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 Adam Bowe.
Adam, let's kick off with the RBA. They did raise rates again this month. Now capping off a hat trick of rate rises to begin the year. Now, although much of it was priced in by markets, I really wanted to get your thoughts on where to from here in terms of the RBA.
Text on screen: Adam Bowe, Managing Director and Head of Australia Portfolio Management
Bowe: Yes, they did raise rates back to 4.35 and the market still has additional rate hikes priced from here over the next couple of months.
But we think there's a reasonable chance they're done now. Just acknowledging there's a lot of uncertainty over the next few months, particularly with regards to the longevity of the conflict in the Middle East. Potential economic implications for countries like Australia. But interest rates are now materially restrictive, we think, in Australia.
So the last time we were at these levels to fight a rise in inflation, it coincided with a two year per capita recession. Acknowledging there's a lot of uncertainty over the next couple of months, it's hard to have high conviction over that short time frame. You know, financial conditions have already tightened materially. All the tailwinds that supported the growth recovery last year are now headwinds. tax cuts from 2024 are now well behind us.
The rise in inflation and fuel costs, risk contracting real household incomes again, and the rise in house prices nationally that was supporting consumption through wealth effects, is also moderating. In fact, in Sydney and Melbourne for the last couple of months they've been outright contracting.
So we're expecting a much more cautious approach to policy in the next few months from the RBA, as I said, acknowledging the uncertainty. And I think Governor Bullock acknowledged that when she said, after three rate rises, the RBA now feel they're in a position that they have some space to see how the data evolves.
So with rate hikes still priced into the market over the next couple of months, policy in two years time still above 4.5%, but an RBA that's pivoted to both focusing on both sides of their mandate, not just inflation risk now, and ten year government bonds still hovering around 5%. We think there's considerable value in Australian duration.
Orazio: Now it’s federal budget time. There's been a lot of chat around changes to CGT and also efforts to rein in government spending to curb those inflation pressures that you talked about. Wanted to get your thoughts on market implications? What should investors be focused on?
Bowe: So I don't think investors should be focussed on material shift in the macro outlook in terms of inflation and growth out of the budget. It's certainly not what we're focusing on. As you say, I think the more interesting thing for investors is just potential changes in the way returns are taxed.
In Australia, as investors, you always get your returns either through income or capital gains or a combination of both. And in Australia, capital gains have always had favourable treatment in terms of taxes. If you've had the asset for more than 12 months through the capital gains tax discount.
So any potential changes to that certainly has the potential to change the relative attractiveness to assets that generate returns from income versus growth assets that rely on returns through capital gains.
So certainly potential shifts there. And so in terms of the policy announcements this month, I think they're both potentially constructive for high quality fixed income which already looks attractive.
We've got high interest rates from the RBA that supports income generation and potential changes in the way returns are taxed that make returns generated from income more attractive relative to growth assets that arguably already look expensive.
Orazio: Thanks, Adam. Appreciate your insights. Now, with the RBA clearly moving into restrictive territory and alert to both inflation risks but also growing risks in terms of growth to the downside, we think it's a great opportunity for investors to lean into the fixed income opportunity set to generate resilient levels of income, but also cushion their portfolio against potential economic downturns. As always, if you have any further questions, please reach out to your PIMCO account manager.