Australian Bond markets posted solid gains over the year, as demonstrated by the Bloomberg Composite index generating a 6.8% return while Bank Bill Indices returned 4.4%.

The Trump administration tariff led economic policy saw volatility in markets in two waves. First, as the likelihood of being elected lifted, so too did the risk premium being priced into bond markets. Second, market movements became idiosyncratic in their reaction to the announcement of tariff measures, shifting deadlines and country specific retaliations, resulting in differing inflation and activity implications.

Unemployment in both Australia and the US remains near 50-year lows, largely on the back of significant government infrastructure and health care spending. The residual impact of the earlier population surge has abated, leading to an easing of housing pressures and private sector wages being contained.  

Australian inflation eased from approximately 4% to 2.5% allowing the RBA to move from a bias to lift cash rates, to cutting cash rates twice by year end, with more rate cuts likely. Australian short-dated bonds rallied 96 basis points to 3.2%, as the RBA became more concerned that the elevated uncertainty would further delay Australian consumers and businesses spending.

Conversely, for the US, 100 basis points of rate cuts were delivered by December 2024. The increased possibility of inflation from the new tariff policies announced, led the US Federal Reserve to pause. US short-dated bonds rallied from 4.7% to 3.7%.

Globally, yield curves steepened. The lift in trade and geopolitical risk, central bank balance sheet reductions via quantitative tightening or Foreign Exchange Reserve reduction and expansionary fiscal policy applied pressure to increase term risk premium. Longer dated bonds rallied, but not by the same yield magnitude as shorter bonds. Although most of the key drivers of elevated risk premiums apply more to international markets than Australia, the Australian 10-year yields fell a modest 15 basis points over the year to 4.15%.

Credit strongly outperformed government bonds over 12-month period, with credit returning 7.76% versus 6.23%. On a duration adjusted basis credit was close to doubling sovereign performance, displaying the elevated accruals and some spread compression among high grade corporate bonds. Five-year single A and BBB rated corporate yields fell 20 basis points versus the equivalent bond. Semi government bonds compressed by 10 basis points. Largely these spreads were unchanged versus the interbank “swap” curve. Asset backed securities continue to be the standout sector with spreads compressing to “swap” by 10 points.

Portfolio outperformance was driven by the significant overweight held in state government, major and regional bank corporate bonds and high-quality asset backed securities. Active duration management, largely via positioning the portfolio for rising bond prices, added to the outperformance.

Outlook for the Funds

We expect central banks to continue with a modest easing cycle, where cash rates are adjusted to neutral levels. For Australia, this is around 2.75%.

Contained volatility is a tailwind for credit. Near full employment conditions are supportive of the bank financials and residential mortgage-backed sectors given low arrears. Fundamental conditions improve with the delivery of expected RBA cash rate cuts. This is expected to contribute to the performance of all funds but particularly the income funds. 

Bond markets are expected to become less sensitive to trade headlines but retain some of the risk premium at the long end, given increasing international government deficit financing, and residual frictional inflation. The elevated term risk premium gives rise to an even steeper yield curve in state and corporate fixed rate markets particularly. The steeper the yield curve, the greater opportunity for capital gains.

As 10-year Australian Government Bonds are anticipated to trade around a 4.1% midpoint, active duration management within the fixed rate portfolios - the Sustainable Bond Fund (SBF), Green Bond Fund (GBF), and Australian Ethical Fixed Income Fund (AEFIF) = are expected to be well positioned for excess returns.  

A significant probability remains that outside of the US, tariffs and the associated trade path reshaping and diminishing oil demand have a disinflationary effect that creates a bullish bias for long dated bonds. This will particularly advantage the defensive duration settings of SBF, GBF and AEFIF.

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Portfolio outperformance was driven by the significant overweight held in state government, major and regional bank corporate bonds and high-quality asset backed securities.  

Fixed Income Funds (Wholesale): Performance vs benchmark^*

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*All returns are net of fees for the Wholesale option. Find more information on these funds via the managed funds page on our website including Retail performance.

Past performance is not a reliable indicator of future returns.

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1 Benchmark changed from Australian 90 Day Bank Bill to Bloomberg AusBond Bank Bill Index from 13 Aug 2019. The historical benchmark returns are calculated by linking indices.