Big superannuation funds on US inflation watch

The prospect of higher global interest rates would make the values of toll road projects and Sydney Airport look less attractive in the short term. Picture: Adam Yip

The big Australian superannuation funds had a special interest in what happened to the US bond market in the early hours of Wednesday morning.

The institutions are making two of the biggest infrastructure investments in the nation’s history, combining the purchase of Sydney Airport and the balance of the WestConnex Sydney toll-road system via Transurban.

While these are very long-term institutional investment strat­egies, it’s always disturbing when short-term fluctuations around “mobilising the cash” time go the wrong way.

If the American inflation rate had ballooned further than expected, the US bond market would have fallen sharply as yields rose and, in turn, the prospect of higher global interest rates would have made the airport and WestConnex values look less attractive in the short term. Australian interest rates over time are closely tied to the global rates.

In the US there are signs that the lingering pandemic infection rates are starting to slow the economy and curb the inflation rate growth. That’s why bond prices rose on Tuesday night, so lowering yields. By contrast, US shares encountered a setback.

The biggest forces governing the medium-term value of Sydney Airport and the toll roads are related to economic recovery in Australia on the back of high vaccination rates. But infrastructure values are also affected by interest rates, particularly if there is a rising momentum.

The global interest rate benchmark is the US 10-year bond rate, which had been edging up over the past week on fears of a further blowout in the US inflation rate. But the August figures showed that while American consumer prices are rising at an annual rate of about 5.3 per cent (a disturbing level), the latest figure was slightly better than expected. Had the inflation rate ballooned further, interest rates would have jumped.

And as trading closed last Friday, that’s exactly what markets feared would happen. The US 10-year bond rate had jumped to 1.34 per cent, fanned by the US producer price index, which had risen by 0.7 per cent in August, taking the index up a staggering 8.3 per cent in a year. The index tracks the changes in selling prices received by domestic producers for their output and is an important contributor to inflation. Upward thrusts above 8 per cent are 1970s-type inflation readings that pose a clear long-term inflationary ­danger.

But the US has experienced a growing number of Covid-19 infections, which has forced companies to delay their return-to-office schedules, and the jobs data is not showing the same explosive demand that was seen in earlier months. In a strange way, Covid is acting like a central banker and moderating demand.

The rise in bond prices was helped by some Federal Reserve buying. The US 10-year bond rate fell below the 1.3 per cent benchmark level to close at 1.28 per cent. Nevertheless, those high producer price numbers are a warning that there will be further fears of an inflationary breakout.

Over in the sharemarket the lower bond rates might have been expected to boost share prices, but the slowdown in growth rates is making investors a little nervous. The US sharemarket has had a fantastic run this year.

The S&P 500 index and the Nasdaq had both achieved gains in the 17-20 per cent range and it’s normal that after such big rises there is a correction. It could have come via higher rates, but this time the forces that appear to be moderating inflation are also causing nervousness in the sharemarket. In particular, the fact that many US offices had delayed their return to on-site work triggers trader nervousness that the Delta variant might have another lunge on the economy.

There are also similar inflationary forces in Europe. For example, there are supply shortages with consumers in the UK seeing empty shelves in grocery stories.

Meanwhile the US Federal Reserve and European Central Bank are looking for an opportunity to reduce their bond buying, which keeps a lid on rates and injects money into the economies.

The Federal Reserve is watching the labour market recovery to help gauge when it will wind down its bond-buying program. The European Central Bank announced that it would slow the pace of its asset purchase program.

The Federal Reserve begins a two-day policy meeting on September 21. Many analysts believe the Fed will talk about tapering in September and not announce it until the November meeting.

The US sharemarket is also becoming aware that the Biden administration proposes higher corporate and individual taxes, which in the longer term will reduce the liquidity in the system. It’s not good for share values.