David Orazio: Hi and welcome to this month's Trade Floor Update.
Text on screen: David Orazio, Head of Distribution, Global Wealth Management
Today I'm joined by portfolio manager, Aaditya Thakur. AT, great to have you with us today.
Now, the RBA this month paused their rate cutting cycle. Now as a firm we've been relatively bullish on Australian duration. Has the latest pause changed our view?
Aaditya Thakur: A lot to unpack here, David.
Text on screen: Aaditya Thakur, Portfolio Manager, Australia & Global
So let me just talk about, give some perspective around the RBA's latest forecasts. Talk about where we differ from their forecasts and why, hence why we're still bullish and still overweight Aussie duration.
So firstly, the forecasts show that underlying inflation will sit around 3.2% for the next couple of quarters. It then gradually declines back to 2.6%, pretty much their target, the midpoint of their target, over their forecast horizon.
So you can think about, the first element being a little bit of a hawkish signal, simplistically suggesting that they'll be on pause now, at least until February, perhaps a little bit beyond.
But beyond that, I guess the more balanced or even slightly dovish element of their forecasts is that they do see inflation coming back to target over time.
So that suggests that they think this bump up in inflation is pretty much just temporary. And we agree with that assessment.
But where we differ from the RBA is around their expectations for growth and employment. So they now forecast GDP to sit at around potential, 2%, over the foreseeable future and unemployment rate to stay very stable at 4.4%.
But we see an accumulation of evidence that the labour market continues to gradually soften. We've seen the pace of employment slow to a level that's below what's required to keep the unemployment rate stable. We've seen a continued fall in job vacancies and job ads. And even employment intentions in the business surveys and the RBA's own liaison survey suggests that the labour market continues to cool and wages will continue to moderate.
So we think the more likely possibility is that the unemployment rate will continue to drift a little bit higher towards 4.7, and that will allow, if not require the RBA, to cut a couple more times to 3.1% by the end of next year.
Now, the final point I would make is that monetary policy also works through expectations. And we think this latest pick up in consumption has embedded in it some expectations of further easing. So with those cuts now not being delivered, at least until the early part of next year, we think that the consumer might become a little bit more defensive, pull back a little bit.
And that's why we think this transition from public spending to private spending is going to be a bumpy one. It's going to be a little bit stop start. It's not going to be this smooth profile of trend-like growth.
And that's why we think this recent back up in yields provides yet another good opportunity for investors to top up their bond allocations. If we look through the cycle, these have been fantastic entry points to add to fixed income.
And finally, I'd say that when we look at it from a global perspective, we have seen these mid-cycle pauses in a few other countries, like the Fed in the U.S., the Bank of Canada, and also the B.O.E. in the U.K. And in all those cases we've seen a resumption of the easing cycle once inflation continues to moderate. So we don't think Australia is going to be any different.
Orazio: Now AT, whilst homeowners and investors would have loved another rate cut by the RBA, fixed income returns for the last 12 months have been incredibly strong. What can investors expect going into 2026?
Thakur: Yes, so despite the volatility, despite these rangebound markets in yields, bond returns have been really healthy. When you look at the one-year return until the end of October for Aussie bond indices, they've been around 6.5%, with the value add, with the excess returns we've been able to generate, our Aussie bond strategies have returned around 8% over that one-year period.
Likewise, global bond indices have returned about 4.75%, and with our excess return, our global bond strategies have returned around 7.5%. So really healthy returns.
And now with yields for these strategies back in the 5 to 6% range, we think that that's a really good estimate for expectations for bond returns over the coming year.
And as a building block to your portfolio, that's your defensive anchor and you're starting off with 5 to 6% yields. We think that that's a really positive return environment and a means to construct really robust portfolios.
Orazio: How have we been able to generate these kinds of returns?
Thakur: Well, not only have the starting level of yields been attractive, but we've been able to exploit these rangebound markets. We've been able to exploit the macro cycle divergences between countries. And we're also using a lot of carry and other relative value strategies that are a bit more agnostic to the direction of interest rates, by a low beta to outright duration. And we think that that environment will continue.
And that's why we remain very positive and we expect those healthy returns to continue even if rate cuts aren't delivered quite at the pace that we initially expected.
Orazio: Thanks, AT. Now, as you heard today, returns across fixed income have been incredibly strong over the last 12 months.
Importantly for all investors, the opportunity is still at hand. We have elevated levels of yield, steeper yield curves and dispersion amongst countries and credit sectors, which provides a perfect opportunity for active managers such as PIMCO to deliver resilient income in a prudent and defensive manner.
Now, if you have any further questions or would like further information, please reach out to your PIMCO account manager.