Text on screen: David Orazio, Head of Distribution, Global Wealth Management
Orazio: Hi, and welcome to this month's trade floor update. Today I'm joined by portfolio manager Rachael Boyte. Rachael, great to have you with us today. Now the RBA, first meeting of the year, they did hike rates. Has that changed our thinking?
Text on screen: Rachael Boyte, Portfolio Manager
Boyte: Yes, absolutely. It was a pretty quick pivot from the RBA, from a rate cut in August last year through to a rate hike at this meeting. And that is a bit different from what we were expecting late last year.
We've had a lot of new data and our view has had to evolve with that data. Private demand has been a lot stronger than we expected. That's come through to some tightness in the labour market. So the unemployment report that we received in January that showed the unemployment rate ticking down to 4.1%, a bit stronger than expected.
And then at the same time, inflation has been higher as well. So underlying inflation is running at 3.4% year on year. It's quite a bit above the RBA's target band of 2 to 3%.
We are seeing some pretty encouraging signs in the last print that the more persistent components of inflation are past the peak. So housing inflation, as an example, both rents and building costs, seem to be moderating. But inflation overall is still a bit higher than the RBA would like and it will take too long to come back to the target band.
And we think that's why they made the decision to hike rates this month.
Orazio: So what do we think the RBA does from here?
Boyte: We're not expecting an extended cycle from here. It's really just one or two adjustment hikes. And that's because the strength that we've seen recently, it's coming from the consumer. And the consumer is very exposed to a higher policy rate. So household indebtedness is very high. When we look at what the average household outlays every month as part of their gross income, it's over 20% towards interest and taxes. That's very close to the peak and that means that we'll see quite a rapid transmission through the cash flow channel that will tighten financial conditions.
The other place where we're seeing quick flow through is in the currency. So the Aussie dollar trade weighted index, the TWI, is up 5.5% since the November meeting.
The RBA's internal models suggest that will bring inflation down over time naturally.
So that kind of appreciation in the dollar would normally bring inflation down by about half a percent over time and that acts as an automatic stabiliser. Because of that, we think the RBA can afford to be pretty patient here. And that's how Bullock characterised the hike in the meeting as well as a cautious move.
Orazio: So wrapping that all up in what you said there, what's our outlook for the fixed income asset class?
Boyte: We're pretty positive on bonds for this year. You might be expecting me to say that as a bond manager, but I've got some pretty good reasons for that.
If we take a step back and we look at last year, it was quite a good year for fixed income.
So our PIMCO bond funds returned between 5% and 7%. The Australian bond funds were at the lower end of that range. The global bond funds and global credit did a little bit better just given that divergence that we did have into the end of the year between Australian rates and global bonds, but it's still a pretty good number overall.
If we look to the year ahead, current yields are quite attractive. They're very high. The ten year bond yield is sitting around 4.90%. So it's still over 100 basis points over the RBA's cash rate. The ten year bond yield now is actually higher than where it was a year ago when the RBA had the cash rate at the peak.
Orazio: And what's the difference between now with everything that you said, and 2022, the rate hiking cycle that we saw there?
Boyte: Yes, it's a very different environment to 2022. If we look back to 2022, starting yields were very low. So because the RBA had had to keep the cash rate at the effective lower bound during the pandemic, the ten year bond yield had got all the way down to 0.75%. Starting yields are a lot more attractive, and so we've got a lot more income buffer in portfolios to protect against any further rise in yields.
The other big difference is inflation. Inflation coming out of the pandemic had started to become unanchored so headline CPI in Australia peaked at 7.8%. In that kind of world that is where correlations tend to break down and bond and equities, both sell off at the same time. Current inflation is only a little bit above the RBA's target band. And in that kind of environment the bond equity correlation tends to be slightly negative.
Orazio: Well Rachael, we covered a lot today. I think some great insights for our clients.
So thanks very much for your time today. And thanks very much for joining us. As you heard, 2026 we have diverging economies, we have changing and shifting policy paths.
And that provides a great backdrop for active fixed income to deliver another robust result in 2026. We've got high starting yields, which is a great position for fixed income investors. And dispersion to really allow clients to position portfolios, go up in quality, up in liquidity and still generate a really attractive return potential at a time when risk assets are fair to fully valued. If you have any questions or would like further information, please reach out to your PIMCO Account Manager.