Value in fixed rate bonds

Last week the OECD downgraded the growth forecast for Australia to 2.6% in 2013, from 3% just six months ago. The prior forecast made a year ago was 3.7%. Lower growth reinforces our view that interest rates will be lower for longer.

FIIG’s economist Dr Stephen Nash expects “a further 0.25% cut to 2.5% to the official cash rate, but if growth starts to moderate in the US, more than expected, the cash rate could fall further”. Assuming US growth remains on track, Dr Nash expects the cash rate to remain at 2.5% for the 2014 year.

Bill Evans, Westpac’s chief economist is more pessimistic, "we retain our position that the terminal cash rate will be 2.0%, with single moves in August, late 2013 and early 2014". He expects rates to reach a record low of 2.0%.

Although we’ve been advocating switching out of fixed rate bonds and into floating rate notes and inflation linked bonds (given our thoughts that interest rates are near the bottom of the cycle), the combination of the possibility of even lower interest rates and the improved returns on fixed rate bonds means we’re seeing some good value.

The emphasis of market commentators on dividend yield or share income has meant we’ve started to focus a little more on running yield (the income you would expect to earn in the next year) given it is more equitable. I’m tending to think of yield to maturity (income plus the capital gain or loss at maturity) being a worse-case, however known, scenario.

Table 1 shows a range of fixed rate bonds with a running yield of 5.4% or more, with many of the bonds showing a running yield of over 6%, attractive in a low interest rate environment.

Table 1

To find out more about opportunities available please call your local dealer.

All prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities.