Ying Yi Ann Cheng, Portfolio Manager of the Switzer Higher Yield Fund joined Peter Switzer on Switzer TV to discuss the latest outlook on interest rates, the housing market and the effect inflation has on fixed income portfolios.
Peter Switzer (PS): Joining me now is Ying Yi Ann Cheng from Coolabah Capital. We want to really understand what the latest outlook is on things like interest rates. There’s a sort of a changing mood at the moment, but I wonder whether the experts at Coolabah are changing their attitude towards interest rates. Good to see you, Ying Yi.
Ying Yi Ann Cheng (YYAC): Good to see you again, Peter.
PS: I don’t expect you to change your mind, but there is an argument going on that maybe interest rates will arise quicker than people expect. What are you guys thinking about those arguments?
YYAC: The market is pricing that in, so a lot of the moves that we’ve seen in bond markets is really about the long end. We’re talking about that 10-year part of the curve. We’ve seen 10-year yields, largely driven out of the US, really spike up. Earlier this week they got to 1.77%, which is quite dramatic in the scheme of things. It doesn’t look like this concern or these market expectations are abating. However, you need to remember that we’re talking about the 10-year part of the curve.
This is the market expectation in 10 years time. Right now, the market is looking at all the stimulus that’s taking place. With this Biden stimulus package, what they’re doing around infrastructure, etc. they’re looking at that and they see this cause inflation down the track. However, what we’ve seen is central banks commit to, whether it’s the ECB, offshore and the Fed, but also in particular the RBA. The way that the RBA is communicated is that they’re very committed to lower rates, at least in the near term. We’re talking about over the next couple of years – the rates aren’t going to be running away anywhere in the next couple of years. Down the track, that might be a bit of a different story. Markets are incredibly intelligent and smart and they’re always thinking ahead.
PS: It seems to me Ying Yi, that even the view on 10 years, it’s not even 2% in 10 years time, it’s probably going to be 4 or 5% in 10 years time. If you look at the kind of boom that’s probably going to happen, with all this spending going on…
YYAC: Quite possibly. We could easily get to 2 or 2.5% down the track, so the risk or the inflation risk for a lot of fixed income portfolios is very real. We have always had the philosophy that we don’t want any fixed rate risk in our portfolio. When inflation does come, and you have fixed rate bonds or fixed rate risks in your portfolio, that is quite detrimental. It’s no different to you deciding to fix your mortgage or not, right?
If you believe that rates are going to be higher in the future, you probably want you to fix your rate right now. However, when you’re a bond holder, i.e., you’re the lender, you sit on the other side. If you fix the rate and lent to someone at a lower rate, when you can get compensated a high rate in the future, you lose out – so it’s the opposite.
PS: Yeah, and that’s why you guys chase floating rates rather than fixed.
YYAC: This is why we decided to hedge all of our portfolios and we have no fixed rate risk. It’s all a hundred percent floating rate. It’s not to stop us from investing in fixed rate bonds. However, when we do invest in fixed rate bonds, we just take out that fixed rate risk. We hedge it.
PS: Your colleague, Chris Joye in the AFR has been looking at the house price boom. He’s very positive that the price is going to rise, but what’s his attitude towards APRA? Does he think APRA’s going to eventually come in and restrict the amount of lending the banks are prepared to make to certain sort of borrowers out there?
YYAC: Lending at the moment isn’t really a concern. If you look at house prices, we’re very much back to pre-COVID levels. In terms of Melbourne, house prices haven’t changed dramatically say since like 2017. Sure, house prices have been recovering, but we’re not in a bubble. If we do get to a point where we consider it to be a bubble, then there is nothing that will stop APRA from stepping in and re-introducing those macro prudential measures. If anything, that’s probably the preference, that APRA introduces macro-pru, rather than the RBA hiking rates necessarily. Some people have been talking about RBA doing quantitative easing. The RBA doing quantitative easing involves them going out and buying Commonwealth government bonds and state government bonds. That shouldn’t affect house prices.
They want to keep the cost of borrowing down for the government, so the government can create jobs, etc. APRA macro-pru, if it was a very targeted measure for the housing market, if it does start heating up excessively, would probably be the most preferred tool.
PS: One of the reasons why I got you guys to manage the bond fund that is out there now, the Switzer Higher Yield Fund, is that I do think you guys are some of the smartest people playing in the interest rate and the bond market space. A lot of people are saying to me that they think in the not too distant future, these fixed rate home loans with a one on the handle like 1.9, will probably start to rise. What’s your feeling about fixed interest rates in the home loan market?
YYAC: I can never give financial advice, but I suspect they will rise in the near to medium term. The reason why is because firstly, the banks have been able to extend very favourable rates on fixed rate mortgages because they have had access to the Term Funding Facility. The RBA introduced the Term Funding Facility in the middle of COVID last year, and they said that the banks would be able to borrow out to three years, at 0.25%.
Later on in the year, they lowered that same rate from 0.25%, to 0.1%, in line with the lowering of the cash rate. However, because the banks haven’t needed, they’ve been awash with liquidity. They haven’t needed to really access this Term Funding Facility that much. Given the banks are not the ones that are struggling at the moment, the RBA has said that they are not going to extend this Term Funding Facility, and that they’re going to just allow this to roll off later this year. In which case, that means that if the banks aren’t able to access the RBA’s Term Funding Facility later this year. This means that we’ll have to go out and effectively borrow at the market rate, rather than that discounted 0.1% rate.
We should expect those fixed rates to move higher. That’s definitely a very conceivable premise that you pose there.
PS: As you said, you’re not giving financial advice, but let me set up a scenario, right? Your favourite cousin comes to you and says Ying Yi, you’re an expert on this, we are going to buy a house, and we’re not sure whether we should do variable or fixed. I’m kind of thinking this fixed rate looks really good. Should I do it for the longest possible time? Or should I do it for the shortest possible time? What would you say? It’s only because it’s your favourite cousin, that you would give your best possible financial education view.
YYAC: Well, all right I can give you a personal anecdote, because I have just bought an investment property myself and I had fixed for the longest possible period. Personally, that’s not financial advice.
PS: Of course it’s not.
YYAC: That’s my own personal opinion.
PS: You know, it’s just brilliant financial education. Ying Yi, thanks for joining us on the program. We’ll talk to you in a couple of weeks’ time.
YAAC: Thank you so much, Peter.