming from the bond market, what are you telling them?

Roy Keenan: Look, it's a damn good question and if I take a second, Yarra is quite unique in the way we operate as an investment team. And I say investment ‘team’ because we work really closely with our equity team. We have great contribution from our macro strategist and economist, Tim Toohey. 

So there's a lot of collaboration. When we look at a particular company, we actually research it from an equity and a fixed income perspective. But I like to say to people that the equity guys can have the blue sky and the rise or fall in the share price. In fixed income, all we want is our money back and our interest payments. So when you look at a company from two different aspects, we actually have a different philosophy on what we're looking for a company.

So it is really helpful that we work close together. But I think the most important thing about what does that mean for our strategy and how we think about it, the fixed income guys can give the equity guys a really good feel of a company's ability to refinance. Where's the risk? Are the costs of borrowing for that company starting to rise? Could they potentially get downgraded? Things that affect the overall performance of that company. 

Tim Toohey, from a top down perspective, will look at the global economy and then convert some of this through to what it means for particular segments of the market and sectors. And I can pull out the pandemic for example, because it’s a really good example. While everyone was quite scared and didn't really get a comprehension of what the pandemic meant in the early days, Tim was very quick to call a V-shaped recovery. 

So we were able to basically take that V-shaped recovery and say, well what does it mean for the property sector? Where are the best likely returns over the next six to 12 months? And we were able to do that in our fixed income portfolios by adding RMBS, which we're paying tremendous credit spreads for the fear that property prices was going to fall. That wasn't Tim's view. On the equity side, we were able to do the same thing. 

And I think that's where working as one investment team, you can really help each other to develop your own ideas, but more importantly, it only works if you both get something working as a team. You can't have one dominating over the other. And I think that's where we get that balance really right at Yarra.

Chris Conway: Are there any signals, Roy, coming from the bond market now as they impact equity markets? I remember reading something in one of your research papers or your monthly recently about the bond market potentially signalling that equity values are full for lack of a better description. Is that fair to say?

Roy Keenan: I think that's fair to say. If we are right and that the Fed is almost finished cutting rates, or they will be depending on what Trump implements in the final outcome we see, my belief is long-term interest rates are rising despite inflation falling. People are going to demand, for investing for 10 years or longer, people are going to demand extra - they want to get paid. 

So I think we're in that scenario which can't be good for long-term valuations in equities. I would say there's globally some equity markets more expensive than others and Australia, in my view, Australia will be a bit of a net beneficiary from both fixed income and equity markets because I think the Aussie dollar is cheap, the US dollar is expensive. 

I think US equity markets and US fixed income markets, particularly investment grade credit are expensive. So we could be a net beneficiary from having that lower currency and looking cheaper from an equity and fixed income perspective. So I think that's going to be really interesting how that draws out.

Chris Conway: It's been a pretty good period for fixed income. Yields have been solid. You've talked about equity like returns when we've spoken in the past, but based on everything that you've just talked about, what does your opportunity set look like moving forward and what levers can you pull when it comes to duration and quality to make sure that you're still getting those solid returns for your investors?

Roy Keenan: Yeah, when we talk equity like returns last two years, we've probably delivered some between 9-10%. So without taking a lot of risk, which is the most important thing - and that's probably the thing I've been most proud of - is that we haven't taken a lot of risk to generate those types of returns.

I still think we're moving into a period where, whilst I'm not promising my investors 9-10%, it's still a very good period for investment grade credit for me. My Yarra Enhanced Income Fund, for example, we’re at a 6.2% running yield. 

If I do the right things and get markets right, then having a return somewhere between 7.5-8.5% is not out of what I'm targeting for the year, which is great returns for investment grade credit, right? But you’ve always got to take returns with risk and the downside risk, when you've got a 6.2% running yield and the amount of risk we're running from a credit point of view, you need a pretty catastrophic event to get a negative return. 

So when I look at segments and multi-asset, where's the best value in markets? I keep coming back here because the upside risk versus the downside risk, it looks pretty darn good in my view. So how are we going about that and what's out in the marketplace?

I talked about interest rates, we've got yield curve steepening plays on in our fund. We are running duration around 1.4, 1.5 years in our fund all focused on the front end of the yield curve where we think the RBA cuts. 

We're probably running a bit more defensive on credit. I'm probably running the highest credit quality in my fund in 22 years, not because I think that there's going to be defaults in my fund. It's because I think that potentially if spreads do blow out, I want to be able to - and I say blow out, i.e. move higher - I want to have that ability to add risk at the right time.

And as I mentioned, don't need to take a lot of risk at the moment to generate really good returns. So the AT1 market is starting to disappear, there will no doubt be some new sectors of the market come in. We've seen over late 2024, early 25, we've seen corporate hybrids start to take off in the market and our Fund has been a participant in the recent AusNet deal last week, but last year we had Pacific National - we think that's really a growth sector of the market. 

We think the REIT sector will be an ongoing issue in that market and whether it's infrastructure or energy companies, the transition of power and that getting to net zero is going to be really important catalyst and very expensive from a capital point of view. So we think that equity will play a part, pure fixed income from senior debt will play a part, but we also will have a big rise in corporate hybrids on issue and that's a really positive sign for the market, returns, and opportunities for us to add alpha.

Chris Conway: Roy, we've talked about what's happening in the market. I just want to zoom in a little on your experience and what you're focused on at Yarra. So, it's fair to say you're a fair dinkum fixed income journeyman. You've been in the space since 1984 as we talked about at the top. Can you just share with us a couple of key insights or lessons over the journey? A couple of war stories maybe

Roy Keenan: If I think about change, and 40 years is a damn long time, I think the biggest change is computers. If I think about what life was like it as a fixed income guy, a lot of my team wouldn't even know what if I was talking about and what I'm talking about there is everything was manual.

For an RBA government bond tender, we'd fill out the form, and we were JB Were at the time, we were up the wrong end of Collins Street and we had to run the two kilometres up the hill to make sure we had that bond tender form in the box at the bottom of the RBA. You may have knocked over four or five people to get there as quick as possible, but that's basically, that was what life was. I remember working for the Victorian government at the time and we're doing the consolidation of the debt borrowing program. 

So like gas and fuel, SEV, CV, Port of Portland, they all borrowed in their own right in Victoria before TCV was created. And I remember we had the job of consolidating all that debt into one government borrowing agency and we could only do 10 trades a day. We had one computer, settlements needed it, accounting needed the computer. I can tell you we didn't have Bloomberg or any software. We had cotton wool to do yield curves, right? 

We had the graph paper and the pins and we're talking about the government borrowing programs. We're doing where's the best place to issue off cotton wool and wool and pins and graph paper. So that evolution, we're just so much more efficient. I'd say we're less personal as a market, but we are much more efficient and the ability to do straight-through processing on trades, compliance checking, all that sort of thing is just an amazing evolution in my lifetime.

A lot of those lessons I learned in the eighties and nineties I apply today and you can never underestimate some of those things you learn, especially the liquidity side because liquidity can be there, be there, be there and just disappears overnight. So having that ability to watch and see and say if something doesn't feel right here, and having been there and seen it, you do have that gut feeling I mentioned earlier, which is pretty important.