Timothy Dowling: Well hello and welcome to today's Trade Floor update. I'm joined by portfolio manager Aaditya Thakur.
AT, we had the RBA put a second consecutive hold on interest rates at 4.35% which was broadly what the market expected. But what was the rationale that was given for that hold?
Aaditya Thakur: Yes, it was a strange meeting in the sense, I don't want to torture a sporting analogy but it was almost like a game of two halves. You had a statement and a set of updated forecasts which leant dovish but then you had a press conference where Governor Bullock was explicitly quite hawkish.
So we have to figure out what's going on there. It's almost like we got to see, ‘this is what we think but this is also how we feel’. And those two things are in contrast. In terms of what they think, the data was pretty clear in their forecasts.
They have unemployment now peaking at 4.8%. So that's 20 basis points above their estimate of full employment. So we're moving into a period of spare capacity. And as a result they now forecast underlying inflation to hit 2.4% in 2028. So that's actually below the midpoint of their 2 to 3% target band. And that's a signal that policy is very restrictive. It's restrictive enough to get inflation down and really it's a signal that they're likely done.
So that's what the forecasts were telling us, but in the press conference, when Governor Bullock was asked ‘how do you see the balance of risks?’ She was quite explicit. She said, she sees the balance of risk to the upside and she said personally we may need to hike one more time should those upside risks materialise.
So I think there are two elements to that. I think one element is it's just partly jawboning. It's too early to declare victory on inflation, and they don't want to pre-emptively ease financial conditions unintentionally. But secondly they're just expressing a very low tolerance for any upside surprises. So that's important for investors.
But how do we reconcile these two things? This is what we think and this is how we feel. How do we reconcile that? Ultimately they're paid to set monetary policy based on the facts, based on data. And that's why we think how they think, and the data will trump how they feel.
Timothy Dowling: Yes, obviously they've got a very clear mandate and they're clearly going to stick to that.
In terms of our own views, how does PIMCO see things? Are we seeing more risks to the upside as Governor Bullock mentioned or is there actually more downside risk in terms of how interest rates are being transmitted through housing and those sorts of concerns around the economy?
Aaditya Thakur: Yes, I think in contrast to Governor Bullock we actually see the risk to the downside. I mean if we think about it, we've got a consumer now whose real incomes are being hit by energy prices.
You've also got house prices that are falling slightly more than what people were expecting. And we're expecting house price falls in the high single digits. You now also have fiscal policy turning slightly negative. So the fiscal impulse turning slightly negative.
So for the first time in a very, very long time we have monetary policy, fiscal policy and asset prices, all working against the consumer not working with them. And that's why we think there's a little bit more downside risk.
We actually think that inflation will come off. The process of disinflation will be a little bit faster and by the end of this year we'll be thinking about rate cuts, at least just a couple of rate cuts in 2027 rather than further hikes.
So that's where we differ from the RBA and with the market already pricing in almost a full hike to go and ten-year government bond yields at 5%, high-quality investment-grade spread product yielding 5.5 to 6.5%, we think that active fixed income portfolios provide a fantastic opportunity for clients.
Timothy Dowling: Yes, fantastic. Well thank you everybody for tuning in.
And as AT mentioned there, an exceptional opportunity to enter into fixed income and take advantage of those higher yields and the potential for capital appreciation if we do see those downside risks materialise. If you have any further questions please do reach out to the team, we'd be more than happy to help. Otherwise we'll see you next time.