Beyond the cash rate: Higher yields, more room for error

The CPI surprise hit a local bond market already under strain from global forces. Brent crude has moved towards US$95, Fed Chair Kevin Warsh struck a hawkish tone at Jackson Hole - describing financial conditions as not broadly restrictive while again declining to offer forward guidance - and Japan's 10-year yield touched 3% for the first time since 1996.

The direction of travel has been the same across major markets, and with yields continuing to grind higher, the local move has been part of that momentum rather than separate from it.

The Bloomberg AusBond Treasury 0+ Yr Total Return Index is a useful benchmark here. Its yield rose from 3.79% to 4.85% over the year to 31 August 2026, a 106 basis point move, and yet the index returned close to zero rather than falling.

Income did the work as the interest earned along the way offset almost all of the fall in prices, so investors who held through the sell-off ended the year roughly where they started rather than nursing a loss.

Aussie government bonds have held their ground while yields climb

Source: Bloomberg. Weekly observations, 1 September 2023 to 31 August 2026, index rebased to 100 at the start. Over the 12 months to 31 August 2026 the index returned -0.1% while the 10-year yield rose 82 basis points. Past performance is not a reliable indicator of future performance.

Higher starting yields have rebuilt the buffer for the year ahead. With the index yield to maturity at 4.85% and duration of 5.25 years, yields could rise a further 92 basis points - to roughly 5.77% - before a simple gross total-return estimate turns negative.

That is close to a full percentage point of further rises that the starting income can absorb.

Rates could still rise further, but the reward for carrying interest rate risk at these yields looks better balanced against that risk than it has over the past five years. For instance, at the start of 2022 when global inflation last caused interest rates to rise, Aussie government bond investors faced a margin of just 28 basis points before one-year total returns turned negative.

The scenario above is one way to view the current market, but the iShares range lets a variety of views be implemented. For investors who are still uncomfortable with interest rate risk, the iShares Enhanced Cash ETF (ISEC) earns attractive front-end yields while keeping capital liquid and giving you portfolio optionality.

The iShares Credit Income Active ETF (ICME) is another shorter-duration option. With a running yield of 6.27%, yield to maturity of 6.86% and duration of 0.59 years, it gives you diversified access to the broader Australian credit market.

And for those who see the risk and reward as well balanced at these levels, the iShares Treasury ETF (IGB) implements the scenario above directly through the same Treasury index illustrated in the chart.