Bond Market Turmoil Threatens Equities Amid Rising Rates
Bond markets in Australia and the US are signaling challenging times for equities. High interest rates and inflation are negatively impacting shares, though not all sectors are affected equally. This dynamic is evident as both regions face upward pressure on borrowing costs, with the bond market serving as a critical indicator of economic sentiment.
The Reserve Bank of Australia is expected to raise official rates by 25 basis points, according to experts. This comes as the ten-year bond rate reaches a 15-year high of around 5.3%. The shift reflects a broader consensus among economists, who only recently anticipated a rate cut as the next move. This reversal shows the rapid changes in economic conditions and the RBA’s efforts to curb inflationary pressures.
Global Bond Market Trends
In the US, the ten-year bond rate has hit 5%, the highest since 2007. The Federal Reserve recently raised rates by 25 basis points, the first increase since 2023. This move, overseen by Federal Reserve Chair Kevin Warsh, highlights the Fed’s commitment to addressing inflation despite political preferences for lower rates, such as those expressed by Donald Trump. The global nature of these trends means that Australian rates cannot be viewed in isolation, as international markets influence domestic economic conditions.
Inflation’s Impact on Equities
Australia’s July trimmed mean inflation figure came in at 3.6%, higher than the expected 2.8%. This represents a significant shift over the past year, with Alvia Asset Partners portfolio manager Daniel Martin noting an 80-basis point revision, described as a “seismic shift” over a 12-month period. Such a dramatic change shows the challenges central banks face in managing inflation expectations.
While higher rates and inflation generally hurt equities, some sectors may perform better. Mining and energy stocks could be more resilient, according to UBS, as they benefit from commodity price strength. In contrast, gold tends to underperform in such environments due to its lack of income-earning potential. Consumer and housing-related equities face headwinds from increasing debt servicing costs, affordability issues, and rising living expenses.
Stocks vulnerable to rate rises include real estate investment trusts like Stockland and Mirvac, retailers such as Wesfarmers and JB HiFi, and companies like Seek. Additionally, firms exposed to long-term rates, including Transurban Group and Commonwealth Bank, face challenges despite banks potentially benefiting from wider margins.
Oil Prices and Refining Capacity
Oil prices have surpassed $100 per barrel due to the ongoing Iran conflict. Shell, for instance, is operating at 102% capacity, forgoing assumed downtime to meet demand. This strain on refining assets means that even if crude prices stabilize, fuel prices at the pump may remain raised due to limited processing capabilities.
Companies with irreplaceable assets and inflation-linked contracts may be better positioned. For example, APA Group, a pipeline operator, recently received approval to build a pipeline in the Betaloo Basin, enhancing its exposure to the gas sector. Similarly, international examples like Getlink, the owner of the Channel Tunnel, demonstrate the value of infrastructure assets with diversified revenue streams, such as electricity transmission between the UK and France.
Expert Opinions and Advice
Nigel Green, head of DeVere, warns of a major repricing of risk, describing the US bond sell-off as a “flashing warning light for investors everywhere.” He cautions that the speed of this repricing should concern those exposed to stocks, property, or long-duration debt. However, Green advises against panic, noting that markets have weathered similar crises, such as when the RBA rate reached 17.5% in 1990 and 7.25% in 2008.
