May 2025 Update from the Australia Trade Floor

Text on screen: David Orazio, Head of Distribution, Global Wealth Management

Hi and welcome to this month's trade floor update. Today I'm joined by portfolio manager Aaditya Thakur.

AT let's start with the RBA. They did cut by 25 basis points this month. What drove their thinking and what are our expectations for further easing this year?

Text on screen: Aaditya Thakur, Portfolio Manager, Australia and Global

Yes, the RBA cut by 25 basis points as you said to 3.85%. But yet again they surprised the market.

So if we cast our minds back to February when they cut, which was also broadly expected, they were very hawkish. They didn't pre-commit to any further easing. But this time around, they very clearly signalled that the journey to neutral has now begun.

So what changed in the last couple of months?

Well, in aggregate, the data just forced them to downgrade their forecasts. So when we look at their year-end forecasts to trim mean inflation, that was lowered by ten basis points to 2.6%, pretty much at target.

When you look at unemployment, that was increased by ten basis points to 4.3%, which is getting very close to the estimates of Nairu. So that's saying a labour market that's much closer to being in balance, and growth was downgraded by 30 basis points to 2.1%, which is around their estimate, perhaps a little bit lower than potential growth.

So you've now got inflation on a clear path to target. As the first chart shows, you have a softer growth environment. And given the global backdrop with policy uncertainty and trade wars, you've got increased downside risks. So that really laid the foundations for a 25 basis point cut. But the RBA actually considered a 50 basis point cut. That's the most dovish element of this meeting. And it really tells you that their hurdle for further easing is pretty low now.

So where are they going to get to? Well, we think that a neutral cash rate in Australia is somewhere between two and a half to 3%, so call it 2.75% as a midpoint. So we're expecting at least another 3-4 25 basis point cuts, at a quarterly pace. And we would say that the risk to that is very much skewed to a faster pace and perhaps deeper cuts, should some of those global recession risks start to materialise.

Orazio: Okay, let's transition globally now. Policy uncertainty in the U.S. this year has been pretty elevated. That's translated to a lot of volatility across a lot of asset classes especially in recent times. And it's also brought into question many people questioning the end of the U.S. exceptionalism thematic that has really driven markets over the last two years. What's your thoughts on this and how are we positioning portfolios as a result?

Thakur: Yes, I think when you think about U.S. exceptionalism and by which I mean, the outperformance of U.S. growth and productivity relative to other countries, I think there are certain serious question marks, whether you're looking at it from a from a cyclical horizon, like in the near-term or even a secular horizon over the medium term.

Let's just take cyclically. You've obviously got a big tariff shock, which is going to be a supply shock to the economy. You've got very elevated policy uncertainty, which the second chart shows. And now you've got question marks around fiscal policy and the hit to sentiment from wider fiscal deficits in the U.S.

So all of that has caused us and other forecasters to downgrade their growth expectations for the U.S.. We now expect growth in the U.S. to be somewhere between 50 basis points to 1%, for this calendar year. That's down from the low twos. And that's really getting to that dangerous stall speed area.

And when you think about over a longer horizon, over a secular horizon, the changes that are being proposed in terms of immigration policy, which will obviously affect population growth,  the potential for reduced spending, or funding on education, on health services, on medical research, all of these things are going to potentially impact the inputs to potential growth. And, really, the foundations attack the foundations of innovation that have distinguished the U.S. from other countries.

So from that perspective, we do have to take these risks seriously. And we do think that there is some additional risk premia that global investors will expect for this additional uncertainty.

So from a positioning perspective, when we think about our risk factor approach to positioning, this is why we have a much more diversified exposure to our duration exposures where long duration in other countries, particularly Australia, the U.K., countries which would have a disinflationary impact from the current trade wars.

When we think about yield curve shape, we have a bias for yield curve steepeners, which should benefit, given that fiscal policy around the world, is going to rebuild this term premia into long end of interest rate curves.

From a spread perspective, we're going up in quality and we have a preference for securitised assets where we're a bit closer to the underlying cash flows of the assets as opposed to generic corporate credit.

And in terms of FX, we now have a short U.S. dollar bias primarily expressed against a defensive basket of Euro and Yen crosses.

And the last point I would make is that should some of these risk materialise, Australia is probably one country that would really benefit. Just given that the political situation here is fairly stable, we've got good rule of law, good transparency and governance.

These are all the things that would attract capital and be beneficial, in terms of capital flows for Australia.

Orazio: Thanks AT, really appreciate your insights.

With attractive starting yields of 6 to 7% for high quality fixed income, we really believe it's an opportune time for investors to lean into fixed income in terms of their portfolio construction, to not only generate attractive and resilient income streams in the face of declining cash rates, but to hedge against potential elevated levels of volatility going forward.

If you have any questions or would like further information, please reach out to your PIMCO account manager.