(Bloomberg) -- The developed world’s continuing roll-back of unprecedented monetary stimulus, alongside an acceleration in inflation, means there’s plenty of pain yet to come in bonds, one of Australia’s largest pension funds says.
“There is no doubt that there is a disconnect between the inflationary risk that’s coming through and where bonds continue to be priced,” Jonathan Armitage, chief investment officer at MLC, the wealth-management unit of National Australia Bank Ltd., said in an interview in Sydney. “The bond market has shifted a fair amount but we’re only part way through that transition.”
MLC has slashed its holdings of government bonds to zero in its so-called real-return funds, valued at about A$5.5 billion ($4.2 billion). Armitage also said MLC has trimmed equity positions to clear the decks for a more volatile environment.
One of the biggest risks: bond investors are underestimating the implications of a pick-up in wages, according to Armitage, who is responsible for investment outcomes at MLC, which has A$78 billion in pension savings and A$199 billion in its asset management business.
“Bond markets are not predicting a sustained rise in wages, particularly in the U.S.,” Armitage said. “The market still seems to think that’s a very low probability. But you’re seeing more evidence coming through in the data. And more and more companies across a wider range of operations are talking about wage increases.”
Ten-year Treasury yields could climb as high as 3.7 percent by year-end, he said. Armitage said he’s favoring inflation-linked bonds, along with bank debt. Credit is also one of his picks, he said without elaborating.
The market is divided on the outlook after the 10-year U.S. yield breached 3 percent last month for the first time since 2014. While Paul Tudor Jones and Ray Dalio are among the famed investors saying a fully fledged bear market is all but inevitable, Bill Gross said this week that it’s more like a "hibernating bear," without much of a growl. Gross sees the 10-year Treasury yield meandering from 2.8 percent to about 3.15 percent through year-end. The median forecast of analysts surveyed by Bloomberg is 3.14 percent for year-end.
For Armitage, the key is that central banks have shifted to taking back liquidity, with the Federal Reserve now raising interest rates and shrinking its balance sheet.
“We have for well over 12 months now been circumspect about markets,” he said. “We are at the close of this ultra-accommodative, ultra-interventionist monetary policy. We are in uncharted territory.”
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