“The four most dangerous words in investing are: ‘this time it’s different’.” - Sir John Templeton Cartoon of the Week Source: www.hedgeye.com Funds Snapshot Movers & Shakers (week ending 2 October): Stocks (ASX 200 ↑ 0.40%, S&P 500 ↑ 1.15%, NASDAQ ↑ 0.64%) Bond Yields (ACGB3Y 4.90%, ↑ 1 bp / ACGB10Y 5.34%, ↔) Bond Curves (A$ 3s10s +44 bps, ↓ 1 bp) Credit Spreads (Major Bank 5Y Senior +69 bps, ↔ / Tier 2 +133 bps, ↑ 3 bps) Policy (RBA Cash 4.60%, ↔ / US Fed Funds 3.75–4.00%, ↔) Oil (Brent US$104.72/bbl, ↑ 2.42%) Gold (US$4,194/oz, ↑ 1.28%) Market Overview The warning light flickers, and markets look past it. Australian inflation expectations jumped, and the risk we flagged last week arrived. Consumer inflation expectations rose to 5.3% in October from 4.9%, precisely the measure we identified last week as the main reason the RBA may not be able to stop at 4.60%. The Melbourne Institute gauge was steadier at 4.8%, with the monthly pace easing to 0.3% from 0.5%. Expectations matter because they feed wage claims and price-setting: a household that expects 5% inflation bargains for it. Yet three-year bond yields rose by less than a basis point. The market heard the warning but weighed it against an equally clear signal from the other side of the household ledger. That signal was confidence, which fell sharply after the hike. Westpac consumer confidence fell ↓4.7% to 80.4, the first reading since the RBA’s decision and well below the neutral level of 100. Cotality data showed national dwelling values ↓1.1% in September and ↓3.7% over the quarter, with Sydney ↓4.9%. Business was firmer: the composite PMI rose to 51.3 from 50.8 and job advertisements rose ↑2.2%. The picture is an economy still expanding, households under visible strain, and inflation psychology deteriorating — a difficult mix for a central bank whose main tool works by slowing demand. The same pattern is emerging in the US. New York Fed one-year inflation expectations rose to 3.90% from 3.58%, well above the 3.64% expected, and the University of Michigan survey put one-year expectations at 4.7% and five-to-ten-year at 3.5%, both up a tenth, while sentiment slipped to 46.3. The ISM services index held at 54.9, but prices paid rose to 74.0. Minutes of the Fed’s September meeting showed all 19 officials supported that hike, and Governor Waller said further increases will likely be needed, though not necessarily at consecutive meetings. Money markets see a high chance of another hike before year-end. Europe supplied the fiscal anxiety. Political and budget turmoil in France pushed the euro to its weakest since May 2025, and UK ten-year gilt yields climbed to around 5.48%, a one-year high. Euro area producer prices rose ↑8.2% over the year to August, from 5.8% and above the 7.6% expected — cost pressure that typically reaches consumers with a lag. As ANZ observed, near-term tightening expectations retreated over the week, yet long yields kept climbing. That points to structural forces rather than doubts about any one central bank: quantitative tightening, heavy government borrowing, and competition for capital, including corporate borrowing to fund the AI build-out. The dominant narrative: inflation psychology versus earnings optimism. The VIX eased to 14.84 and the S&P 500 set its first record since August. Equity investors are focused on an expected ~25% rise in US third-quarter profits; bond investors on rising inflation expectations and government debt. Both cannot be right for long. In Australia the tension is sharper: expectations are rising while confidence and house prices fall, leaving the RBA to balance a deteriorating inflation mindset against a weakening consumer. Oil rose despite more supply, because the market doubts it will last. Brent rose ↑2.42% to US$104.72 per barrel, ↑61% over twelve months. The G7 agreed to release up to 100 million barrels of emergency oil and diesel over four months, and Middle Eastern exports have recovered to around pre-war levels, briefly taking Brent to about US$100. Prices recovered as Iranian attacks on vessels in the Strait of Hormuz resumed and the US deployed another aircraft carrier to the region. With inventories estimated at five-year lows, there is little buffer against another disruption, so a risk premium is rational. Energy remains the dominant driver of headline inflation, and its persistence is now visible in household expectations. Equity Markets Records offshore, a thinner cushion at home. Australian equities edged higher, but the valuation cushion thinned again. The ASX 200 rose ↑0.40%, leaving it ↓2.19% over the month and ↓2.82% over twelve months. The weakest session was Thursday (↓0.76%), led by Materials (↓2.03%) and Financials (↓0.99%), while Staples (↑1.42%) and Energy (↑1.36%) rose; full weekly sector data were unavailable. On 18.2x forward earnings, the 5.50% earnings yield sits just 16 bps above the ten-year bond, down from 21 bps — this time squeezed by rising prices rather than rising yields. The 3.57% dividend yield remains 103 bps below cash before franking. With expectations rising and confidence falling, consumer-facing earnings face pressure that valuations leave little room to absorb. US equities reached new highs on earnings, not on bonds. The S&P 500 rose ↑1.15% and the NASDAQ ↑0.64%, led early by technology and AI-related names ahead of a reporting season expected to show profits ~25% above a year ago. The rally faded as elevated oil revived inflation concerns and chipmakers sold off on doubts that AI spending can be justified by revenue as borrowing costs rise. At 21.6x, the S&P 500 earnings yield sits about 61 bps below the ten-year Treasury, the NASDAQ about 201 bps below. Some strategists argue the combined pressure of US$100 oil, 5% yields and a firm dollar is consistent with a 20–25% fall. We’re not necessarily forecasting that, but when bonds and equities disagree this sharply, bonds have more often been right. Elsewhere, cheapness is still not a catalyst. Europe’s STOXX was flat (↑0.03%) despite a 6.71% earnings yield, held back by French political risk and surging producer prices. Japan’s Nikkei rose ↑1.06% (↑42% over twelve months), while China’s CSI 300 fell ↓0.93% and is ↓11.5% over the quarter. Regional valuation gaps are wide, but cheap markets need a reason to re-rate, and Europe does not yet have one. Fixed Income & Credit A quiet curve, a louder question. Australian government bonds barely moved despite the jump in expectations. Three-year yields rose ↑1 bp to 4.90%, five-year ↑1 bp to 4.98% and ten-year were unchanged at 5.34%, flattening the three-to-ten-year curve by 1 bp to 44 bps. The ten-year traded near 5.40% on Tuesday, close to a 15-year high, before global yields eased. The three-year sits 30 bps above cash and three-month BBSW 17 bps above at 4.77%, consistent with some chance of further tightening rather than a firm expectation. Calm in the face of a 40 bp jump in expectations suggests investors believe falling confidence and house prices will do part of the RBA’s work. The RBA: caught between expectations and confidence. The risk we flagged materialised, but so did the cost of tightening. Tuesday’s minutes will show how the Board weighs inflation psychology against household strain. Thursday’s labour force survey (consensus +20,000 jobs, unemployment steady at 4.6%) will show whether the labour market — the channel through which expectations become wages — is still tight. A firm report alongside 5.3% expectations would make a second hike much harder to rule out; a soft one would support a longer pause. US Treasuries eased after touching multi-decade highs. Long-dated yields hit multi-decade highs early in the week before easing as risk appetite cooled. Two-year yields fell ↓4 bps to 4.79% and ten-year ↓3 bps to 5.24%, leaving the curve near 45 bps. The rally came despite hawkish minutes and higher expectations, a reminder that weekly moves are noise around a rising trend: the ten-year is still ↑40 bps over the month and ↑110 bps over the year. A Fed pause may not bring long yields down if term premium stays elevated, and offshore long yields are setting a floor under Australian ten-year yields regardless of domestic weakness. Credit: senior steady, subordinated debt softening. Major bank senior spreads were unchanged at 69 bps, below their 73 bp one-year average, but Tier 2 widened ↑3 bps to 133 bps, with some dealer quotes at 134–136 bps. Tier 2 is ↑6 bps wider over the month though still inside its 137 bp average. The floating rate credit index widened ↑0.3 bps to 63.9. Investors are asking more to sit lower in the capital structure as the domestic outlook softens — gradual repricing, not stress. RMBS / ABS deal flow has been heavy, with demand strong down the stack. For income investors, the hike is now fully in the coupon. Floating rate credit yields approximately 5.41% all-in, major bank senior approximately 5.95% and Tier 2 approximately 6.59%. Floating rate credit pays roughly 81 bps above cash and 184 bps above the ASX 200 dividend yield, ranking ahead of equity, and slightly more than ten-year government bonds with far less price sensitivity. This week reinforced our preference for floating rate credit as the core income engine: if rising expectations force another hike, coupons reset higher; if weak confidence brings a long pause, short-to-medium duration benefits. Long bonds remain hostage to global term premium. In Tier 2, the 64 bp pick-up over senior is reasonable today, but selectivity matters and better entry levels may emerge if the slowdown deepens. Outlook The data that decides the pause. The central case. Growth is slowing unevenly rather than collapsing: Australian business surveys and job advertisements are holding up while household confidence and house prices fall. Inflation is still energy-led, but its spread into expectations in Australia, the US and Europe mean it is becoming more than a headline story. A pause at 4.60% remains the RBA’s most likely path, but we now regard a second hike as a meaningful minority scenario rather than a tail risk. Rate cuts are not a realistic near-term scenario while expectations are rising. Central banks. The Fed appears set on further tightening; Waller’s flexibility on timing makes Wednesday night’s September CPI (consensus 3.6% headline, up from 3.4%, and 2.5% core) especially important. The ECB faces producer prices above 8% and a French fiscal problem that could test its willingness to support bond markets. Policy rates are close to their peaks, but long-dated yields are increasingly set by government borrowing and inflation risk. Key risks. First, that rising expectations become self-reinforcing through wages, forcing the RBA to tighten into a weak household sector, with consequences for house prices, mortgage arrears and bank subordinated debt. Second, that US and UK long yields break higher, pressuring equities already carrying negative risk premia and lifting Australian long yields. Third, that US earnings disappoint against ~25% growth expectations, or AI doubts broaden in a highly concentrated market. Fourth, a renewed disruption to Middle East oil flows with inventories at five-year lows. Key opportunities. Floating rate credit at around 5.4% remains the core income opportunity, with built-in protection if rates rise further. Short-to-medium duration offers asymmetric value if weak confidence forces a long pause. Wider Tier 2 spreads are beginning to offer better entry points for investors comfortable with subordination. Ten-year government bonds near 5.34% will become attractive once global term premium stabilises, a condition still not met. What would change the narrative? In Australia, a strong labour force survey alongside 5.3% expectations would revive hike pricing, while a weak one would strengthen the case for a long pause and for adding duration; NAB’s business survey (confidence previously −8) will show whether firms share households’ gloom. In the US, a hot CPI with rising expectations would make another Fed hike close to certain, while a soft core reading and weaker retail sales (consensus +0.3% after +1.1%) would ease the pressure. China’s producer prices, expected to rise to 4.5% from 3.8%, will show whether China is adding to global goods inflation. Beyond the data, oil and the first major US earnings reports will decide whether equity optimism or bond-market caution proves correct.

“It takes only one drink to get me drunk. The trouble is, I can't remember if it's the thirteenth or the fourteenth.” - George Burns Cartoon of the Week Source: www.heraldsun.com.au Funds Snapshot Movers & Shakers (week ending 2 October): Stocks (ASX 200 ↑ 0.20%, S&P 500 ↓ 0.27%, NASDAQ ↑ 0.45%) Bond Yields (ACGB3Y 4.89%, ↓ 12 bps / ACGB10Y 5.34%, ↓ 3 bps) Bond Curves (A$ 3s10s +45 bps, ↑ 9 bps) Credit Spreads (Major Bank 5Y Senior +69 bps, ↓ 1 bp / Tier 2 +130 bps, ↔) Policy (RBA Cash 4.60%, ↑ 25 bps / US Fed Funds 3.75–4.00%, ↔) Oil (Brent US$102.25/bbl, ↓ 1.98%) Gold (US$4,141/oz, ↓ 3.35%) Market Overview The RBA hikes, and the bond market exhales. The RBA raised the cash rate to 4.60%, a 15-year high and short-dated bonds rallied. The 25 bp increase was exactly what consensus expected, and three-month BBSW had already embedded it. Three-year yields nonetheless fell ↓12 bps to 4.89%. That is not a contradiction. Markets price the path of policy rather than the decision itself, and once a well-telegraphed hike is delivered the question becomes how much further the Bank needs to go. The week’s data gave investors reason to think the answer may be “not much”. Inflation was high, but not quite as high as feared. The August monthly indicator rose to ↑4.0% from ↑3.5%, below the ↑4.1% expected, while the trimmed mean held at ↑3.6% and rose only ↑0.2% in the month against ↑0.3% forecast. A headline rate 40 bps above the trimmed mean says the acceleration is concentrated in volatile items — consistent with energy — rather than spreading through the broad basket (yet). Underlying inflation well above the 2–3% target band justifies the hike; its failure to accelerate is what allowed markets to price less beyond it. The domestic consumer paused. Household spending was flat in August against a 0.4% rise expected, following 1.1% in July. Building approvals fell ↓6.1% against ↓1.0% expected, job vacancies fell ↓0.9% over the quarter, and the final manufacturing PMI of 49.6 remains in contraction. The trade surplus narrowed to A$495m, well short of the A$2.0bn expected. Private sector credit still grew ↑0.6% in the month, so borrowing has not slowed. One flat month is not a trend, but it sits alongside last week’s weak PMIs, and the RBA has now tightened into it. The US delivered softer jobs and firmer prices. September payrolls rose only 29,000 against 90,000 expected, with a net 60,000 revised away from prior months, and unemployment ticked up to 4.2%. Consumer confidence fell to 81.9 against 89.0 expected. Yet the ISM manufacturing prices index jumped to 77.9 from 71.1, and annual revisions lifted second-quarter growth to 2.2% from 1.5%. Core PCE of ↑3.0% looked soft against ↑3.3% expected, but the prior month was revised down by the same amount, so the apparent miss reflects revisions rather than genuine cooling. In Europe, headline inflation rose to ↑3.8% from ↑3.2% with core steady at ↑2.5%. The synchronised inflation problem we described last week was confirmed, and its energy-led character is clearest there. The dominant narrative has moved from “how high” to “how long”. Sentiment stayed calm, the VIX edging up to 15.31. The revealing signal was the shape of bond markets: short-dated yields fell in Australia and the US as less tightening was priced, while the US ten-year rose to within 2 bps of its one-year high. Markets are increasingly confident policy rates are near their peak, and increasingly unsure how long inflation will hold them there. Brent eased ↓1.98% to US$102.25 per barrel, a fourth week without a decisive move, leaving prices ↑6.9% over the month and ↑59.5% over twelve months. For inflation the level matters more than the weekly change: with crude roughly 60% above a year ago, energy will keep lifting headline inflation for some months even if prices drift lower. Europe’s 130 bp gap between headline and core inflation, and the jump in US manufacturers’ prices paid, show that transmission is still under way. Equity Markets A quieter week that settled very little. Australian equities steadied as the bond market gave a little back. The ASX 200 recovered ↑0.20% after the prior week’s ↓0.76% fall, though it remains ↓3.30% over the month. On 18.0x forward earnings the index yields 5.54% against a ten-year bond at 5.34%, an equity risk premium of roughly 21 bps. The eight-week sequence reads 33, 27, 18, 16, 10, 19, 16 and now 21 — every move driven by bonds, none by earnings. The hike sharpened the comparison with cash, which now pays roughly 103 bps more than the market’s 3.57% dividend yield before franking. Over twelve months the index has returned ↓2.95% in price terms, or roughly ↑0.6% with dividends. Franking narrows the gap, but shareholders are still accepting full equity risk for less than a term deposit. Offshore valuations are under growing pressure from long-dated yields. US equities were broadly flat while the ten-year Treasury yield rose ↑11 bps to 5.27%. The S&P 500 at 21.4x yields 4.67%, a risk premium of roughly negative 60 bps from negative 52 bps; the NASDAQ at 31.0x sits some 204 bps below the risk-free rate. Weak payrolls would ordinarily help equities through lower rate expectations, but the long end — which matters most for valuing growth earnings — moved the other way. Europe is the contrast: the STOXX on 15.1x offers an earnings yield of 6.64% yet fell as regional inflation rose. Cheapness is not a catalyst while headline inflation is still climbing. Fixed Income & Credit The front-end rallies on the hike, the long end does not. Australian government bonds rallied, led by shorter maturities. Three-year yields fell ↓12 bps to 4.89%, five-year ↓7 bps to 4.97% and ten-year ↓3 bps to 5.34%, steepening the three-to-ten-year curve by 9 bps to 45 bps. This says near-term policy is credible and the peak close, while investors still demand a premium to lend for ten years. The three-year now sits 29 bps above the new cash rate, against 66 bps above the old rate a week ago, and three-month BBSW was unchanged at 4.76%, just 16 bps above cash. The tightening that was priced has been delivered, and markets have scaled back how much more they expect. The RBA decision: the right instrument for half the problem. A week ago we argued that the Bank’s tool works on domestic demand, while much of the inflation is imported. This week’s data sharpened both halves: spending was flat and approvals fell, while the gap between headline and trimmed mean inflation points to energy. Underlying inflation at 3.6% justifies the move; whether it justifies another depends on whether that figure rises. The next signals are the Melbourne Institute gauge (4.8% previously) and consumer inflation expectations (4.9% previously). Elevated expectations are how a temporary energy shock becomes a persistent wage problem, and the main reason the Bank may not be able to stop here. US Treasuries steepened again, this time against the data. Two-year yields fell ↓2.7 bps to 4.82% while ten-year yields rose ↑11 bps to 5.27%, steepening the curve to 45 bps from 31 bps. The front end responded to softer jobs data; the long end rose on upward growth revisions, rising input prices and, in our view, higher compensation demanded for holding long bonds through an inflationary period. When long yields rise on bad news, term premium rather than the next Fed decision is setting the price. A 14 bp gap opened between the US and Australian ten-year moves in a single week, with local long bonds anchored by soft domestic data. Bank credit held steady while the broader market softened slightly. Major bank senior spreads were recorded at 69 bps, ↓1 bp, and Tier 2 unchanged at 130 bps, while the floating rate credit index widened ↑1.2 bps to 63.6 and fixed rate ↑1.1 bps to 80.0. The floating index is now around 5 bps wider than three months ago and marginally above its one-year average. Stable bank spreads alongside a softer broad index is consistent with modest weakness among non-major issuers, though our data does not break this down. It is orderly rather than stressed — investors asking slightly more as growth softens, not doubting repayment. We have no RMBS or ABS spread data this week; flat household spending under a higher cash rate is the combination we will watch through mortgage arrears. For income investors, the hike was already in the price — and that is the point. Floating rate credit yields approximately 5.39% all-in, broadly unchanged, because BBSW moved ahead of the RBA rather than after it; floating rate investors captured the hike in preceding weeks without bearing capital risk. Major bank senior yields approximately 5.96% and Tier 2 approximately 6.57%. Floating rate credit pays roughly 79 bps above cash and 182 bps above the ASX 200 dividend yield and ranks ahead of equity. Last week we said duration had cost investors’ money; this week some was returned, but almost entirely at the three-to-five-year part of the curve. Short maturities respond to domestic policy, long maturities to global term premium, which is still rising. For defensive portfolios that argues for floating rate credit as the core income engine, complemented by moderate duration at the shorter end rather than long bonds. Outlook From pricing the hike to pricing the peak. The central case. Headline inflation remains elevated across Australia, Europe and the US, driven substantially by energy, while underlying inflation is high but no longer accelerating. Growth is slowing unevenly: the Australian consumer has paused, US hiring is fading even as surveys stay firm, and China is stabilising. We now attach a higher probability to the RBA holding at 4.60% for a period, with further tightening contingent on underlying rather than headline inflation — and a lower but meaningful probability to a second hike if inflation expectations keep drifting up. Central banks. The RBA has acted and markets expect a pause. The Fed faces a labour market losing momentum and input prices rising sharply; the minutes of its September meeting, due this week, will show how it is weighing them. The ECB confronts headline inflation of 3.8% and producer prices expected to jump to 7.9% from 5.8%, a pipeline pointing to further pressure. Central banks can steer the front end of their curves, but long-dated yields are increasingly set by global inflation risk. Key risks. First, that US ten-year yields break decisively above their one-year high, pressuring equities already carrying a negative risk premium and pulling Australian long yields with them. Second, that consumer inflation expectations, already around 4.9%, continue rising and convert an energy shock into a wage problem requiring more tightening than a paused consumer can absorb. Third, that the gradual widening in broad credit spreads accelerates if domestic growth weakens further. Key opportunities. Floating rate income at around 5.4% remains the clearest, with the hike already captured and spreads close to average rather than stretched. Short-to-medium duration has begun to work and should continue to if the RBA is near its peak. Ten-year government bonds at 5.34%, within 8 bps of their one-year high, offer an attractive entry once global term premium stabilises — a condition not yet met. What would change the narrative? Most immediately, this week’s Australian inflation expectations and Melbourne Institute gauge: a further rise would revive hike pricing and reverse much of this week’s front-end rally, while a decline would strengthen the case for a pause and for adding duration. Westpac consumer confidence will show whether August’s flat spending was a pause or a retreat. In the US, the services ISM prices component and the Fed minutes will show whether cost pressure is spreading beyond manufacturing. Beyond that, a decisive move in crude, or a US ten-year that settles back below 5%, would resolve much of what neither markets nor central banks can yet answer.

In this video, Scott Rundell, Chief Investment Officer at Mutual Limited, looks at what a softer Australian housing market means for residential mortgage-backed securities, or RMBS. Using recent bank reporting season data and observed market evidence, Scott explains why falling property values do not automatically translate into mortgage credit losses, and why borrower repayment capacity, arrears and unemployment remain the key indicators to watch. Watch the full video below (16:40). Transcipt Scott Rundell (0:00:07) Today we're covering two connected stories. First, a short look at the August bank reporting season: what the major and regional banks told us about profitability, capital, credit quality, funding, and their outlook. Second, and this is where we'll spend most of our time, the Australian housing market and what it means for residential Mac mortgage-backed securities or RMBS. House prices have started to fall, and it's a fair question to ask what mean what that means for investments backed by mortgages. We'll work through the question step by step using observed data wherever we can. Let's start with the banks. If I had to sum up this reporting season in a sentence, it would be this: the profit lines were fine, the balance sheets are strong, but the forward-looking credit indicators have started to drift. Starting with profitability. Earnings generally beat expectations, but those expectations were low. You can see the profit growth figures at the bottom left, CBA up 7%, Westpac and NAB up 2%, ANZ up 5%, Bendigo up 3%, and Judo the standout, with profit before tax up 34%. The more interesting point is where the margin came from. At every major, the pricing on loans actually went backwards. What helped margin was treasury income, hedging, and deposit pricing. That matters because some of these supports are more durable than others. On capital, every bank is above its target. The CET rate, CET one ratios on the chart range from about 11.3% at Benigo up to 12.5% at ANZ. The direction of travel is slightly low at CBA, Westpac, and Bendigo, but that's because capital is being used to fund growth, not absorb losses, which is important. ANZ is the one building capital. NAB has the thinnest headroom at roughly 50 basis points on top of pro forma basis. Finally, asset quality. Realised losses remain very low by historical comparisons. Mortgage arrears are edging up at CBA and ANZ, but falling at Westpac. On the business side, watch lists are growing, but non-performing loans have barely moved. Provision buffers remain well above the bear case, the bank's bear case scenarios. So, this story is about loan potentially migrating to weaker grades over time. It's not a solvency question. Turning to liquidity and funding. The banks are comfortable here. Liquidity ratios are between 130 to 140% compared to a regulatory requirement of 100%. And the net stable funding ratios between 100 and 111%, 125%, again compared to a regulatory requirement of 100%, all well above regulatory minimums. But there's a subtle shift underway. Deposits are no longer keeping pace with lending, so these stable funding ratios are grinding lower. The banks are issuing a lot more term debt. For example, Westpac last year issued $38bn this financial year, against $28bn the previous year. The competition for deposits is now where margin's being won or lost. Now for the outlook statements, which is our bridge into housing. The banks agree on the direction: economic growth is slowing, inflation remains high, and housing is turned down. Mortgage applications fell between 15% - 20% following the May Federal Budget and three rate rises this year. Where they disagree is in the magnitude. Westpac made the standard revision of the season, cutting its calendar 2026 house price forecast from a rise of 2.5% to a fall of 1%. And on the chart, you can see the spread of forecast for housing credit growth, next financial year from 2.5% at NAB to between 4% and 6% of CBA. All three grew roughly 6.5% - 8.5% last year. So, everybody's expecting a slowdown. The debate is how sharp. The share market's verdict was quite clear. Banks with heavy housing exposure were marked down, while ANZ and Judo with stronger business lending were rewarded. So, what are the key takeaways? First, credit is sound. Capital, liquidity, and provisions are comfortable across the sector. Nothing this season changes the credit picture for the major banks. The realistic risk is gradual deterioration from a historically strong base, not solvency concerns. Second, bank debt supply will stay heavy through the next financial year. Westpac has 31 billion of maturities ahead, and NAB has raised over 30 billion, including 6 billion of tier two capital. Expect an active primary market. Third, deposit pricing is the live battleground. It drove margins at CBA, Judo, and Bendigo, and it's where competitive presses show up first. Fourth, growth is rotated from housing to business growth. That's where above system growth margin and demand will set in. And fifth, bank specific factors increasingly separate one bank from another. Bendigo's regulatory conditions, a control issue identified at Judo, and BOQ’s limited disclosure until October are all examples that sector-wide numbers won't show you. That's the banking picture. Now let's turn to housing and RBS. Here are the six numbers we think matter most. I'll introduce them now and we'll unpack each one over the rest of the presentation. On values, national dwelling prices have fallen 3.1% over the quarter to the end of August. That's a meaningful quarterly fall, though prices are still higher than a year ago. On market sensitivity, during the risk period or risk off period, I should say, in March, triggered by the conflict in Iran, our sample of mezzanine RMBS holdings moved by less than 0.5% in capital price terms. And in the 30 days after the May budget, those same holdings actually rose by just over 50 basis points or 50.5%. On credit: weight average 30 day plus day arrears on RMBS mortgages in the pools we hold is 2.59%. That compares with around 3.5% for the broader market as measured by Standard Poor's SPIN data. On structural protection: house prices would need to fall 25%, and nearly 4% of the mortgage in a pool would need to default before a single B rated tranche was at risk of a capital loss. And on history, the realised loss rate on Australian rated RMBS, both prime and non-conforming, is zero, no losses ever. If you take one idea away from this section, make it this one: falling valuations are not the same thing as borrowers not being able to pay. Mortgage pools are damaged when borrowers lose the capacity to meet their repayments, not when property values drift lower. Let's look where prices have actually moved because the headlines don't tell the full story. The dark blue lines in this chart show the change over the quarter. Almost every capital city fell, and nationally prices were down 3.1%. Sydney and Melbourne led the decline down 4.7 and 3.9%, respectively. But now look at the lighter coloured bars, which show the change over the full year. Sydney and Melbourne are the only two major cities that are meaningfully negative over that period, both around 4.5% lower. Canberra’s roughly flat. Everywhere else is still up, and in some cases strongly. For example, Perth is up over 15% for the year, Darwin also nearly 15%, Brisbane 11%, Adelaide, Hobart around 8%, and regional markets are up 8%. Nationally, house prices are still 3% higher than they were a year ago. So, the picture is one of momentum moderating sharply in two markets rather than a broad-based collapse. The quarterly numbers that make the headlines are coming off a very strong base, and in most of the country prices still above where they were twelve months ago. That raises the obvious question. Does the weakness in Melbourne and Sydney matter for mortgage pools? Let's look at that next. Our view is that the composition of this decline matters much more than its size. And two features make a valuation story rather than a credit story. First, nobody's being forced to sell. Transaction volumes have fallen because buyers are pausing, expecting lower prices, while sellers are refusing to accept prices. We're not seeing any material for increase in foresales. That's important because losses in a mortgage pool come from distress sales, where a lender has to realize the property at a discount. They don't come from valuations drifting lower while the owner keeps paying. Second, the weak just largely sits outside the pools. The falls in Sydney and Melbourne are concentrated in higher value property, the top quartile. The average mortgage in the deals we hold is $750,000, and concentration limits cap exposure loans above two and a half million. The segment showing the most price stress is substantially absent from these pools. Now, we don't dismiss the headwinds. Three RBA rate hikes and likely another possible two, cost of living pressure, weak consumer sentiment, and the budgets of tax changes are all real. But there are real structural offsets too: constrained housing supply, continued population growth, and most importantly, a resilient labour market. On housing supply, the government is likely to fall two hundred thousand dwellings short of its election target of 1.2 million. Let's put the forecast into context. Consensus is now for a peak the trough fall of anywhere between six to ten percent fall over the next twelve to fifteen months. In the 2019-2020 COVID period, prices fell around six to eight percent. In 2022 to 2023, when the RBA started to hike rates aggressively, prices fell eight to ten percent. RMBS losses in both episodes were zero. It was very much the same story in the GFC in the 2008-2010 period. And our stress-testing bear case already assumes a 10% fall in the first year of a deal we look at, plus a 15% haircut on the value of the property at the point of default. That's effectively a 25% decline. So, the fall now being forecast is of the same order as the last two downturns, and it sits comfortably inside what we already test for. Common concern is, even if there are no credit losses, won't RMBS prices fall when markets get nervous? We don't need to model the answer to that. In March, the conflict involving Iran produced a broad multi-asset risk off event. So, the market ran the test for us, and this chart shows the result. Over that period, the ASX 200 fell nearly eight percent, the S&P 500, about five percent, even government bonds fell around 1.4% and fixed rate credit 1.2%. Mutual High Yield Fund, which is a big investor in RMBS, was able to maintain its capital position and gained point zero four percent. Slow, but it's still positive. Floating rate credit also in this chart you can see up 0.2%. And our sample of RMBS holdings moved less than 0.5% in the capital price. And the coupon from that series meant that the fund delivered a positive return. The reason is structural. These are floating rate notes because the coupons reset the bank will swap above the bank will swap rate. There's no interest rate duration to reprice. The only thing that can move the price is credit spread. And in a period like March, only spread widening is partly offset by higher BBSW and the ongoing coupon income. It's also worth remembering that these figures are price movements only. Coupon income continued to accrue throughout, And as we saw in the earlier slide, in the month of after the May budget, those same holdings recovered and moved higher despite the new structural risk to housing. This is the most detailed slide in the presentation, so let me guide you through it rather than read every number. Each row is a house price decline from down 5% to the top of 60% at the bottom. Each column is a tranche rating from single B through to AAA. And each cell shows the percentage of mortgages in the RMBS pool that would need to default before the tranche loses any capital. So, start at the top. At a 5% or 10% price decline in housing. There's no plausible default rate that produces a capital loss at any rating. Remember, consensus is a 6% to 10% national fall. Now move down to 25% row, which is the effective decline our bear case already tests. Here, a single-A tranche needs nearly 10% of the pool to default before capital is lost. Even a single B trance, the lowest rating, needs nearly 4%. Compare that with what we've actually seen, arrears of 2.59%, and arrears are not defaults. The vast majority of loans in arrears catch up on their repayments. Historically, cumulative loss rates on mortgages have been in the order of two to ten basis points or 0.02% to 0.10%. Put differently, that's $200 lost for every $1 million lent, which is very, very low by historical and global standards. It's also worth noting that Australia has never recorded a 25% national price decline in any given 12-month period. Through the early 1990s recession, the GFC, COVID, peak declines were around 10%. One honest point that at this about this table, it isn't linear. As price falls deepened, each default causes a bigger loss. So, the required default rate drops away quickly. But even at a 60% decline, a scenario well beyond anything in Australian history, a single B trend still needs 1% of mortgages to default. And triple-A tranche is nearly fourteen percent. So how do we apply this in practice? Every deal is stress tested before you can buy it. It's a three-step process. First, we analyse the pool loan by loan, forecasting arrears and foreclosure rates on every individual mortgage. Second, we run those foreclosures through the deal's cash flow structure to test that every layer of the capital stack is repaid in full over the life of the deal. And third, it's a binary decision. If the model forecasts a capital loss, the deal isn't approved, and our portfolio managers are prohibited from investing in that particular deal. The bear case is deliberately conservative. The cash rate peaks at 5% by the end of 2027, increasingly more likely than not, given the current inflation scenario, but still. Unemployment rises to 5%. And the over the remaining life of the exposure and house prices fall that 10% plus the 15% haircut I mentioned earlier. So, 25% house price decline. Timing matters as much as magnitude too. A deal that collects excess spread for several years before defaults emerge is far better protected than one that defaults in day one, and that's extremely unlikely. And importantly, the tests generally exclude deals. We only approve about two-thirds of what we look at. So, four in ten deals fail because of the forecast on cash flow loss. Those rejected deals are available to buy. This is a reflection of process, not a shortage of supply. We just don't invest in everything. And you can see the outcome in our numbers. Our arrears numbers are 2.59%, sitting against 3.5% for the broader market. Stress tests are useful, but history is more persuasive. Australian dwelling prices have fallen twice since 2014, and this table compares the two episodes. In 2019 to 2020, house prices fell 6 to 8% while the RBA was cutting rates, with the three-month bank bill falling from 2.9 to just under 1%, and that was the COVID impact. Unemployment was around 5% and rising. In 2022 to 23, prices fell 8 to 10% alongside a really aggressive RBA rate height cycle, and then from 0.1% to 4.35%. Fastest policy tightening in a generation. The bank bill went from 0.3 to 4%, which is what our the bank's price in mortgages off. And non-conforming arrears nearly doubled from 2% to 4%. Spreads moved in both episodes. They widened further down the capital stack but stayed contained higher up. And in both cases, RMBS losses were zero. So, we've seen downturns of the same order as the one we now forecast under both falling and rising interest rates without a single loss. And going further back, non-conforming arrears exceeded 23% in 2000 in the early 2000s, an average in the mid-teens during the GFC. In both scenarios, no rated RMBS trench ever incurred a loss or a default. So, what do we watch? You'll notice house prices and not on the list. Historically, they haven't been a meaningful driver of RMBS performance. We watch arrears first, and specifically non-conforming arrears, because they move first and the furthest. Unemployment matters, but perhaps less than you expect. The chart on the left here shows you that. During COVID, unemployment spike to around seven percent, yet arrears peaked at only five percent. On the right-hand side, interest rates have historically been the stronger influence, which is why inflation and the rate path it drives is the indicator most likely to change our view. So, to bring it together, the housing market is softening, and that's a valuation story. The stress required to impair capital in rated RMBS is has no local precedent. And most importantly, what matters is whether borrowers can keep paying, not where valuations sit. Thank you for watching. If you'd like to discuss any of this in more detail, please get in touch with the Mutual team.

“Political language is designed to make lies sound truthful and murder respectable.” - George Orwell (1946) Cartoon of the Week Source: www.heraldsun.com.au Funds Snapshot Movers & Shakers (week ending 25 September): Stocks (ASX 200 ↓ 0.76%, S&P 500 ↑ 1.21%, NASDAQ ↑ 2.06%) Bond Yields (ACGB3Y 5.01%, ↑ 8 bps / ACGB10Y 5.37%, ↑ 10 bps) Bond Curves (A$ 3s10s +36 bps, ↑ 3 bps) Credit Spreads (Major Bank 5Y Senior +68 bps, ↓ 2 bps / Tier 2 +129 bps, ↓ 1 bp) Policy (RBA Cash 4.35%, ↔ — consensus 4.60% at Tuesday’s meeting / US Fed Funds 3.75–4.00%, ↔) Oil (Brent US$104.32/bbl, ↑ 0.43%) Gold (US$4,285/oz, ↓ 2.14%) Market Overview… the RBA prepares to tighten into a slowing economy. The Australian labour market delivered a strong headline and a weak report. August employment rose ↑39,500 against ↑20,000 expected, reversing July’s revised fall of 15,900. Beneath it, full-time employment fell ↓6,300 while part-time rose ↑45,800, and unemployment rose to 4.6% from 4.5% as participation lifted to 67.1%. More people found work and more looked for it, but the jobs created were the less secure kind. An unemployment rate rising on participation is not the same as one rising on redundancies, but nor is this the robust print the headline suggests. The business surveys, released a day earlier, were unambiguous and poor: the September composite PMI fell to 50.8 from 52.7, services to 51.4 from 53.2, and manufacturing to 49.3 from 52.0 — below the line separating expansion from contraction. Surveys lead where employment data lags, and the surveys point down. Markets nonetheless moved to price a rate rise. Consensus expects the RBA to lift the cash rate to 4.60% on Tuesday, and the August monthly headline inflation indicator due the following day is expected to jump to ↑4.1% year-on-year from ↑3.5%, with the trimmed mean steady at ↑3.6%. That combination explains the week: an inflation print the RBA cannot ignore, arriving as forward-looking activity data weakens. We flagged this configuration three weeks ago; it is now the base case rather than a risk. We should be plain about last week’s call. We described the decoupling as the week’s most important development, while listing as our first key risk that it might prove a positioning unwind that reversed on a firm employment print. That is precisely what happened. The lesson is not that the domestic weakness was imaginary — the PMIs confirm it — but that weak growth does not protect a bond market when inflation is the binding constraint on policy. The US gave the clearest growth signal of the cycle. The September composite PMI jumped to 58.4 against 55.3 expected, with manufacturing at 57.0 and services at 58.7, while core capital goods orders rose ↑1.6% and jobless claims fell again to 197,000. Against that, the regional Federal Reserve surveys were weak — Philadelphia non-manufacturing at -22, Richmond manufacturing at -2 — and consumer sentiment remains depressed at 48.1. Households feel poor and spend anyway; we treat the aggregate as strong but the dispersion as a caution. Europe improved too, its composite PMI beating at 53.1, while this week’s flash CPI is forecast to jump to ↑3.7% from ↑3.2%. If delivered, the inflation problem is synchronised rather than domestic. The dominant narrative is a central bank cornered by inflation. Sentiment showed no stress — the VIX was unchanged at 14.87 — but the composition of returns tells the story: bond yields rose globally, the US long end led, gold fell sharply and the Australian dollar weakened against every major currency. Markets are pricing more inflation and more tightening without pricing a growth accident. That is coherent, and demanding. Equity Markets… a widening gap between Australia and everywhere else. Direction, not just dispersion, separated markets this week. The Nikkei rose ↑2.07%, NASDAQ ↑2.06%, S&P 500 ↑1.21% and STOXX ↑0.50%, while the ASX 200 fell ↓0.76%, the Hang Seng ↓0.97% and the CSI 300 ↓1.51%. Australia and China fell; the rest of the developed world rallied, leaving the ASX ↓5.45% over the month. Australian equities fell for an explicable reason. A market with no valuation cushion cannot absorb a 10 bps rise in the discount rate, and a market facing a central bank expected to raise rates next week has a second problem on top of the first. The ASX 200 now trades on 18.1x forward earnings for an earnings yield of 5.53% against a ten-year bond at 5.37%, an equity risk premium of roughly 16 bps. The seven-week sequence reads 33, 27, 18, 16, 10, 19 and now 16. The prior week’s improvement, handed over by the bond market rather than earned by the equity market, was taken back by the same bond market within seven days. Over twelve months the index has returned -1.23% in price terms and roughly ↑2.4% including dividends before franking, against a cash rate of 4.35% that carried no volatility and a floating rate credit yield now above 5.3%. Franking narrows that gap for domestic investors, but full equity risk continues to be paid less than cash and materially less than senior credit. American equities did something harder to explain. The S&P 500 rose ↑1.21% and the NASDAQ ↑2.06% in a week when the US ten-year yield rose ↑16.4 bps to 5.16%. The S&P now yields 4.64% on forward earnings against that 5.16% bond, a risk premium of roughly negative 52 bps from negative 30 bps a week ago; the NASDAQ at 31.1x yields 3.22%, some 195 bps below the risk-free rate. Equity and bond investors are reading the same PMI data differently — equities as earnings strength, bonds as inflation. Both cannot be right, and equity holders are accepting no compensation for being wrong. Brent rose ↑0.43% to US$104.32 per barrel, a third consecutive week without a material move, leaving prices ↑17.8% over the month and ↑50.3% over twelve months. Energy has stopped rising but has not started falling, which means it continues to feed through into headline inflation — including, most likely, the Australian print expected this week. The Australian dollar fell against every major currency — ↓1.47% against the US dollar to 0.7016, ↓0.64% against the euro, ↓0.30% against sterling and ↓1.19% against the yen. This is materially different from the prior week, when the AUD fell against the dollar alone and rose against everything else. Broad-based weakness in the week a domestic rate rise was priced in is a meaningful signal: currency markets are treating Australia as a growth problem rather than a yield opportunity. A weaker currency also raises the price of imported goods, which is unhelpful for the inflation problem the RBA is responding to. Fixed Income & Credit… the front end prices a hike, credit ignores it. Australian government bonds sold off across the curve, three-year yields rising ↑7.8 bps to 5.01%, five-year ↑8.3 bps to 5.04% and ten-year ↑10.3 bps to 5.37%. The curve bear-steepened to 36 bps from 33 bps, the long end leading, which points to inflation and term premium rather than near-term policy. Three-month BBSW rose ↑7.0 bps to 4.76%, a one-year high and 41 bps above the cash rate — a full hike and then some is now embedded in the very front end. The three-year sits 66 bps above cash, back to its level of a fortnight ago. The RBA meets on Tuesday and consensus expects 4.60% (↑25 bps). We expect the board will hike as the Bank confronts an inflation indicator expected at ↑4.1%. Clouding the decision, they’re confronted by a labour market adding only part-time jobs while unemployment rises, and manufacturing in contraction. Its instrument works on domestic demand, which the PMIs say is already slowing, while much of the inflation is imported through energy and traded goods. Raising rates addresses the part of the problem the Bank can reach, not the part driving the print — which argues against positioning aggressively for either outcome. US Treasuries sold off harder, and the shape changed. Two-year yields rose ↑10.8 bps to 4.85% while ten-year yields rose ↑16.4 bps to 5.16%, steepening the two-to-ten-year curve to 31 bps from 25 bps and reversing the prior week’s flattening. Last week the front end led as the revised dots were absorbed; this week the long end did. A bear steepening says the market is repricing inflation and the term premium on long-dated risk rather than the next meeting. A US ten-year decisively through 5% is the highest funding cost this cycle has produced, and the single most important number for valuing every other asset. Credit went the other way — and tightened. Major bank five-year senior narrowed ↓2 bps to 68 and Tier 2 ↓1 bp to 129, while the broad floating rate credit index widened ↑0.63 bps to 62.4 and fixed rate credit was unchanged at 78.9. This is the third consecutive week in which Australian spreads have been indifferent to substantial moves in government yields, and this week they improved outright. A spread compensates for the risk a borrower fails to repay, and nothing suggested that risk rose. Senior at 68 bps sits just 5 bps above its one-year tight, so we would call it well priced rather than cheap. For income investors this was a good week, and for the right reason. Floating rate credit now yields approximately 5.38% all-in, up ↑8 bps, driven entirely by BBSW reaching a one-year high rather than by any widening in spreads — investors were paid more without taking more credit risk. Major bank senior is approximately 5.97% and Tier 2 approximately 6.58%, both marginally higher. It pays roughly 179 bps more than the ASX 200 dividend yield, ranks ahead of equity, and moved less than a basis point while the local share market fell and bond yields rose 10 bps. If the RBA tightens on Tuesday, the outlook for floating rate coupons improves while fixed rate holdings absorb the capital loss. We said last week that duration had earned a place in defensive portfolios; this week it cost investors money, and we should own that directly. A ten-year ACGB at 5.37% is within 5 bps of its one-year high, so the eventual entry point is attractive — but the case for adding rests on inflation peaking, and this week’s prints will test that first. Outlook… the stagflationary configuration is now the base case. The central case. Inflation is proving broader and more persistent than the growth data justifies. We attach the highest probability to headline inflation rising further in Australia and Europe, policy rates moving to or remaining at restrictive levels, and growth slowing unevenly — robust in the US, weakening in Australia, mixed in Europe and China. This is the configuration we described three weeks ago and withdrew twice; the domestic evidence now supports it more clearly than at any prior point. Central banks. The RBA is the immediate question, with consensus at 4.60% on Tuesday. The Fed has already moved and given guidance for a higher path and a higher long-run neutral estimate, with last week’s PMIs supporting it. The ECB has moved and faces a September inflation print expected at ↑3.7%. The direction of travel across all three is the same, which removes a diversification investors have relied on: when policy rates move together, so do bond markets, and the offshore hedge against domestic tightening becomes less reliable. Key risks. First, that the RBA tightens into a slowing economy and the PMIs prove the better guide — a genuine policy error risk, though we would not weight it above a reasonable probability given how little visibility anyone has. Second, that a US ten-year sustainably above 5% forces a repricing of equities already carrying a negative risk premium. Third, that the Australian dollar’s broad weakness compounds imported inflation, requiring more tightening than growth can bear. Key opportunities. Floating rate income is the clearest, improving again through a higher base rate rather than deteriorating credit. Bank spreads tightened in a difficult week, evidence of underlying demand rather than complacency. And government bonds now offer starting yields near one-year highs — not yet a signal to extend duration, but a materially better entry point than three months ago. What would change the narrative? Most immediately, Tuesday’s RBA decision and Wednesday’s inflation indicator. An inflation print materially below the ↑4.1% expected would remove the justification for further tightening and reward duration sharply from a high starting yield. A hold from the RBA alongside a high print would tell us the Bank is weighting the PMIs over the inflation data, which would be significant information about its reaction function. Beyond that, a US ten-year that stabilises below 5% would relieve pressure on global valuations, and a decisive move in crude either way would resolve much of the inflation question neither we nor the central banks can currently answer.

“The most terrifying words in the English language are: I'm from the government and I'm here to help.” - Ronald Reagan Cartoon of the Week Source: www.hedgeye.com Funds Snapshot Movers & Shakers (week ending 18 September): Stocks (ASX 200 ↓ 0.11%, S&P 500 ↓ 0.08%, NASDAQ ↑ 0.72%) Bond Yields (ACGB3Y 4.93%, ↓ 7 bps / ACGB10Y 5.27%, ↓ 10 bps) Bond Curves (A$ 3s10s +33 bps, ↓ 4 bps) Credit Spreads (Major Bank 5Y Senior +70 bps, ↑ 2 bps / Tier 2 +130 bps, ↑ 3 bps) Policy (US Fed Funds 3.75–4.00%, ↑ 25 bps / RBA Cash 4.35%, ↔) Oil (Brent US$103.87/bbl, ↓ 0.71%) Gold (US$4,379/oz, ↑ 0.68%) Market Overview The defining event was a rate hike that markets welcomed. The Fed lifted the upper bound of the funds rate to 4.00% from 3.75%, exactly as expected. The surprise was in the projections, where the median path moved up at every point: 4.125% for next year against 3.875% expected and 3.625% previously, and — most consequentially — a long-run estimate of 3.25% from roughly 3.06%. Moving the long-run dot is a statement about the destination rather than the route: the Committee now believes the neutral rate itself is higher than it did in June. The Fed moved because American demand refuses to slow. August retail sales rose ↑1.2% against ↑0.8% expected, with the control group that feeds GDP up ↑1.4% against ↑0.5%. Initial jobless claims fell to 196,000 against 207,000 expected and continuing claims fell to 1.730 million. This is the benign version of tightening: a central bank raising rates because consumption is strong is a very different proposition for risk assets than one raising rates because energy prices have spiked, which was precisely the prior week’s configuration. Imported inflation is now visibly a US problem too. Import prices rose ↑0.7% in August against ↑0.5% expected, and ↑0.8% excluding petroleum against ↑0.3%, taking the annual rate to ↑7.0%. This is the same channel we described last week from the Chinese side. Europe rhymed: headline CPI was softer at ↑3.2% with core at ↑2.4%, yet the ECB’s survey showed one-year consumer inflation expectations rising to 3.0% and three-year to 2.9%, both above forecast. Realised inflation is behaving; expectations are drifting. China complicates last week’s thesis, and we should say so. Industrial production beat at ↑5.2% YoY, but demand was poor — retail sales grew just ↑0.4% against ↑0.8% expected, fixed asset investment contracted ↓7.2% year-to-date and property investment fell ↓19.9%. China has indeed stopped exporting disinflation, but this is a cost and supply phenomenon rather than a demand one. The distinction matters: demand-pull inflation is self-reinforcing, while cost-push inflation can unwind when the cost does. Australia produced almost no data, the Westpac Leading Index falling ↓0.04% in August from a revised ↑0.02%. The substantive domestic test arrives this week with the August labour force report — consensus ↑20,000 after July’s fall of 15,800, unemployment holding at 4.5% — followed by the September PMIs. Brent fell ↓0.71% to US$103.87 per barrel, following gains of ↑7.80% and ↑8.65% in the two preceding weeks. The pause matters more than the decline. Energy is the single most important variable in the inflation regime question, and a fortnight of roughly 17% gains failing to extend is tentative evidence the shock may be levelling. We would not overstate it — prices remain ↑14.1% over the month and ↑54.0% over twelve months, and the Middle East conflict is unresolved. This is the absence of further bad news rather than good news. The dominant narrative is therefore policy divergence. Seven days ago Australian bonds were dragged higher in yield by a global inflation impulse despite domestic evidence pointing the other way. This week the impulse had an identifiably American source that Australia does not share, and Australian bonds went their own way. Sentiment agreed: the VIX fell 1.03 points to 14.81 in a week when a major central bank tightened. Markets treated the hike as confirmation of growth rather than a threat to it. Equity Markets Global equities finished close to unchanged, with dispersion by region rather than direction — the Nikkei ↑1.57% and NASDAQ ↑0.72% against the S&P 500 ↓0.08%, ASX 200 ↓0.11%, Hang Seng ↓0.22%, CSI 300 ↓0.06% and STOXX ↓0.57%. After a week in which every market we track fell, that is a notable stabilisation. Rate rises hurt equities through a higher discount rate and weaker earnings; last week only the first applied. The Australian equity risk premium widened for the first time in six weeks — but not for the reason investors would want. The ASX 200 trades on 18.3x forward earnings for an earnings yield of 5.46% against a ten-year bond at 5.27%, a premium of roughly 19 bps, with the six-week sequence now reading 33, 27, 18, 16, 10 and 19. The bond market handed it over rather than the equity market earning it: the earnings yield barely moved while the ten-year fell 10 bps. Over twelve months the index has returned -0.16% in price terms and roughly ↑3.4% including dividends before franking, against a cash rate of 4.35% that carried no volatility at all. The more striking valuation fact is American. The S&P 500 at 21.3x yields 4.70% against a ten-year Treasury at 5.00%, a risk premium of roughly negative 30 bps; the NASDAQ at 30.2x yields 3.31%, some 170 bps below the risk-free rate. That is only rational if earnings grow strongly into those multiples — and this week's consumption data says they might — but a negative risk premium is not a cushion, it is the absence of one. Dispersion elsewhere is wide, with the STOXX on 15.3x and the Hang Seng on 11.4x, though the latter is the cheapest market we track and has still returned -6.8% over a year. Cheapness is a condition, not a catalyst. Fixed Income & Credit Australian government bonds rallied across the curve — three-year yields ↓6.7 bps to 4.93%, five-year ↓7.5 bps to 4.96% and ten-year ↓10.3 bps to 5.27%, with swaps in line. The curve bull-flattened to 33 bps from 37 bps, the long end leading, which reflects easing inflation and term premium concerns rather than a change in near-term policy expectations. These yields remain 155 bps and 107 bps above where they sat a year ago at the three- and ten-year points. The decoupling is the week's most important development for domestic portfolios. Australian yields fell in the same week the Fed hiked and US two-year yields reached a one-year high. Over the prior week Australian bonds sold off on no domestic news; this week they rallied on no domestic news. Both moves were about the character of the offshore impulse — the prior week's a broad inflation shock that respected no borders, this week's specifically American demand, which Australia, with a negative leading index and a labour market that shed jobs in July, has nothing resembling. The RBA did not meet and the cash rate remains 4.35%, unchanged over the week, month, quarter and year. Market pricing is the more useful signal: the three-year now sits 58 bps above cash, down from 65 bps, so the market has trimmed — not removed — the tightening it had embedded, while three-month BBSW rose ↑2 bps to 4.69% and has not repriced at all. US Treasuries moved the opposite way, two-year yields rising ↑11.8 bps to 4.74% against ten-year yields up only ↑2.9 bps to 5.00%, flattening that curve to 25 bps from 34 bps. The front end did the work because that is where the revised dots live. Investment grade credit was, for the second consecutive week, almost entirely indifferent. Floating rate credit widened ↑0.25 bps to 61.8, fixed rate tightened ↓0.55 bps to 79.0, major bank senior widened ↑2 bps to 70 and Tier 2 ↑3 bps to 130. A central bank raised rates and Australian spreads moved by fractions of a basis point, because a credit spread compensates for the risk a borrower fails to repay while a bond yield compensates for time and expected inflation — and nothing this week suggested repayment risk rose. Senior remains 7 bps wider over the month and 7 bps above its one-year tight, so the slow drift persists, but the subordination premium widened to 60 bps from 57 bps, back toward its one-year average near 64 bps, modestly improving Tier 2 relative value. For income-focused investors, the arithmetic held through a hike. Floating rate credit yields approximately 5.30% all-in, major bank senior 5.97% and Tier 2 6.57%, essentially unchanged as slightly lower swap rates offset wider spreads. At 5.30% against an ASX 200 dividend yield of 3.56%, floating rate credit pays roughly 174 bps more income, ranks ahead of equity and carries a fraction of the volatility. While talking our book somewhat, it remains our preferred income vehicle, though a ten-year ACGB at 5.27% is now a genuinely useful fixed rate alternative — this week it rallied while risk assets were flat, and a barbell of floating rate credit for income and government duration for protection is better priced than at any point this year. Outlook The central case. An inflation regime change remains underway, driven by energy, the reversal of Chinese disinflationary exports and rising traded goods costs, with US import price inflation at ↑7.0% the clearest single evidence. We moderate the severity, though: Chinese production was strong against weak domestic demand, which reframes that contribution as cost-push rather than demand-pull. We attach the highest probability to elevated but not accelerating inflation, policy rates at or above current levels, and adequate but unevenly distributed global growth. Central banks. The Fed has given its clearest guidance of this cycle: a higher path and a higher estimate of where rates settle in the long run. The ECB has already moved and is watching expectations drift up while realised inflation behaves. The RBA has not moved, and this week the market reduced its conviction that it would need to. We would not call that a dovish turn by any stretch — the three-year still sits 58 bps above cash — but the extreme pricing of ten days ago has been trimmed, appropriately so on the domestic evidence. Nonetheless, we expect the RBA will hike next week at its September meeting. Key risks. First, that this week’s Australian rally is a positioning unwind rather than a genuine repricing, and reverses on a firm employment print. Second, that US import price inflation passes through to consumer prices and forces the Fed beyond even its revised projections — the channel through which a series of shocks becomes a true regime change. Third, valuation: the US carries a negative equity risk premium and Australia’s is 19 bps, so neither market has meaningful protection if growth disappoints. Key opportunities, growth and inflation. Income remains the clearest opportunity and it survived a Fed hike without deterioration, while government duration has become a potential defensive asset rather than a drag. Growth, not inflation, was this week’s surprise — strong in the US, weak in European industry and Chinese demand, unknown in Australia until next week. Growth that is adequate and unevenly distributed is more manageable for diversified portfolios than the synchronised shock we described seven days ago, because it creates dispersion, and dispersion is what allocation decisions can exploit. What would change the narrative? Three things, in order of immediacy. An Australian employment report this week confirming July’s decline would validate the decoupling, shift the domestic conversation toward eventual cuts and reward duration sharply from a high starting yield; a strong print would put the imported-tightening thesis straight back on the table. A resumption of the oil rally would reinstate the severe version of the inflation scenario — we would watch the rate of change rather than any threshold, having set one last week the market ignored. And evidence that US import and producer price pressure is reaching consumer prices would tell us the regime change is real rather than a sequence of separate shocks.

We view private credit as a potentially valuable component of a diversified portfolio for investors seeking income and long-term capital appreciation. However, it is not a substitute for liquidity, nor is it risk-free. While the asset class can offer attractive income and portfolio diversification benefits, investors need to tread warily given broader risk dynamics and to fully understand said risks vs return prospects. Recent developments have brought private credit back into focus. Regulatory scrutiny has intensified, early losses are beginning to emerge (particularly in parts of the US market) and concerns are growing around concentration risks, especially within software and technology-related borrowers. With an estimated 20% or more of private credit exposure linked to software firms, questions are being asked about the impact of AI-driven disruption on earnings, cash flows and refinancing capacity. Against this backdrop, it is worth revisiting the key risks embedded in private credit and, in particular, examining how it compares with another income‑oriented asset class familiar to Australian investors: bank hybrids. It is important to state upfront that while Mutual Limited’s investment team has extensive experience in private credit, the firm does not invest in private credit within any of its funds or third-party mandates, nor does it intend to do so in the future. The risk profile of private credit does not align with Mutual Limited’s broader investment philosophy, which prioritises liquidity, transparency and capital stability. Key Risks in Private Credit 1. Limited Liquidity Private credit investments are typically structured as loans and not traded on public markets. Accordingly, secondary liquidity is heavily constrained, and investors often must accept their capital is committed for several years. While redemptions are sometimes permitted, they are limited typically to quarterly and only up to a small percentage of fund assets under management (AUM), say 5% - 10%. Given this absence of tradability, redemptions are often funded from cash flows, which can be further constrained during periods of heightened market stress. What does this mean for investors? Private credit is best suited for capital that does not need to be accessed in the near term. Investors must be comfortable with the possibility that capital may not be immediately available when markets are under stress. 2. Risk of Borrower Default Private credit funds lend to companies that may not have access to traditional bank financing, typically firms not formally rated by the rating agencies and therefore considered sub-investment-grade with a higher probability of default. These businesses are often smaller or more leveraged and if a borrower experiences financial difficulty, repayment may be delayed or reduced. Recent research from UBS suggests private credit default rates could surge to 15%[1] compared with prevailing estimates of 3% - 5% range. For context, global default rates through the GFC peaked at 15.6% in 2009[2]. While not all strategists share this view, the risk of materially higher defaults looks to be rising. What does this mean for investors? While income payments are typically contractual, there is no guarantee they will always be paid. Losses are possible, more so than an investor would expect with investment-grade public bonds. 3. Sensitivity to Economic Conditions Private credit performance depends on the financial health of borrowers. In stable economic conditions, loans generally perform well. On the other hand, during recessionary conditions, default rates can rise. Monetary policy settings also matter. Higher interest rates increase borrowing costs and can strain already leveraged balance sheets, particularly for companies reliant on refinancing. What does this mean for investors? Even if fund values do not fluctuate daily, economic slowdowns can materially increase risk beneath the surface. 4. Valuation and the Illusion of Stability Valuation of private credit is amongst the dark arts. Private credit is not exchange-traded, so valuation is typically model-based, not price-discovery-based. That creates structural differences versus public credit. At a very high level, value equals the present value of expected future cash flows, discounted at a market-implied yield. In theory, private loans are not priced daily on any exchange and any valuation updates are made quarterly. What does this mean for investors? Returns may appear smoother than public bond markets, but underlying risks remain. The bottom line is private credit valuation is model-based, spread-sensitive, impairment-driven, and typically slow-moving until credit stress becomes undeniable. 5. Manager Discipline Matters Private credit is not a passive asset class. Underwriting standards vary, and ongoing due diligence and experience navigating stressed situations is critical. Some managers may take greater risk in pursuit of higher yields than others. What does this mean for investors? Manager selection plays a significant role in outcomes. Poor underwriting decisions can have long‑lasting consequences in illiquid portfolios. 6. Fees and Expenses Private credit has an array of fees and expenses to be mindful of. They include management fees (~1.00% - 1.25%), operating expenses (~0.30% - 0.60%), performance fees (~0.50% - 2.00% or more), and potentially foreign currency hedging costs (~0.30% - 1.00%) where offshore exposure exists. Add this up and the estimated total cost drag of ~2.00% - 4.00% per annum. What does this mean for investors? Higher fees reduce net returns and must be carefully weighed against expected income. By comparison, public credit funds including Mutual’s own, typically have fee ranges in the 0.5% - 1.0% range. Private Credit vs Bank Hybrids: Not a like-for-like switch Ultimately, the greatest risk in private credit is not day-to-day volatility, but a sudden collapse in confidence. Illiquid, model-valued assets with periodic redemption features can expose the gap between perceived stability and underlying credit risk when sentiment turns. Defaults may rise, refinancing conditions tighten, or investors rush to redeem at the same time – I call this the George Costanza trade, “women and children first, get out of my way.” Consequently, funds may impose gates, delay withdrawals or reprice assets sharply. For retail investors, this means returns that appeared smooth can change quickly — and access to capital may not be immediate, when it is most needed. Private credit can play a role in diversified portfolios, but it should be approached with realistic expectations about liquidity, valuation transparency and the true downside risks in a stressed environment. Anecdotally, many retail investors have been drawn to private credit as a replacement for their bank hybrids, particularly as APRA phases bank hybrids out as an acceptable form of capital, with an end date of 2032. The challenge here is that this is not a like-for-like transition. There is an illusion of symmetry between the two asset classes. Both are floating‑rate, offer higher yields than term deposits and are marketed to income‑focused investors. Beyond that, the similarities fade. Bank hybrids are exposed to systemic banking stress and are sensitive to equity volatility but they are priced daily and traded on the ASX. Private credit, on the other hand, is exposed to SME leverage and refinancing cycles. It’s sensitive to credit spreads and default clustering, while valuations adjust slowly, if at all. What are the alternatives? For investors seeking income with greater transparency and liquidity, there is a broad range of income‑generating funds underpinned by public credit markets. These securities are traded, priced daily and may offer materially superior liquidity dynamics, while delivering return profiles comparable to bank hybrids. Mutual Limited offers two such strategies—the Mutual Credit Fund and the Mutual High Yield Fund—which may be considered hybrid alternatives for investors prioritising liquidity, transparency and capital stability. [1] UBS Investment Bank Credit Strategy note (Sachin Ganesh et al.), February 2026; as reported by Bloomberg. [2] Standard & Poor's.

“Every cloud has its silver lining but it is sometimes a little difficult to get it to the mint.” - Don Marquis Cartoon of the Week Source: www.heraldsun.com.au Funds Snapshot Movers & Shakers (week ending 14th August): Stocks (ASX 200 ↓ 2.94%, S&P 500 ↓ 0.80%, NASDAQ ↓ 0.66%) Bond Yields (ACGB3Y 5.00%, ↑ 25 bps / ACGB10Y 5.37%, ↑ 19 bps) Bond Curves (A$ 3s10s +37 bps, ↓ 6 bps) Credit Spreads (Major Bank 5Y Senior +70 bps, ↑ 2 bps / Tier 2 +127 bps, ↔) Oil (Brent US$104.61/bbl, ↑ 8.65%) Gold (US$4,349/oz, ↓ 1.83%) Market Overview The inflation repricing goes global, and Australia imports it. The week's defining fact is where the repricing came from. Australian three-year yields rose ↑25 bps to 5.00% in a week when the domestic data was uniformly poor. Westpac consumer confidence fell ↓5.2% in September to 84.4, reversing a ↑6.0% gain. NAB business conditions fell from +4 to -1, their first negative reading in this dataset, and confidence slipped to -8. Consumer inflation expectations remained stuck at 4.9%. Australian bonds did not reprice on Australian news. They repriced because they are priced in a global market, and three things happened offshore. First, US producer prices accelerated sharply. Final demand PPI rose to ↑5.4% YoY against ↑5.3% expected, up from a revised ↑4.8% YoY, with the core measure at ↑4.6% YoY from ↑4.3% YoY. Producer prices sit upstream of consumer prices, so this signals pipeline pressure rather than current inflation. The consumer data was better behaved, with headline CPI holding at ↑3.4% YoY and core easing to ↑2.4%. The pipeline is heating while the outlet cools, and we do not yet know which resolves. Second, the ECB raised rates — the deposit facility ↑25 bps to 2.50% and the main refinancing rate to 2.65%, both as expected. Until this week higher-for-longer was a market forecast; it is now an observed central bank action. The ECB also tightened into improving growth, with euro area Q2 GDP revised up to ↑1.2% YoY and investor confidence firming. Third, and least discussed, China stopped exporting disinflation. Chinese producer prices rose to ↑3.8% YoY against ↑3.6% expected, consumer prices to ↑0.8% YoY from ↑0.5% and core to ↑1.0%. For two decades Chinese factory-gate deflation was a persistent disinflationary force in global traded goods that Australian and US inflation benefited from without anyone arranging it. That channel has reversed, and with exports ↑25.0% YoY and imports ↑28.2% this is not weak demand but a genuine change in the cost of the goods the world buys. Add Brent up ↑8.65% to US$104.61 and the picture is complete. The dominant narrative is therefore a change in the inflation regime rather than another data point within it. Energy, Chinese producer prices and US pipeline costs moved in the same direction at once, and a central bank acted. That is why bond markets repriced the entire curve rather than the next meeting, and why Australia was carried along despite domestic evidence pointing the other way. For Australia this is the uncomfortable combination, and we need to revisit a view. Three weeks ago we described Australia as drifting toward a stagflationary configuration. Last week we withdrew that after the GDP beat. This week we raise it again, and we should be transparent that this is the second revision in three weeks. The data does not contradict itself: GDP measured the June quarter and was backward-looking, while confidence surveys are September readings and forward-looking. Surveys lead, national accounts lag, and both can be right about different moments. What has changed is the mechanism. The earlier concern was domestic demand keeping core inflation elevated; the concern now is an external shock arriving as domestic confidence deteriorates. That is the harder version, because the RBA cannot influence the price of oil or Chinese factory-gate prices — its only instrument works on domestic demand, which is already weakening. Oil – Brent rose ↑8.65% to US$104.61 per barrel, following a ↑7.80% rise the previous week, for a two-week gain of roughly ↑17% and a twelve-month gain of ↑57.6%. With the conflict in the Middle East persisting and no apparent off-ramp, energy prices are unlikely to come off any time soon, remaining a persistent inflation and growth headwind. Equity Markets There was nowhere to hide — every major market we track finished lower, led down by the Hang Seng at ↓3.30% and the ASX 200 at ↓2.94%. Australia was the worst performer in the developed world, for a reason we have flagged for five consecutive weeks. The equity risk premium had compressed to roughly 16 bps entering the week, leaving no valuation cushion between Australian shares and government bonds, so when the ten-year rose 19 bps there was nothing to absorb it. The market with the thinnest risk premium has the most to lose when the discount rate moves. We would stress this was an observation about the absence of a cushion rather than a forecast of a shock: we did not predict the repricing, only that Australian equities had no protection if one arrived. The arithmetic has worsened again, and the twelve-month record has crossed an important line. The ASX 200 trades on 18.3x forward earnings for an earnings yield of 5.47% against a ten-year bond at 5.37%, an equity risk premium of approximately 10 bps and a fifth consecutive week of compression from 33 to 27 to 18 to 16 and now 10. Over twelve months the index has delivered a price return of -0.72%. With a 3.53% dividend yield the total return is roughly +2.80% before franking, against a cash rate of 4.35% that carried no volatility at all. Franking improves the comparison for domestic investors and we would not dismiss it, but the plain statement is that an investor who accepted full Australian equity risk for a year has been paid less than one who did nothing. US markets held up comparatively well because core CPI eased to ↑2.4% YoY, so US equity investors received a better consumer inflation signal than bond investors received from producer prices. Even so, the NASDAQ at 29.6x against a ten-year Treasury at 4.97% is the tension we flagged last week, and it has begun to resolve against valuations. Dispersion remains wide — the S&P 500 on 21.3x, the ASX 200 on 18.3x, the STOXX on 15.4x and the Hang Seng on 11.4x — but the Hang Seng cautions against treating cheapness as an entry signal: already the cheapest major market, it fell furthest this week and is down 4.91% over twelve months. Fixed Income & Credit Australian government bonds and the RBA – three-year yields rose ↑25 bps to 5.00%, five-year ↑25 bps to 5.04% and ten-year ↑19 bps to 5.37%, with swaps in line. Every one of those levels is a one-year high, as is three-month BBSW at 4.67%. The curve bear-flattened to 37 bps from 43 bps, and short yields rising faster than long yields is the classic signature of an inflation scare rather than a growth upgrade. The three-year now sits 65 bps above the cash rate and BBSW 32 bps above, up from 24 bps, so market pricing embeds a meaningful expectation of tightening. The RBA did not meet and the cash rate is unchanged over the month, quarter and year, however futures are now pricing a cash rate at 5.00%, suggesting almost three hikes left in the cycle (not our base case). We will not forecast, but we will describe the position plainly: the RBA faces an imported inflation shock it cannot influence arriving as domestic confidence deteriorates sharply. That is the hardest configuration a central bank can face, and it is why we would caution against positioning aggressively for either outcome — pricing has travelled a long way in one direction, which makes it vulnerable in both. US Treasuries – the two-year rose ↑26 bps to 4.63% and the ten-year ↑18 bps to 4.97%, flattening the two-to-ten-year curve to 34 bps from 42 bps and reversing the prior week's steepening. The front end led because that is where policy expectations live. We flagged last week that a bear steepening said growth is holding while inflation repriced further out; this flattening says attention has moved back to near-term policy. Against it, core CPI easing to ↑2.4% and NY Fed inflation expectations easing to 3.58% are genuine counter-evidence. Producer and consumer prices point in opposite directions, and we would not pretend to know which wins. Investment grade credit and Australian bank paper – this was the reassuring part of the week, with floating rate credit widening 1.1 bps to 61.5, fixed rate 0.6 bps to 79.5, major bank senior 2 bps to 70, and Tier 2 unchanged at 127. Credit barely moved while government yields rose ↑20 – 25 bps and equities fell around three per cent, and the reason is worth explaining carefully. A credit spread compensates for the risk that a borrower does not repay, and nothing this week suggested rising default risk: job advertisements rose 2.5%, US initial claims held at 206,000 and continuing claims fell. What repriced was the risk-free rate, the price of time and expected inflation, which is a different question entirely. This is the clearest illustration in months of why credit and government bonds are distinct instruments rather than variations on the same one. One caution. Senior spreads are 7 bps wider over the month and now sit 7 bps above their one-year tight, so the drift is persistent rather than absent, and credit may be lagging the rates repricing rather than immune to it. The subordination premium compressed further to 57 bps against a one-year average near 64 bps, reinforcing our existing view: at approximately 6.56% all-in, Tier 2 is attractive in absolute terms, but the case rests on that absolute yield rather than on relative value. What this means for income-focused investors – the arithmetic improved again, and for the right reason. Floating rate credit now yields approximately 5.28%, major bank senior 5.99% and Tier 2 6.56%, levels that rose ↑8 – 24 bps over the week driven almost entirely by higher base rates rather than wider spreads. Income investors were paid more without taking more credit risk. The comparison we would put on the table is floating rate credit at 5.28% against an ASX 200 dividend yield of 3.53%: credit pays roughly 175 bps more than the share market, ranks ahead of equity, and carries a fraction of the volatility — as this week showed, with shares down 2.94% while spreads moved a single basis point. Outlook The central case. An inflation regime change is underway, driven by energy, the reversal of China's disinflationary exports and accelerating US producer costs. Developed market policy rates stay at or above current levels, with the ECB having already moved. Growth globally is adequate while Australia deteriorates in forward-looking measures. We attach the highest probability to this scenario while acknowledging the evidence within it is genuinely conflicting. Key risks. The one we weight most heavily for domestic portfolios is imported stagflation in Australia, for the reasons set out above. Second, the equity valuation cushion is gone — with the risk premium at roughly 10 bps and the ten-year at a one-year high, nothing stands between Australian equities and a further de-rating if yields rise again. Key opportunities. Income is the clearest, and it improved this week through higher base rates rather than deteriorating credit quality. Government bonds at one-year-high yields now function as genuine portfolio insurance rather than a drag, and equity valuation dispersion remains wide — though this week was a reminder that cheapness alone is not a catalyst. Central banks. The ECB tightened into improving growth, which is the comfortable version. The Federal Reserve faces producer prices at ↑5.4% against core consumer prices easing to ↑2.4%, conflicting evidence we would not predict a response to. The RBA faces the hardest position of the three. Inflation and growth. Inflation risk has shifted higher and the source has broadened: energy is now joined by China, and if the withdrawal of that long-standing disinflationary subsidy persists it matters more than any single central bank decision, because it changes the starting point from which all of them must work. Growth is adequate globally — Europe revised up, the US labour market stable, Chinese trade strong — leaving Australia the outlier on the downside, a reversal of the picture we described only last week. What would change the narrative? A sustained retreat in crude, though we set that bar at US$85 last week and the price moved twenty dollars the other way, so we would treat any single threshold with humility. A US producer price reading that fails to pass into consumer prices would reverse the front-end repricing quickly. And an Australian labour market that confirms the confidence surveys would flip the RBA conversation back toward cuts and reward duration sharply from a one-year-high starting yield..

“Expert: a man who makes three correct guesses consecutively.” - Laurence J. Peter Cartoon of the Week Source: www.heraldsun.com.au Funds Snapshot Movers & Shakers (week ending 14th August): Stocks (ASX 200 ↓ 0.95%, S&P 500 ↑ 0.09%, NASDAQ ↑ 0.40%) Bond Yields (ACGB3Y 4.75%, ↑ 9 bps / ACGB10Y 5.17%, ↑ 8 bps) Bond Curves (A$ 3s10s +43 bps, ↓ 1 bp) Credit Spreads (Major Bank 5Y Senior +67 bps ↓1 bop/ Tier 2 +127 bps, ↔) Oil (Brent US$96.28/bbl, ↑ 7.80%) Gold (US$4,429/oz, ↓ 0.56%) Executive Summary Australia's June quarter GDP grew +0.4% YoY, lifting annual growth to +2.1% YoY against a +1.8% YoY consensus. US payrolls added 162,000 jobs against 55,000 expected, with prior months revised up by 55,000. The growth scare that shadowed August has faded, and with it much of the case for near-term rate cuts. Yields rose accordingly. Australian yields rose 8 – 9 bps across the whole curve, and the US ten-year rose 6 bps. Unlike the prior week, the long end moved too. That reflects a repricing of inflation and growth, not merely the timing of the next central bank meeting. Brent crude rose 7.8%, complicating the inflation picture further. Equities finally took notice, with the ASX 200 down 0.95%. For income investors the arithmetic keeps improving: investment grade floating rate credit now yields approximately 5.20%. Market Overview The growth scare fades, and the inflation problem gets harder Last week we flagged genuine downside risk to the June quarter GDP print. It did not materialise, and we should say so plainly. GDP grew +0.4% for the quarter against +0.3% expected, with annual growth at +2.1% against a +1.8% consensus. The composition matters more than the headline: net exports added +0.1 percentage point, inventories subtracted, and company operating profits rose +1.8% after a revised -1.5% fall. With business investment contracting, growth had to come from somewhere, and the prior week's household spending figure of +7.0% tells you where. Australia's problem is therefore simpler than we described a week ago, and not obviously better. It is not a stagflation problem; it is an inflation problem in an economy that is still growing. The Melbourne Institute's monthly gauge accelerated to +4.8% annually from +4.0%, private sector credit grew +8.4%, and the composite PMI rose to 52.7. Credit expanding at more than eight per cent alongside a services sector in solid expansion is not what a genuinely restrictive policy setting produces. The counterweight sits in housing supply, with building approvals down -3.6% and private house approvals down -4.2%. The US delivered the week's largest surprise. Payrolls rose 162,000 against 55,000 expected, with the prior two months revised up a combined 55,000 and the three-month average lifting to 71,000. Unemployment held at 4.1% and underemployment fell to 7.7%. The internals were softer: ADP recorded 38,000, job openings fell to 7.27 million, the quits rate slipped to 1.9%, and services employment contracted at 47.8. The most accurate description is a low-hiring, low-firing labour market that produced one strong month. The inflation-relevant American data was arguably more important. ISM services prices paid rose to 72.6 against 70.0 expected and manufacturing prices paid held at 71.1, both at levels historically consistent with accelerating rather than decelerating services inflation. Europe requires us to qualify a view. Last week we described it as the exception, converging on target. Headline inflation has jumped to +3.3% from +2.9% and producer prices to +5.8%, though core did ease to +2.4% and retail sales fell -0.6%. China stabilised rather than recovered, with official surveys still in contraction at 49.5 composite while private surveys expanded at 52.1. Sentiment stayed calm throughout, with the VIX up just 0.10 points to 14.53. Whatever markets concluded this week, they did not conclude it anxiously. Equity Markets It was a divided week, and the split has a straightforward explanation: the good growth news was American. The S&P 500 rose +0.09% and the NASDAQ +0.40%, while the ASX 200 lost -0.95%, the STOXX -0.81%, the Nikkei -2.09% and the CSI 300 -1.33%. The Hang Seng was a modest exception at +0.26% higher. A US payrolls print beating by more than 100,000 jobs supports US earnings directly, offsetting the discount rate effect of higher yields. Elsewhere, investors received the higher-for-longer message without the growth compensation. Australia is the clearest illustration of higher rates doing what higher rates do. A GDP beat and an accelerating inflation gauge weakened the case for RBA easing, ten-year yields rose 8 bps, and the index fell. What makes the local market particularly exposed is the absence of any valuation cushion. The ASX 200 trades on 18.8x forward earnings for an earnings yield of 5.33%, against a ten-year government bond at 5.17%. The equity risk premium is therefore approximately 16 bps, a fourth consecutive week of compression from roughly 33 to 27 to 18 and now 16. That is the compensation an investor currently receives for accepting the volatility, drawdown risk and earnings uncertainty of the Australian share market in place of a government bond, and we would characterise it as thin by any historical standard. The twelve-month record reinforces the point: a 2.0% price return and a 3.41% dividend yield against a 4.35% cash rate that carried no volatility at all. Franking improves that comparison materially for domestic investors, but it does not change the observation. Valuation dispersion across global markets is now unusually wide — the NASDAQ on 30.0x forward earnings, the S&P 500 on 21.5x, the Nikkei on 21.0x, the ASX 200 on 18.8x, the STOXX on 15.7x, the CSI 300 on 14.7x and the Hang Seng on 11.6x. The NASDAQ at thirty times has the most to lose from a sustained rise in long yields, and the ten-year Treasury rose 6 bps this week to within 2 bps of its one-year high. It rose anyway, on the strength of the employment data. We flag that tension rather than pretend to resolve it, because it will resolve one way or the other. Europe at 15.7x, with a 6.36% earnings yield, remains the better-valued developed market, though this week's inflation and retail sales figures weakened the supporting macroeconomic case. The Hang Seng at 11.6x is the cheapest major market, and cheap for identifiable reasons given China's official surveys remain in contraction. Both are valuation observations rather than recommendations. Fixed Income & Credit Australian government bonds and the RBA – yields rose across the entire curve: three-year bonds up 9 bps to 4.75%, five-year up 9 bps to 4.79% and ten-year up 8 bps to 5.17%, with swaps moving almost identically. The character of the move is the important part. The prior week's sell-off was a front-end bear flattening that repriced the next few RBA meetings. Last week the whole curve moved together, and the three-to-ten-year curve narrowed only 2 bps to 43. A near-parallel shift says the market is repricing the level of rates across the entire horizon, and the expected path of inflation with it, rather than the timing of the next decision. That is more consequential for holders of fixed rate bonds, because a parallel shift hits long duration hardest in price terms. The market's view of what comes next from the RBA is visible in prices: three-month BBSW at 4.59% sits 24 bps above cash, up from 20 bps and 1 bp below its one-year high, while three-year swap at 4.75% is 40 bps above. Neither is consistent with a market expecting easing. We will not forecast the decision, but we observe that a portfolio positioned for near-term easing is now positioned against consistent market pricing, and that this week's data moved decisively against it. US Treasuries – the two-year rose 2 bps to 4.37% while the ten-year rose 6 bps to 4.78%, steepening the two-to-ten-year curve to 42 bps from roughly 37 bps. The two-year barely moved on an employment report beating by more than 100,000 jobs because it had already completed its repricing — at 4.37% it sits within 3 bps of its one-year high with cuts largely priced out. The long end absorbed the message instead, with stronger growth, services prices paid at 72.6 and crude up 21% over the month arguing for higher inflation compensation and term premium. A bear steepening driven by the long end is a materially different signal from the prior week's bear flattening. Flattening said tighter policy now and weaker growth later. Steepening says growth is holding and inflation risk is being repriced further out. We place more weight on this week's move because it is corroborated by the ISM price series and the oil price, rather than resting on curve shape alone. Investment grade credit and Australian bank paper - spreads widened modestly for a fourth consecutive week, though the moves remain small: floating rate credit 1 bp wider to 60.5 bps, fixed rate 1.4 bps to 78.9 bps, major bank five-year senior -1 bp to 67 bps, and Tier 2 unchanged at 127 bps. Context is important. The floating index is still 1.6 bps inside its one-year average and only 4.5 bps above its tight; senior at 67 bps is 6.5 bs inside its average. These are tight spreads drifting gently off their tights, not a credit market showing stress. The subordination premium now stands at 60 bps against a one-year average of approximately 64 bps. We noted in late August that the relative value case for reaching down the capital structure had largely been captured, and that view is unchanged: senior has continued to cheapen while Tier 2 has not moved. At approximately 6.32% all-in, Tier 2 remains attractive in absolute terms against a 4.35% cash rate — the point is narrower, that the case now rests on absolute yield rather than relative value. One technical observation. Fixed rate credit widened more than floating this week and now trades 18 bps points wide of it. In a week when the entire curve shifted higher, spread product carrying duration cheapened more than spread product without it. That is a rates effect rather than a credit quality effect. Nothing in this week's data points to deterioration in the capacity of Australian banks or investment grade corporates to service their debts. What this means for income-focused investors? The arithmetic continues to move in favour of front-end and floating rate exposure. BBSW at 4.59% is close to a one-year high, and it is the reference rate off which floating rate coupons reset. Investment grade floating rate credit is currently generating approximately 5.20% all-in at an index credit quality of around AA-. The comparison worth making is against equities. The ASX 200 earnings yield is 5.33%. An investment grade floating rate portfolio yields approximately 5.20% with a fraction of the volatility, no earnings uncertainty and a substantially higher position in the capital structure. 13 bps is not adequate compensation for accepting equity risk. Fixed rate investors had a poor week. An 8 bps rise in ten-year yields costs roughly 0.6% in price on a ten-year bond, and that cost was incurred across the curve rather than at a single point. This is the mechanical cost of holding duration while yields rise, and it is why we have consistently preferred floating rate exposure through this phase. Outlook The central case. Growth is holding up better than markets feared a month ago in both Australia and the US, inflation is proving more persistent than assumed, and policy rates stay at or above current levels for longer in both economies. We attach the highest probability to this scenario, with the caveat that the phrase holding up is doing considerable work in a world where crude has risen 21% in a month. Key risks. The clearest adverse scenario is energy-driven: crude holds around current levels, headline inflation re-accelerates across developed markets, expectations follow, and central banks tighten into economies growing only modestly. That combination is unfavourable for equities and fixed rate bonds simultaneously, which is the correlation problem that made 2022 so uncomfortable for balanced portfolios. Second, an Australian inflation surprise — the Melbourne Institute gauge at 4.8%, household spending at 7.0%, credit growth at 8.4% and a GDP beat all point one way, and a September quarter CPI confirming it shifts the discussion from when the RBA cuts to whether it hikes. Third, and in the opposite direction, the US labour market internals: if ADP, job openings and the quits rate prove the more accurate signal, growth expectations reset lower and the long-end sell-off reverses. That is the scenario in which duration pays, and the principal argument against abandoning fixed rate exposure entirely. Key opportunities. Front-end and floating rate income remains the clearest, with investment grade floating credit at approximately 5.20% for AA- quality and Tier 2 at approximately 6.32% all-in — yields unavailable for most of the past decade, delivered without duration risk. Second, government bonds at 5.17% in Australia and 4.78% in the US now offer entry levels at which duration functions as a genuine hedge rather than a drag. Third, equity valuation dispersion is wide, and non-US developed markets are priced considerably more forgivingly. Central banks. We will not forecast decisions, but the direction of travel in this week's data made RBA easing less likely rather than more. The Federal Reserve confronts strong payrolls alongside services prices paid at 72.6, which argues against near-term easing. The ECB faces the least comfortable position, with headline inflation at +3.3%, core at +2.4% and retail sales contracting — the beginning of a genuine growth-versus-inflation trade-off. Inflation and growth. Inflation risk has shifted higher again and the source has changed: Australian services inflation and sticky US core PCE both remain, but energy has been added on top, and energy affects every economy simultaneously rather than sequentially. Europe's headline reversal is the first visible evidence. Growth is better than expected and more evenly distributed than we described last week, though we would characterise it as adequate rather than robust — and adequate growth alongside firming inflation favours income over capital growth. What would change the narrative? A sustained retreat in crude below roughly US$85 would remove much of the newly added inflation risk and improve the outlook for bonds and equities together. An Australian September quarter CPI confirming core above +3.5% would shift the conversation from no cuts to how many hikes. And a genuine deterioration in US employment would reverse the long-end sell-off quickly and reward the duration that cost investors’ money this week.

“Originality is the fine art of remembering what you hear but forgetting where you heard it" - Laurence J. Peter Cartoon of the Week Source: www.hedgeye.com Funds Snapshot Movers & Shakers (week ending 14th August): Stocks (ASX 200 ↑ 0.37%, S&P 500 ↑ 0.49%, NASDAQ ↑ 0.85%) Bond Yields (ACGB3Y 4.66%, ↑ 9 bps / ACGB10Y 5.10%, ↑ 4 bps) Bond Curves (A$ 3s10s +44 bps, ↓ 5 bps) Credit Spreads (Major Bank 5Y Senior +68 bps, ↑ 4 bps / Tier 2 +127 bps, ↔) Oil (Brent US$89.31/bbl, ↓ 5.38%) Gold (US$4,455/oz, ↓ 3.21%) Executive Summary Australian inflation refused to fall as expected. July Headline CPI came in at +3.5% YoY against a +3.3% YoY forecast, and the trimmed mean — the RBA’s preferred core measure — held stubbornly at +3.6% YoY, above expectations and above the target band. Household spending accelerated to +7.0% annually against a +5.7% forecast. It doesn’t look like prices are going south anytime soon. The front end of the bond market repriced immediately. Three-month BBSW rose 6 bps to a one-year high, three-year government bond yields rose 9 bps, and three-year swap rose 12 bps. Australian and US curves both flattened sharply as markets priced out easing and began pricing tightening risk. Equities barely reacted, rising modestly with volatility falling. For income investors, the practical consequence is favourable: floating rate coupons now reset higher, with investment grade floating rate credit yielding approximately 5.15%, for a weighted average credit rating of AA–. Market Overview The dominant narrative: The disinflation trade has stalled For much of this year the working assumption in markets has been that inflation was on a slow but reliable path back to target, and that policy rates would eventually follow it down. This week supplied contrary evidence in both Australia and the United States, and the front end of both bond markets responded decisively. Headline inflation did fall, from +3.8% YoY to +3.5% YoY. But it fell by less than expected, and the more important number is the trimmed mean at +3.6% YoY — unchanged from the prior month, above the +3.5% YoY forecast, and comfortably above the 2–3% target band. The distinction matters, and it is worth explaining plainly. Headline inflation includes volatile items such as fuel and fresh food, which can swing sharply for reasons unrelated to the underlying pressure in an economy. The trimmed mean strips out the largest movers in both directions to reveal the persistent component. Headline inflation improving while the trimmed mean stands still tells you that the improvement is coming from volatile items, not from the underlying inflation problem. The monthly trimmed mean actually accelerated, to +0.5% MoM from +0.3% MoM. Household spending explains a great deal of why. Spending rose +7.0% YoY against a +5.7% YoY forecast, with the monthly figure at +1.1% MoM against +0.3% MoM expected. Australian consumers are not behaving like people constrained by a 4.35% cash rate. Demand of that strength gives businesses room to pass on costs, which is precisely the mechanism that keeps core inflation elevated. The other side of the Australian ledger: We would be presenting an unbalanced picture if we stopped there, because the business side of the economy delivered genuinely poor numbers in the same week. Private capital expenditure fell 3.6% in the June quarter against an expected +0.8% rise, reversing a +6.9% gain. Construction work done fell 2.1% against an expected +0.4% increase. These are meaningful misses, and they follow last week’s employment report showing a 16K fall in jobs and unemployment rising to 4.5% (albeit still well below post-GFC averages). Australia now presents an uncomfortable combination: sticky core inflation and a strong consumer on one side, contracting business investment and a softening labour market on the other. At least, that is what the latest data suggests — with the caveat that capex is a volatile series. Nonetheless, this is closer to a stagflationary configuration than anything we have described in recent months, and it is the least helpful backdrop for a central bank. Policy that addresses the inflation problem worsens the investment problem, and vice versa. The RBA’s August Statement had already flagged that “historically weak productivity growth continues to constrain potential growth.” Capital expenditure contracting 3.6% in a quarter does not improve that outlook. Equity Markets A quiet, mildly positive week across developed markets, with the NASDAQ leading at +0.85%. The most striking feature of the week was how little equity markets cared about the data. The VIX fell 0.70 points to 14.43, and every major developed market rose modestly. A meaningful hawkish repricing at the front end of two major bond markets produced almost no equity volatility. The more interesting question is why developed equities rose at all. Bond markets spent the week concluding that rates will stay higher for longer. Higher rates ordinarily compress equity valuations. Yet the NASDAQ, the most valuation-sensitive major index at 28.9x forward earnings, led the market higher. We can offer two partial explanations. The repricing in bond markets was concentrated at the front end — the US ten-year actually fell ~2 bps and the Australian ten-year rose only 4 bps — and long-dated equity valuations are more sensitive to long yields than short ones. Alternatively, equity investors may be reading the strong household spending and consumption data as supportive of earnings, offsetting the discount rate effect. We flag both as hypotheses. The Australian equity risk premium has now compressed for a third consecutive week — from approximately 33 bps to 27 bps, to 18 bps. Australian equities rose modestly while bond yields rose more, and the gap narrowed again. Eighteen basis points is the compensation an investor currently receives for accepting the volatility, drawdown risk and earnings uncertainty of the Australian share market instead of holding a government bond. We would characterise that as thin by any historical standard. The twelve-month picture reinforces it. The ASX 200 has returned 1.3% in price terms over the past year while cash paid 4.35%. The index yields 3.27% before franking, and on a grossed-up total return basis the twelve-month comparison improves materially, to approximately +5.1%. On price alone, however, an investor who accepted full equity market risk for twelve months was rewarded with a little over one per cent. Europe remains the best-positioned major market on valuation grounds at 15.9x forward earnings, a 6.30% earnings yield, and a third consecutive week of improving confidence data alongside inflation expectations converging on target. Fixed Income & Credit Three-month BBSW rose 6 bps to 4.55%, which is its highest level in a year. Its premium over the cash rate widened to 20 bps from 14 bps. This is the single most informative number in this week’s dataset, and it deserves explanation. BBSW is the rate at which Australian banks lend to each other over three months. It sits above the cash rate by an amount that reflects both bank funding conditions and, importantly, market expectations for where the cash rate is heading over that horizon. A 6 bps jump to a one-year high, in a week when the RBA did not meet, is the market attaching greater weight to the possibility that the cash rate goes up rather than down. The government bond curve bear-flattened, meaning short yields rose more than long ones. Three-year yields rose 9 bps against the ten-year’s 4 bps, narrowing the three-to-ten year curve to 44 bps from 49 bps. The interpretation is straightforward. Yields at the short end are driven primarily by expected policy. Yields at the long end are driven more by expected long-run inflation and growth. A curve that flattens because the short end sold off is a market saying: policy will be tighter than we thought over the next few years, but this does not change our view of the long-run economy. Given a trimmed mean stuck at +3.6% and household spending at +7.0%, that is a coherent conclusion. In US Treasuries, the two-year rose 11 bps to 4.34% — essentially its one-year high of 4.35% — while the ten-year fell ~2 bps to 4.72%. The two-to-ten year curve collapsed to 37 bps from 50 bps. This is a sharper version of the Australian move, and the divergence between the two ends is instructive. The front end responded to sticky core PCE and an upward revision to Q2 core inflation. The long end responded to collapsing survey data — Chicago PMI at 47.1, Philadelphia non-manufacturing at -10.6 — which speaks to weaker future growth. A curve flattening this aggressively reflects a market pricing tighter near-term policy and weaker medium-term growth simultaneously. Historically, that combination has been associated with slowing economies, though we would caution that curve signals have been unreliable in recent cycles and we place limited weight on it. Credit spreads widened modestly again, with major bank senior paper the most affected at 4 bps. A three-week pattern has now established itself that requires us to revise a view. Major bank senior spreads have moved 63 → 65 → 68 bps over three weeks, widening 5 bps in total. Tier 2 has been unchanged at 127 bps for two of those weeks. The consequence is that the subordination premium — the additional spread earned for holding subordinated bank paper rather than senior — has compressed from 64 bps three weeks ago to 59 bps, now below its one-year average of approximately 64 bps. In our commentary of 14 August we noted that Tier 2 offered better relative value than senior, on the basis that senior sat exactly at its one-year tight with no cushion while Tier 2 sat 16 bps above its own tight. That relative value gap has now substantially closed, and we are updating the view. Senior has cheapened by 5 bps and now sits 5 bps above its tight. Tier 2 has not moved. Investors are being paid less than the one-year average for accepting subordination risk. We would not characterise Tier 2 as poor value — at approximately 6.24% all-in it remains attractive in absolute terms. But the relative case for reaching down the capital structure has weakened somewhat over three weeks, and investors who acted on the earlier observation should recognise that the opportunity has largely been captured. One further observation. Credit spreads widened this week while equities rose and the VIX fell. That combination is unusual — credit and equities normally move together in risk terms. When credit widens against a rising equity market, the cause is more often technical than fundamental: new issuance requiring concessions, or spread product cheapening against a sharply repricing rates curve. And that is exactly what happened: credit supply was on the heavy side, which nudged senior spreads wider. Nothing in this week’s data suggests any change in the ability of Australian banks or investment grade corporates to service their debts. Outlook The central case. Inflation is proving more persistent than markets assumed six months ago, policy rates stay higher for longer in both Australia and the US, and growth slows gradually without breaking. Australia is the harder case: inflation persistence sits alongside contracting business investment and a softening labour market, which limits the RBA’s room to move in either direction. Central banks. The RBA now faces exactly the upside inflation risk its August Statement said would prompt further tightening — a trimmed mean holding at +3.6% YoY against an expected fall, household spending at +7.0% YoY, consumer inflation expectations at 4.9%. Against that: employment down 16K, unemployment at 4.5%, capex down 3.6% and construction down 2.1%. We will not forecast the decision, but the market has moved decisively — BBSW at a one-year high, three-year swap up 12 bps — and anyone positioned for near-term cuts is now positioned against a clear signal. Q2 GDP on 2 September is the next test, with consensus at +0.3% QoQ and annual growth slowing to +1.8% YoY from +2.5% YoY; given the capex and construction figures, we see genuine downside risk. A weak print alongside +3.6% YoY core inflation would sharpen the dilemma considerably. The Fed faces sticky core PCE at 3.3% and an upward Q2 revision against internally contradictory survey data — with the two-year Treasury at a one-year high, the market appears to have concluded inflation persistence outweighs the survey weakness. Inflation. Risk has shifted upward in both Australia and the US. Australia’s trimmed mean has not fallen in two months and the monthly rate accelerated, with household spending at +7.0% YoY giving firms pricing power; oil retracing 5.4% helps the headline but not the core. US core PCE has held at +3.3% YoY for three months. Europe remains the exception, with expectations converging on target. Growth. Deteriorating at the margin, regionally uneven. Australia’s business sector is contracting while its consumer spends strongly — an unusual and probably unsustainable divergence. US hard data points to gradual rather than sharp slowing despite conflicting surveys. China continues to weaken; Europe continues to improve modestly.

“Prediction is very difficult, especially if it's about the future" - Niels Bohr Cartoon of the Week Source: www.hedgeye.com Funds Snapshot Movers & Shakers (week ending 14th August): Stocks (ASX 200 ↓0.62%, S&P 500 ↓1.43%, NASDAQ ↓2.03%) Bond Yields (ACGB3Y 4.57%, ↑ 5 bps / ACGB10Y 5.06%, ↑ 5 bps) Bond Curves (A$ 3s10s +49 bps, unchanged) Credit Spreads (Major Bank 5Y Senior +65 bps, ↑ 2 bps / Tier 2 +127 bps, ↑ 4 bps) Oil (Brent US$94.39/bbl, ↑6.63%) Gold (US$4,603/oz, ↑5.18%) Executive Summary Last week's growth scare unwound almost entirely. The US S&P Global composite PMI jumped to 56.0 against a 54.0 forecast, with services at 56.8, contradicting the weak retail sales that had unsettled markets seven days earlier. Europe's PMIs also beat. The relief came at a price. Stronger data pushed US two-year yields up 6.7 bps and the ten-year to 4.73% — effectively its highest level in a year — and equities paid for it. The NASDAQ fell ↓2.1%, the S&P 500 ↓1.4%. Australia received the opposite news. Employment fell ↓16K against a forecast ↑12K, unemployment rose to 4.5% from 4.4%, yet consumer inflation expectations climbed to 4.9%. Australian bonds still sold off. For investors, the message is unchanged but sharper: with the ASX flat over twelve months and investment grade credit near 5.1%, income is being rewarded and equity risk is not. Do we sound like a broken record? Market Overview The dominant narrative: good news is bad news — and Australia got the bad news without the good Two weeks ago the concern was the US consumer had stalled. Last week that concern was substantially retired, and markets discovered they did not enjoy the alternative. The US S&P Global composite PMI printed 56.0 for August against a 54.0 consensus, up from 54.5. Services drove it at 56.8 versus 54.0 expected. That is not a marginal beat; it is a survey pointing to an economy expanding at a healthy clip. Manufacturing was the exception, easing to 53.2 from 53.9, but the composite tells the story. The Conference Board's Leading Index also turned positive at +0.2% after a negative prior reading. Supporting evidence arrived from the US labour market. Initial jobless claims came in at 206K against a 210K forecast — better than expected. But the detail is less comfortable than the headline: the four-week moving average rose to 204K from around 200K, and continuing claims increased to 1.8m. The weekly number improved; the trend did not. We would describe the US labour market as gradually loosening rather than deteriorating. Why this mattered for markets: when growth data is strong and a central bank is already reluctant to ease, strong data removes the prospect of rate relief. Bond yields rise. And when bond yields rise, the discount rate applied to future company earnings rises with them, which compresses equity valuations — most severely for companies whose earnings sit furthest in the future. That is precisely the pattern we saw, with the NASDAQ falling ↓2.1% against the S&P 500's ↓1.4%. On the inflation front, Europe presented the cleanest picture of the three major regions. Eurozone CPI was confirmed at +2.9% YoY with core at +2.5% YoY — above target but stable. More importantly, forward-looking measures improved: ECB one-year consumer inflation expectations eased to +2.9% YoY from +3.0% YoY, and three-year expectations fell to +2.7% YoY from +2.8% YoY, close to target. Negotiated wages cooled to +2.44% YoY and labour costs to +3.1% YoY. Europe is achieving something the US and Australia are not — disinflation in expectations, not just in outturns. Australia moved in the wrong direction. Consumer inflation expectations rose to +4.9%YoY in August from +4.7% YoY. This matters more than it might appear. The RBA's August Statement was explicit that short-term inflation expectations, while easing, remained higher than earlier in the year. They have now stopped easing and started rising. Central banks - the RBA held at 4.35% on 11 August, and its Statement carried a materially more hawkish tone than a simple hold implies. The Board noted three cash rate increases this year, described policy as only "somewhat restrictive," projected inflation would not return to around the midpoint of the target band until late 2027, and stated explicitly that it would raise rates further if upside risks materialise. The decision was unanimous. The employment report was a genuine miss — a fall of ↓16K where the market expected a gain of ↑12K, with unemployment rising to 4.5% from 4.4% and participation slipping. The RBA's own Statement had said labour market conditions "have eased by a little more than expected" and that leading indicators pointed to "only limited easing in the near term." This print eased considerably more than that framing anticipated. One important nuance that just a cursory look will miss: the composition was better than the headline. Full-time employment rose ↑16K while part-time employment fell ↓32K. Full-time roles carry higher hours and income, so a shift toward full-time within a falling total is a genuine mitigant. This is a soft report, not a collapse, and we would caution against over-reading a single month of a notoriously volatile series. Wages were benign — the Wage Price Index rose ↑0.8% QoQ and ↑3.2% YoY, both exactly in line. Wage-driven inflation is not the problem. Rising consumer inflation expectations, sitting at +4.9% YoY while wages run at +3.2% YoY, are a different and more awkward issue. Investor sentiment softened but did not break. The VIX rose 0.88 points to 15.13 — higher, but still low by any historical standard and below where it sat a quarter and a year ago. European sentiment was firm, with the ZEW expectations survey jumping to 31.4 from 23.4. The most telling sentiment indicator was in credit, where spreads widened only fractionally in a week when equities fell and bond yields hit one-year highs. We discuss this below, because we think it is the single most useful observation in this week's data. Equity Markets The week was an almost exact reversal of the prior one. The Nikkei, which gained ↑4.7% the prior week, fell ↓3.9% last week. The Hang Seng, which fell ↓2.1%, rose ↑3.6%. When two markets swing that sharply in opposite directions across consecutive weeks without a corresponding shift in fundamentals, the most likely explanation is positioning and profit-taking rather than a change in outlook. We flag that as inference — we have no flow or positioning data — but the symmetry is difficult to attribute to anything else. The US decline has a clearer cause. Strong PMIs pushed yields higher, and higher yields compress equity valuations. The NASDAQ's underperformance is consistent with this: at 28.8x forward earnings, more of its value sits in distant cash flows, which are more sensitive to the discount rate. This is textbook duration risk expressing itself in equities rather than bonds. Australia held up comparatively well, falling ↓0.6% against the S&P 500's ↓1.4%. Given the employment miss, that is a reasonable outcome, and the ASX's lower weighting to long-duration technology likely helped in a week defined by rising yields. The valuation observation that matters most. The ASX 200 has returned +0.4% over the past twelve months. Cash paid 4.35%. An investor who took full equity market risk for a year captured essentially nothing in price terms, while an investor who took none earned the cash rate. Dividends and franking improve the equity picture materially — but as a statement about where risk was rewarded, the comparison is stark. The Australian equity risk premium has compressed further, from roughly 33 bps a week ago to 27 bps last week. In the US it remains negative. Investors buying the S&P 500 today accept a forward- earnings yield fractionally below what a risk-free Treasury pays. Two caveats we owe clients. Franking credits meaningfully improve the after-tax return on Australian equity income, so the raw comparison understates the domestic equity case. And a compressed risk premium is a statement about prospective long-run returns, not a timing signal — thin premia can persist for years. But the direction is unambiguous, and it has moved the wrong way again this week. Europe remains the valuation outlier among developed markets at 15.9x forward earnings, a 6.3% earnings yield, and — uniquely — improving PMIs alongside inflation expectations falling toward target. Hong Kong at 11.8x is cheaper still, but this week demonstrated that its price action is presently disconnected from its fundamentals Fixed Income & Credit The most instructive fact from last week is that Australian bond yields rose after a weaker than expected employment report. Employment fell ↓16K, unemployment rose to 4.5%, and the market's response was to sell bonds across the curve. That is not irrational and understanding why matters. Bond yields reflect both the expected path of policy and expected inflation. A weak jobs report argues for a lower policy path. But three things pushed the other way: consumer inflation expectations rose to 4.9%, the RBA has an explicit and recently restated hiking bias, and US yields rose sharply on strong American data. Australian bonds do not price in isolation, and last week the global and inflation signals overwhelmed the domestic growth signal. The message for investors is that the Australian bond market is currently more worried about inflation persistence than about a slowing economy. Until that changes, weak activity data may not deliver the bond rally that intuition suggests. Consider the environment credit faced last week: global equities fell across almost every major market, volatility rose, US ten-year yields reached a one-year high, Australian employment contracted, and Chinese activity deteriorated. Australian investment grade credit spreads widened by less than one basis point, and Tier 2 hardly moved at all. That is a meaningful demonstration of the asset class's defensive characteristics. Credit spreads compensate investors for default risk, and nothing this week changed the probability that Australian major banks and investment grade corporates will repay their debts. Equity prices react to earnings expectations and discount rates; investment grade credit reacts primarily to solvency. When the news is about growth rates and valuations rather than balance sheets, credit holds. Some detail worth noting. Major bank senior paper widened 2 bps from 63 bps to 65 bps, moving off the one-year tight it reached last week because of technicals (supply) rather than fundamentals. We regard this as healthy rather than concerning — a market at its absolute tights offers no compensation for anything going wrong, and a small step back builds a modest cushion. Tier 2 held steady at 127 bps, still 16 bps above its one-year tight of 111 bps. The subordination premium — the extra spread for holding subordinated over senior bank paper — narrowed to 62 bps from 64 bps, now marginally below its one-year average of around 64 bps. Tier 2 remains the better positioned of the two within its own trading range, though that advantage has narrowed as senior widened. Outlook The central case - the most probable configuration from here is one of resilient but decelerating global growth, inflation that is improving unevenly by region, and central banks — particularly the RBA — that are more reluctant to ease than markets would prefer. The RBA is the central question for local investors, and last week sharpened it considerably. The August Statement was hawkish: three hikes this year, policy described as only "somewhat restrictive," inflation not expected back at the midpoint until late 2027, and an explicit readiness to hike again. A week later, employment fell and unemployment rose to 4.5%. The Board now faces genuinely conflicting evidence. Wages at +3.2% YoY are benign. Employment is contracting. But consumer inflation expectations rose to +4.9% YoY, and the RBA's own framework treats embedded expectations as the principal danger. We would not attempt to predict the outcome. We would say that the probability of near-term easing appears lower than a weak jobs print alone would suggest, and the probability of further tightening is not zero. Two events this week will materially inform this. The RBA Minutes on 25 August will reveal how the Board weighed these risks. Far more importantly, July CPI is released on 26 August, with consensus expecting headline inflation to fall to +3.3% YoY from +3.8% YoY and the trimmed mean to ease to +3.5% YoY from +3.6% YoY, both still well above the 2–3% target band.

Residential mortgage-backed securities (RMBS) are one of the fastest-growing areas of Australia’s fixed income market, yet the asset class remains relatively unfamiliar to many investors. In this webinar, Scott Rundell, Chief Investment Officer at Mutual Limited, joins John Clothier, General Manager of Distribution at Copia Investment Partners, to explore how Australian RMBS works, what is driving the growth of the market, how it differs from the US experience, and why institutional investors are increasingly looking to the asset class for income, diversification and capital preservation. Watch the full webinar below (38:05 minutes). Transcript John Clothier (00:01.174) Good morning everybody. My name's John Clothier. I'm the general manager of distribution at Copia Investment Partners. We have the pleasure of partnering with Mutual Limited, a cash through to fixed income fund manager based out of Melbourne. Today I have with me Scott Rundell, who is the CIO of Mutual, who has a a pretty in interesting topic for us to run through. Pretty interesting markets on the equity side, volatility in the markets. I think there are a lot of people having a look into this space for some income solutions without having to dial up that volatility. So, I think it'd be a great opportunity to hand over to yourself and take us through all the nuances of this space, if that's all right. Scott Rundell (00:45.39) Thanks, John. Good morning everyone. I am Scott Rundell, Chief Investment Officer of Mutual Limited. We’re a Melbourne-based funds manager. We specialise in fixed income, primarily floating rate product, with just under five billion under management spread across retail and wholesale institutional mandates. So .the topic today is the fastest growing asset class you've never heard of, mainly RMBS. Now most people have probably heard of RMBS or may be familiar with it from the GFC. What happened during the GFC? Why it matters is it is an excellent alternative income generating asset that a lot of people are probably not familiar with. Just on this slide, on the left-hand side, there's a very generic breakup of what a client's portfolio might look like: cash, equities, property, and traditional bonds. In the Australian context, we are as a country are heavily invested in equities and property for that matter, while traditional bonds, which would incorporate thesort of product we're talking about today is probably less appreciated for various reasons which I won't go into. But to give you some context, within the Australian superannuation asset pool, roughly 19% is held in traditional bonds or fixed income. This compares to about 35% across the OECD average. So, we are well underrepresented and somewhat overrepresented in equities for historical reasons. Again I won't go into it, but I'd say your typical fund manager would say they have zero in RMBS. So. Hopefully we’re looking to change that. So, what are we going to touch on today? What securitization is, which is the sort of the technology backing RMBS and ABS, and then why the market's grown so rapidly over the last few years. Even though it has grown rapidly recently, the market has in fact been around for almost 30 years. Why institutional investors such as us use it, why it differs from US products, which some people may be more familiar with given the GFC and some of the stories coming out of the US. And where RMBS fits into your portfolio potentially. The size of the opportunity. Over the past decade we've seen strong growth in RMBS and ABS, , especially in the last five years. And this chart on the righthand side shows you RMBS issuance going back to 2004. YWe can see the impact of the GFC in 2008, it dropped quite drastically and then it's recovered consistently. That final column is iyear to date. If you analyze the data, we're in for another strong year. If we add ABS securities, which uses the same technology, we're looking at about $80 billion a year on issuance over the last two or three years. And the outstanding market is roughly $250 billion. To give you some context, the overall credit market, so that's bonds issued by companies and banks generally in Australia, is roughly around. two hundred and fifty billion in the floating rate space and slightly less in the fixed rate space. Arrocingly, it’s a meaningful part of the domestic investment landscape, especially the area that we're focused on. Why is it growing so quickly? What are the drivers? There's three key areas in this regard. On the left, you'll see banks. Banks are the main funding mechanism for credit in the Australian market. A lot of people, the banks control, say 75-80% of the ABS, sorry, the mortgage market, and a similar percentage of the deposit market. But increasingly, because of regulatory changes around the banks post GFC and the differentiation between what's called a prime mortgage, what's called a non conforming mortgage, has seen the banks step away from a particular type of lending, specifically lending to people who are classified as non conforming. It's not a stigma, it's just a sort of regulatory classification. But nevertheless, they are big users of RMBS as a funding tool, but less so in than in the past. The big users of funding this space are the nonbank originators . And they’re names you might be familiar with, Red Zed, if you follow Rugby League. Other major non-bank originators include the likes of Liberty Home Loans, Red Z, Resimac, and Pepper. These are companies that have been around for 20 plus years. And their specialty is lend to mum and dad investors who perhaps aren’t consider prime borrowers for various reasons. And they fund themselves using RMBS securities. Why ? Well, it's a deep, cheap, and a very accessible market for them, but they also don't have access to deposit takers, deposits, because they're not a regulated institution, although they do adhere to regulatory requirements and the like. And then lastly, the right-hand side is demand from investors such as ourselves has been growing very, very strongly. Interest rates have been rising. RMBS and ABS securities are floating rate securities. So as interest rates go up, the coupons that you generate through these securities increase as well. They're what you call inflation immune, and your income continues to rise as interest rates go up. Who uses it, as I've touched on, or from an investor's perspective, Australian superannuation funds are big investors in this space, particularly the triple A part of the capital stack, and I'll touch on what that means in a moment. Insurance companies, banks, sovereign wealth funds, and then asset managers such as ourselves, we like this product because it generates stable income. As I mentioned earlier, it's inflation immune and historically the capital price has been very, very stable, such that your capital downside in a risk off events such as COVID is relatively modest. So the GFC itself is relatively modest compared to say equities or other securities that are more exposed. How do they work? What is securitisation? Securitization is basically a bundling up of assets. In a simple example of the left, say 1,000 mortgages. If we placed all those mortgages into a trust, a specialized vehicle, its only job in life is to own those loans or those mortgages and then issue securities to fund the purchase of those mortgages. We investors buy the securities and they're backed by the loans. As borrowers make repayments on their loans being principal and interest, the investors receive income through time. And on the righthand side, I've talked about sort of the broad dynamics. There's RMBS, so home loans, there's owner occupied and investment loans. And obviously the latter will be growing slower because of the budgetary changes or proposed budgetary changes around negative gearing and capital gains tax. As I mentioned, the income source is your mortgage payments. And in Australia, mortgages are very, very robust relative to offshore markets. They're full recourse. We have a first charge over the underlying property and for tax reasons you're incentivised to pay your mortgage off as quickly as possible. The underlying debt is ABS. So this is asset back for auto loan. Banks sort of don't do as much auto lending as they used to again for capital charges that have increased post the GFC in the regulatory environment. Equipment finance. So an example is there's an ABS issue out there that finances solar panels. there are specialist RMBS or ABS deals, I should say, that do medical equipment. So dentist chairs, operating table, all those sort of things need to be financed. and those assets are So the loans that buy those assets are bundled up into these securities and allows us to buy them and get decent risk adjusted returns. One of the big misconceptions about RMBS is that it's risky. I've put a picture of the movie The Big Short here, which is a fantastic movie. very entertaining even if you're not into finance. Mywife who is not financially inclined watched it and actually found it very enjoyable and it is it is a fun watch. But it goes around what happened in the US market and why we had the GFC, the catalyst and the there's Michael Bury who is a renowned person who predicted the decline of the US housing market and it tells the story of how it collapsed. Now people watch this and think RMBS is a dirty word. The difference between what happened in the US in Australia is quite stark and is worth focusing on for a few moments. But from what a lot of people remember in the RMBS is the GFC, the subprime market and Lehman Brothers collapse, the housing collapse in the US, and that sort of thing. As I said, great movie, but does not reflect what happens in Australia or has happened historically in Australia. as I said, RMBS has a branding problem. and hopefully we can start to turn that around. Whyare mortgages in Australia so much better than or stronger historically than the US. There's just a couple of examples here, just some metrics that I've put up. If you look at the size of the housing market in Australia relative to outstanding mortgages, so top left chart there. These stats are a little older, bit out of date, but the relativity is about right. It says that the value of housing in Australia is about 10 trillion, it's close to 11 trillion at the moment. And the loans back against our 2.2 is close to about 2.5, 2.6 trillion. In an aggregate sense, the loans and value ratio is around 25-26%. lot lower than say the US example, where it's roughly don't do the math. It's actually the same LVR, but where it differs is the actual individual loan level. So it sort of implies a lot more people own their houses in America. On the right hand side, we see how important housing is to our GDP. It is a major part of the market. We are incentivized in Australia to own our own property from a tax perspective, and I'll get on to that in moment. Then the bottom left is what percentage or the arrears rate, I should say. So this is the percentage of mortgages that are behind scheduling their payments. If you look at the Australian example at the moment. Arrears data per this slide is 3.65%. So that's 3.65% of non-conforming mortgages are behind in their payments by more than 30 days. The long run average there is written as 5.95%. This uses a varied degree of data. Other data I have sort of indicates the long-on-average is about eight percent, but the current level is about three and a half percent compared to say eight percent long on average, and at its worstwhich was in 2002, the arrears rate was 23% in the Australian mortgage market, which is obviously very, very high. in the US market, you can see it's a lot higher consistently. The average is north of 20% over the long run, and it's currently running well above it's okay well above what the Australians experience. And then you have on the right hand side bottom sort of prime arrears prime. To define prime, prime is a mortgage where the borrower has a salaried job. Every week or every month they receive the same income from their job, their employee to whether, say, a company or a business, and they're getting the same money every week. They don't have any black marks against their name from a credit perspective. They've never missed a bill, they've never defaulted on anything. and the loan to value ratio of their mortgage is less than 80%. They're the three main determinants of what's a prime mortgage. Anything that's not classified as prime in the Australian context with regards to APRA is non-conforming. For example, if you're a self-employed doctor, lawyer, accountant, or anything like that, and then in solid professions that earn good income, albeit from one month to the next, would be variable, they are considered non-conforming. Theoretically the banks don't lend to people like that. They then go to what we call a non-bank originator, which is the companies I mentioned earlier, the RedZed, Liberty’s, and so on. Prime versus non-conforming in Australia mean a lot different than say the US versus prime versus subprime. Subprime is a much more negative, I guess, if I could use that term, classification. A little bit more detail about the historical performance and dynamics of a US mortgage versus the Australian mortgage. A US mortgage, your interest payments on your primary residence are tax deductible. Any profit you make when you sell your primary residence is taxed. Because of these two dynamics, you are incentivized to maintain your loan to value ratio as high as you can. And I think the average is about 85% LVR in the US mortgage system compared to, say, in Australia, where it's about 45% in secondary markets. Mortgages in the US are typically non-recourse. Now it does vary state by state. So this is a very generic commentary here. You compare that to the Australian market, and yes, this has changed recently because of the budget but mortgage payments on your primary residence are not tax deductible, and profits on your prime residence are not taxed. So roughly 70% of mortgages in Australia are owner occupied. The balance of 25, 30% is investment. So that's a different dynamic. Further, as a result of those dynamics, you are incentivized to pay your mortgage off as quickly as possible because you're building up equity that's essentially tax free. and that's what we see in Australian mortgage. The average mortgage in Australia is written up to 30 years, but on average are repaid within nine years or refinanced within nine years and with RMBS securities, and I'll go a little bit more detail on how they're structured in moment, but the weighted average life of these securities is around three and a half years. So, we invest in an RMBS today, usually within 18 months of us investing, we start to amortize our exposure because people start paying their mortgages back. and then with three and a half years we're paid off. So again, very good risk return dynamics. and the last thing with regards to Australia mortgages, we are full recourse. So you can't just walk away from your mortgage. if there's a shortfall, the bank will come after you, your first born, your car, your kidneys, whatever, they'll take it. With regards to the US mortgage, you know, there's terms through the GFC called jingle mail. Once you're in negative equity, you can just walk away. You're incentivized to walk away. The bank can't come after you and chase your other assets. So there was a thing, jingle mile, where people put the keys to their house and just mail it back to the bank. Come and get me, you can't. So if you look at the bottom left-hand side there, you'll see between 2000 and now, loss rates on RMBS have ranged from two and a half percent prime to seven and a half percent non-conforming. Now that's prime. That's that's people who have very good jobs and that sort of thing. You look at the Australian market, there has been zero loss across both prime and non conforming over the same period. So no rated RMBS security has ever made a loss or a capital loss that hasn't been cured through the history of RMBS. And I've been doing RMBS since ninety six, which is pretty much when the market took off. A little bit more detail about the resilience of the market here. and there's a sort of commentary from the RBA during or post the GFC on mortgages and sort of talking about the loss rates that have been seen elsewhere versus here where it's virtually donut. The chart on the left there, the data's a little bit old, it sort of ends in 2014, but it covers a very important 30-year period there. And you can see in '94, the last global recession before the GFC inspired one. But you can see the Australian loss rates or non-performing housing loans is very, very static and stable. Whereas you can see the volatility in other markets such as the US and UK, we just don't have that volatility, which is encouraging. Bottom right hand side, this shows you historical arrears rates across the non conforming market. So we can see back in the early noughties it did get as high as twenty three percent, which I mentioned. Even when it hit twenty three percent back then. No RBS security lost any money in a capital sense. There's volatility in market valuation, but there was no loss of capital through default of underlying mortgages and that sort of thing. Into the GFC, areas were rising, you know, 15%, still no losses. And then post the GFC, the underwriting standards and the regulatory oversight has really improved. That's why we have such strong and consistent performance through time across the asset class. So why do we like RMBS? Each RMBS deal typically has about a thousand lines. As a security holder, we get a coupon every month, which is based on the bank bill swap rate plus a predetermined margin. As I mentioned, floating rates, so it's immune from inflationary pressures. Historically low realised loss rates, as I said, or virtually zero. and then structural protection. So we get paid before the originator gets paid. They don't receive any of their money back. They don't get their equity back until we're repaid in full. So the Liberty’s, the RedZeds, Peppers, for them to get paid, we need to get paid first. And then the right hand side is the secret source as we call it, which is the credit enhancement. There's multiple layers of protection within a structure. And the next slide I'll go into the structure and how it works in a bit more detail. But there's what we call an excess spread capture. We just build a reserve account to cover any losses. There's subordination. You can pick what layer of the mortgage pool you invest in. And then in some instances there's more insurance, which is which is less common in non-conforming, more common in prime, that provides you a layer of protection as well around losses. This is what an RMBS looks like. On the left hand side is a rough and dirty, what an RMBS deal looks like. There's class A through to class G. Class A is the highest ranked, typically rated triple A. Sometimes there's three layers of triple A with varying structural dynamics. Class B, which is double A, which is the same rating as a major bank senior bond. Then you go class C D E and F. The ratings change from A, triple B, double B, single B, and then down to equity, the unrated tranche, or theoretically, the first loss piece. As you can see, a thousand mortgages in that structure. It doesn't mean that if you buy the class E note or the class D date, you have a select percentage or a select number of mortgages allocated to you. You have a floating exposure to a thousand loans. Now if the thousandth loan or one of those loans defaults or goes into arrears, the losses start at the bottom and work their up. now keeping in mind that the loan to value ratio of a of a mortgage is typically on a new structure about 65 to 75 percent. Borrowers typically have 25 to 35 percent equity already in their house. soif there is a major cyclical downturn, we would need to see house prices fall on average by 25 to 35 percent and the borrower to default before we were at risk of being impacted from a capital sense. On the right hand side is what a major bank's balance sheet looks like. And I just want to highlight that an RMBS is very similar to a bank's balance sheet and vice versa. Another way of looking at a bank's balance sheet is it's just one big RMBS. Major banks and the regional banks, such as Bendigo Bank and Bank of Queensland, their main asset pool is mortgages, roughly 80%. At the very bottom is the equity piece, so the shares you buy in the share market. Then there is the hybrids, which are being phased out. But then there's the tier two, the subordinated bonds, which if you look across the rate A-Rough and dirty, similar to the class C notes on RMBS deal. Then you've got senior debt and deposits, which is just different layers of the capital stack. And whereas a bank is exposed to commercial property and housing, RMBS structures are exposed only to residential housing. We can choose which layer of the stack that we want to invest in. I've given you some rough yield coupons, given prevailing credit spreads and BBSW rates. Let's take the triple B tranch, the class D, you could get 6.3% to 6.5% on thatFor roughly three, three and a half year exposure. If you compare that to a triple B corporate or bank paper in the market, you're getting a roughly 100 basis points more than what you would for something else that was a bit more vanilla. The argument for that, why you get more spread, some people would attribute that to a complexity premium because RMBS are all a bit more complex than, say, vanilla bond issued by Westpac, or sorry, Westfarmers or Woolworthsand then there is also the argument there is a liquidity premium added to this because RMBS structures are not as liquid as say bank paper. That used to be the case. now I'm not saying that a double B rated RMBS tranche is as liquid as a bank senior or subordinated bond, but they are traded. You can buy and sell them in secondary markets, and increasingly we are seeing trading banks, global trading banks coming to Australia and trading this paper in secondary markets. So if we were forced to sell for whatever reason, there is a market for us to sell them. and just in the middle is just an example of the investor base. This is not just a random part of the market where a few small fund managers invest. There are some big global and systemic fund managers active in this space quite aggressively and deeply into the broader market. And we also see a lot of foreign investors come into the RMBS market, especially out of Japan and Europe as well are very active in this space. Just a bit of a comparison and I don't like to kick private credit when they're down, but for the record, Mutual is not active in private credit and by private credit I mean the stuff you see in the AFR and all the coverage that ASIC and everyone's looking at. We do a small smattering of what we call warehousing, which is doing RMBS before it becomes a public deal. So, it's technically private. but it's still backed by first ranked mortgage over property and the like. So, a different sort of risk profile. But anyway, private credit, often based on model pricing, it is illiquid, often unrated and very opaque. There's been a lot of talk and focus on the transparency of the underlying assets. It's pricing often left at par. Sometimes you have coupons accruing, all those sort of bits and pieces. Whereas the RMBS market is priced daily and independently and transparently. It is liquid. Is traded in over-the-counter markets, as are all bonds in the Australian market. It's publicly rated by any of the three major rating agencies, S&P Moody’s or Fitch. It's very transparent. We receive regular monthly reports on the state of the underlying mortgage pool that we've invested in. And when an RMBS deal is done, say it starts with a thousand loans, loans are not replaced. Once a loan is paid off, whatever reason the underlying borrower goes and refinances, gets a better rate elsewhere, that mortgage is repaid, and the capital returns to the borrower, to the investors such as ourselves. And this is why RMBS pools typically have an average life of three and a half years, because people refinance, chase cheaper deals, and the money comes to us first before going to the equity holder - he RedZed’s and Liberty’s and so on. So that's a key feature as well. Just a bit more detail around why it's I think an area that advisors should look at is there are a lot of cash balances in the market are elevated. There is a degree of uncertainty. You know, we looked at so yesterday we passed the financial year end and the ASX 200 is up only 1.2%. So not exactly a great performance for equity with a lot of uncertainty going forward, whereas these sort of products, capital secure and you will generate solid income and consistency. Going forward. And we would expect sort of our high yield fund, which invests in extensively in RMBS and ABS. You know, your 12-month returns are running around 9% with very minimal capital downside. As an alternative to private credit, and we also see a lot of people looking at RMBS as an alternative to hybrid capital. Now, the challenge for a lot of investors is RMBS is not available to retail investors. It is a wholesale or institutional market. The only way they can really invest in it is through a managed fund. There are some ETFs out there, but they're mainly triple A level, they don't give you the same return. but nevertheless it is a liquid market underlying it. Our own higher yield fund has daily pricing, is has daily redemptions and applications and the like. What could go wrong? I had a meeting this morning with a client who asked these questions, as you would expect, given the budget, and that we're seeing house prices have come off 3%, 3.2% in Sydney as of June. Over the last three months, Melbourne's off a bit. Historically, through housing cycles, on any rolling 12-month period, the worst performance in house prices at a national level we've seen is typically around 10% downside. If you look at the GFC, you look at COVID, rolling 12 month return, the worst has been around 10%. Keeping in mind the weight average loan value ratio on these things is around 65 to 75%. So yes, down 10% versus equity in the individual homes of around 65-75% at the mortgage level. What could go wrong? I mean, a severe recession would obviously be a major headwind for at least sentiment, not necessarily the underlying performance. We saw an unemployment shock that would I mean people pay their mortgage while they have their job. Importantly, unemployment 4.4% earlier this week. The post-GFC average for unemployment is 5.6. We're more than a percent under that. The long-run average is about 6.7%. We are well below the long-on average. and employment's holding up pretty well, despite sort of GDP growth being pretty anaemic. It's still positive, but not as strong as it could be. A housing downturn, obviously. There's been a lot of press, a lot of coverage about the structural dynamics of the Australian housing market. I saw a statistic the other day since the Labour government, Federal government came to power, we've added one point four million immigrants to the country. Without any bias towards immigration policy or whatever, regardless, one point four million people need to be housed. And as an economy we are not building enough houses to cope with the rising population. So that causes in basic economics 101 supply versus demand. Demand greater than supply, prices go up. and that demand won't change, but supply is still being constrained. As a result, that provides, I guess, a floor, if you will, over the next twelve to eighteen months where a lot of forecasters are suggesting house prices could fall up to 10%. Spread widening, we saw this post the Iran war. We saw credit spreads move wider and that sort of caused a very, very modest capital decline, capital price decline, but that's normal. and those spreads have come back, i.e. capital gain. So again, not a major concern for us at the moment. And then there's a liquidity event. COVID was an example, GFC is an example. Donald Trump announcing tariffs last April, or actually last year, causes a shock to the system and liquidity dries up. So all those things aside, I think it's other key things to remember. It is, I would say, systemically important. So Australian banks, I'd say, are systemically important, i.e., during times of crisis, the government steps in to support them. We saw that with COVID, we saw that with GFC. The RMBS market has also attracted government support. Through COVID, the AOFM. the government's funding arm bought RMBS paper to ensure the continued funding of that market. While RMBS funding for mortgages is modest in the grand scheme of things, the estimates roughly around seven to ten percent of mortgage funding, it's still a major part of the market. It lends to parts of the market that the banks don't touch. So politically, there is a will, if you will, to support it. Fundamentally different to the US, touched on that earlier. Credit enhancements provide plenty of protection. So, for all the negative headlines you see in the paper about house prices, these things can withstand some pretty severe downside. And I'll go through that in moment in a separate chart. And they provide good portfolio diversification from an income perspective. If income is key for you or your clients with capital preservation, also a strong desire, then these are an asset class thatyou should look at as well. And lastly, there are floating rate structures. So more interest rates are potentially going up again, depending on which view you have. I think Westpac has two more rate hikes in the in the can, other banks one, some none. Either way, we're still in the rising and inflationary environment. There's risk to higher interest rates. These are floating rates, so your income improves and you don't have the duration hit or capital hit from a duration position. Still plenty of positives to go of the asset class and it is continuing to grow and has very strong support in in the institutional space. Just some very broad fundamental charts here. bottom left shows you the arrears number first is unemployment. As you can see, not a huge or easily observable correlation there. More observable is the is the next one to the right, which shows you arrears versus interest rates. Interest rates have risen strongly from 2022 onwards, obviously given inflation. But as we can see, yes, arrears have gone up, but not by as far as you might be expecting. And then on the top two charts, the same data, just in a scattered plot form. Key points, I think, is the black dots. That's the post COVID data. And as you can see, unemployment has gone from three to seven percent. yet the arrears rate stayed well below long on average, and the same with interest rates stay well below long average. And that's a function of the improved underwriting standards we've seen post GFC, and basicallyregulatory oversight and like, which has really, really helped. How bad can it be? This is an actual deal we looked at earlier in the year. Sapphire 2026-2. So that's the name of the trust. This one has a 1,300 loans, roughly a billion dollars, average loan size 765,000. and that table at the bottom left shows you and I've highlighted a particular part. So the B-rated tranche, which has credit support below it of 0.4%. if house prices fall. 10% and mortgages in that pool, or 27% of that mortgage in that pool default, the capital is still safe. That's just giving you this sense of how much these things can withstand. Now, this also assumes the drop in house prices and the default rate happens all at once. It just doesn't happen. So again, these things are designed to withstand very, very strong, I'm sorry, very, very negative dynamics. Before I go into the last slide, the thing, some data I'd sort of like to leave you with. Since the 1980s, the cumulative loss rate from mortgage lending from the banks is 0.02% of what they've lent. To put that in context, that's a $20 loss for every $100,000 lent. Now, if you look at what the non-bank originators, this is the unregulated part of the market. Their loss rates in the last or before the or late 90s onwards is around a similar figure, some a little bit high, but not much. On average, $20 for every $100,000 lent has been lost through mortgage lending. That's very, very, very low. And again, a reflection of the strength and quality of the underlying assets in these pools. Some myths vs reality. Again, I've touched on a lot of this stuff. RMBS caused the GFC. No, it's not right. It was US subprime lending caused the problem. And I'll give you an example actually. There was a lady in Los Angeles who was 85 years of age and had repaid her mortgage 20 years prior to the GFC, and a rather unscrupulous mortgage broker convinced her to remortgage her house at 95%. She lost her house within 12 months. So it's an example of the US system versus the Australian system. We're much more regulated. We have 12 banks that control 90% of the market. In the US, you have six, seven thousand banks, and you have many, many number of defaulting banks in finance companies every year. All securitization is risky. No, structure matters. So. we spend as much time on the structure as we do the underlying loans, the originator, all those bits and pieces. We don't just look at the pool of assets and go, yep, that's ours. That's our source of repayment. We look at the history of the borrower of the lender, how good they've been through the cycle, what their arrears rates are versus the broader market. House prices must rise. That is a myth. we've saw through COVID house prices fell 10%, arrears rates still stayed below the long and average. I think they peaked about 5% versus an 8% average. and these transactions are designed to withstand stress. The GFC taught a lot of people lessons. and we're just stronger through it. Only institutions can access it. Yes, that's correct, but through managed funds you can access these securities. there are several managers out there who can do it. we would obviously promote ourselves. try our website, there's plenty of information there or reach out directly. There's our funds. There's four of them. Just a bit of a product flog. the bottom two funds have RMBS in them. and there's the fee structure. So the both of them are rated recommended by Zenith and Lonsec. the income fund, so the credit fund's been around. We actually launched that March 2020, which is great timing, but that fund has doubled in size. You know, performance has been very strong. And the high yield fund was launched a year earlier. Sort of that's five hundred and fifty million now. and performing very, very well. So I will leave it there. John, any comments you want to make. John Clothier (37:06.038) No, thanks very much for that. It's a pretty comprehensive play by play there of what's available within the mutual limited portfolio. I think pointing out some of those fundamental differences between the market here and in the US and how stable it has been in that environment, the return for the risk taken on board's been a a pretty handsome trade. And and I think, especially in the current environment, that that consistent access to money. the no buyer sale spreads, the daily liquidity for people to get in and out is becoming more and more important with with some of the other developments that we've seen in the market. So thank you very much for your time. If anybody has any questions, please r reach out to any of your business developers at copia and we're happy to provide you with any more information on any of the strategies within mutual or more broadly within the Copia stable. Thanks very much. Scott Rundell (38:02.2) Thank you.

“Patriotism is supporting your country all the time, and your government when it deserves it" - Mark Twain Cartoon of the Week Source: www.hedgeye.com Funds Snapshot Movers & Shakers (week ending 14th August): Stocks (ASX 200 ↓1.60%, S&P 500 ↑0.36%, NASDAQ ↑0.14%) Bond Yields (ACGB3Y 4.53%, ↑ 4 bps / ACGB10Y 5.01%, ↑ 8 bps) Bond Curves (A$ 3s10s +48 bps, ↑ 4 bps) Credit Spreads (Major Bank 5Y Senior +63 bps, ↓1 bp / Tier 2 +127 bps, ↑ 4 bps) Oil (Brent US$88.52/bbl, ↑5.95%) Gold (US$4,373/oz, ↑0.73%) The Payrolls Shock: When the Data Breaks, Markets Listen Executive Summary Global markets spent the week digesting a benign inflation signal and a deteriorating growth signal at the same time. US July CPI landed exactly on expectations at 3.4% headline and 2.5% core, both lower than June, and producer prices were softer still — yet retail sales fell 0.6% and the control group dropped 0.4% against expectations of a 0.3% gain. The RBA held the cash rate at 4.35%, as universally expected, alongside its Statement on Monetary Policy. The statement remained hawkish, supported by the post meeting press conference. Markets split accordingly. US short-dated yields fell while the 10-year rose, the ASX 200 shed 1.6% as China's PMIs sat in contraction, and credit spreads ground tighter. Brent jumped almost 6%. For investors, the message is that carry, not capital gain, is doing the work. Cash rates near 4.35% and investment grade spreads near one-year tights leave short-dated, high-quality income looking better rewarded than equity risk. Market Overview The dominant narrative: disinflation without demand If there was a single organising idea for the week, it was this — the inflation problem is visibly improving, but so is the growth story, and not in a good way. The US July CPI report was as clean as central bankers could hope for. Headline inflation eased to +3.4% YoY from +3.5% YoY, core to +2.5% YoY from +2.6% YoY, and both monthly prints matched consensus exactly (+0.1% and +0.2%). Producer prices were softer again: final demand was flat month-on-month against a +0.2% forecast, and the annual rate collapsed from +5.5% to +4.7%. Geopolitics and the energy shock - Brent crude rose 5.9% on the week to $88.52 as the situation with Iran and the Strait of Hormuz remains uncertain, which will keep oil prices elevated and weigh on inflation. The catch is that the American consumer appears to be running out of road. Retail sales fell -0.6% in July against expectations of a +0.1% gain. Excluding autos and gas, sales fell -0.2% where a +0.3% rise was expected. The control group — the measure that feeds most directly into GDP — declined -0.4% after a +0.4% gain the prior month. That is not a rounding error; it is a genuine break in trend. The labour market data pointed the same way. Initial jobless claims rose to 209K against a 202K forecast. Most tellingly, real average hourly earnings fell -0.2% YoY and real weekly earnings rose just +0.1%. When real wages stop growing, consumption is eventually funded by savings or credit — neither of which is a durable base. An awkward wrinkle in the inflation data - one detail deserves attention because it complicates the disinflation story. Core producer prices (PPI) are running at +4.2% YoY while core consumer prices are at +2.5% YoY. That is a wide gap, and it can only resolve in one of two ways: either producers absorb the cost pressure and margins compress, or the pressure eventually passes through to consumer prices. Neither outcome is friendly to the "inflation is solved" thesis. We would treat the current disinflation as real but not yet secured. The RBA held at 4.35% on 11 August, matching consensus, and released its quarterly Statement on Monetary Policy the same day. The statement and post meeting press conference were hawkish. Domestic activity data supports a cautious stance. NAB business confidence deteriorated to -6 in July from -5, though conditions ticked up to +4 from +3 — a soft but not alarming combination. Housing finance told a sharper story. Total home loan values fell 5.2% in the June quarter, with investor lending down 10.2% against a 3.0% decline the prior quarter. Restrictive policy is transmitting to credit growth, which is precisely what it is meant to do. And of course, the Federal Government’s tax changes are having a meaningful impact with major banks reporting 15% - 20% drop in mortgage applications since the budget. Europe quietly improved. Second-quarter GDP grew 0.4% QoQ and 1.0% YoY, in line with forecasts. Industrial production returned to positive territory at +0.1% year-on-year against a -0.6% expectation. China moved the other way. The most recent official readings showed manufacturing PMI at 49.2 against a 50.1 forecast, non-manufacturing at 49.0 and the composite at 49.3, down from 50.6. All three sit in contraction. Industrial profit growth decelerated to 15.1% year-on-year from 21.1%. For an Australian investor, this is not an abstract data point. Equity Markets Australia's 1.6% decline stands out because it came in a week when US equities rose. The most plausible explanation is the ASX's structural exposure to Chinese industrial demand at a moment when China's PMIs are in contraction across manufacturing and services. Sector performances support this explanation with Materials down -1.77% on the week, while bank reporting and weakening mortgage growth weighed on the Financials sub-index, down -3.23% on the week. A +2.84% rally in energy stocks, buoyed by surging oil prices, eased the broader pain somewhat. Valuation: the observation that matters most - the Australian equity risk premium has effectively disappeared. The ASX 200 trades on a forward earnings yield of 5.34%. The 10-year Australian government bond yields 5.01%. Investors are being compensated approximately 33 bps for taking equity risk over a risk-free government bond. Historically, that compensation has been measured in whole percentage points. In the US, the premium is negative. The S&P 500's forward earnings yield of 4.61% sits below the 10-year Treasury at 4.69% — a negative 9 bp premium. For the NASDAQ, at a 3.40% earnings yield, the gap is negative 130 bps. Two honest caveats. First, franking credits materially improve the after-tax position of Australian equity income for domestic investors, and the raw 3.26% ASX dividend yield understates the grossed-up return. Second, a compressed equity risk premium is a statement about expected returns over years, not a timing signal — markets can sustain thin premia for extended periods. But as a guide to where the risk-reward sits today, the numbers are unambiguous: investors are being paid very little to move up the risk curve. By contrast, Europe at 15.9x and Hong Kong at 11.3x are the only major markets trading at multiples that leave visible room for disappointment. Europe's improving data makes that combination more interesting than it was a quarter ago. Fixed Income & Credit Australian yields moved higher on the week. The curve is modestly positive — 48 bps from three to ten years — and the 10-year is holding above 5.0%, near the top of its one-year range of 4.10% to 5.12%. For income-focused investors, this is the most important number in the report. A 5.01% yield on a AAA-rated sovereign bond is a genuinely different proposition to what was available a year ago at 4.21%. Duration has gone from being a source of return-free risk to being properly compensated. We would still add it gradually rather than all at once. The long end faces two identifiable headwinds: an energy price impulse and, in the US, a fiscal picture that is deteriorating faster than expected. US Treasuries: a revealing twist - the US curve did something worth explaining. The two-year fell 2.6 bps while the ten-year rose 4.7 bps, steepening the curve by roughly 7 bps to 52 bps. This is the market saying two things simultaneously. The front end responded to weak retail sales and rising jobless claims by pricing a softer policy path — the rational response to a slowing consumer. The long end went the other way, and the likely reason arrived on 13 August: the July federal budget deficit came in at $432.3bn against a $346bn forecast, versus $291.1bn the prior month. A deficit that large means more bond supply, and more supply at the long end means a higher term premium regardless of what the growth data says. The 6% oil move would have reinforced this. The lesson for clients is that long-end yields are no longer a pure function of the inflation and growth outlook. Fiscal supply is now an independent driver, and it does not respond to weak economic data the way policy rates do. This is why we would be careful about assuming long bonds will reliably hedge an equity drawdown. Looking across different asset classes, the cash rate is at 4.35%, floating rate bank credit offers ~5.50% to ~6.10% across senior and subordinated, which compares favourably to the ASX 200’s 3.26% dividend yield. The blunt conclusion is that investors do not need to take equity risk to generate a solid income return in the current environment. That has not been true for most of the past decade. More on the RBA…the board left the cash rate unchanged at 4.35% in a unanimous decision, judging policy to be somewhat restrictive after three increases this year. The statement noted that inflation picked up materially in the second half of 2025 and both headline and trimmed mean measures remain too high, with the Board noting also that some of the increase reflects genuine capacity pressures rather than temporary factors (i.e. oil prices). Tighter financial conditions are transmitting broadly: money market rates and bond yields have risen, the exchange rate has appreciated, consumer spending growth is slowing as expected, housing prices are falling in some capital cities and new housing loans have declined noticeably, and labour market conditions have eased slightly more than anticipated. Against that, business debt and investment growth is strong and trading partner growth has beaten expectations as AI-related investment outweighed conflict-related drag, while weak productivity continues to constrain potential growth. The Board expects inflation to remain elevated for some time and does not see it returning to around the midpoint of the target band until late 2027, with upside risks to that projection. It has chosen to hold while it assesses how the economy evolves but stated explicitly that it will raise the cash rate further if upside risks materialise. Outlook The most probable path from here is one of continued gradual disinflation accompanied by decelerating growth — the classic late-cycle configuration. US inflation is falling on both consumer and producer measures. US demand is weakening. Europe is modestly improving from a low base. China is contracting. Australia sits with a restrictive policy rate and visibly slowing credit growth. In that world, policy rates drift lower eventually rather than imminently, long-end yields stay stickier than the growth data alone would justify because of fiscal supply, and credit spreads at current tights have more room to widen than to compress – but can also stay firmly at prevailing levels also, which is our base case. The RBA appears comfortably on hold. The 11 August decision changed nothing and markets did not reprice. Two upcoming releases could change that: the Q2 Wage Price Index on 19 August (consensus +0.8% QoQ and +3.2% YoY, easing from +3.3% YoY) and July employment on 20 August (consensus +12K after a remarkable +76k, with unemployment steady at 4.4%). A wages upside surprise, particularly alongside consumer inflation expectations at +4.7% YoY, would reopen a conversation the market currently considers closed. A sharp employment miss would open the opposite one. The Fed faces a genuinely difficult set of signals: inflation is behaving, but the consumer is not. Weak retail sales and rising claims argue for easing; a +4.2% YoY core PPI rate and a $432 billion monthly deficit argue for patience. We would not put high confidence in any particular path.