Text on screen: John Valtwies, Account Manager
Valtwies: Rob, it's been a remarkable month. We've seen some incredible moves in markets, some policy U-turns. What does all this mean for Australia in particular the RBA's decision to hike less than most were expecting?
Text on screen: Rob Mead, Co-head of APAC Portfolio Management and Head of Australia
Mead: Yes John, we've definitely seen some volatility in the past few weeks. I guess it all started with the interplay between fiscal and monetary policy in the UK and we saw the incredible bouts of volatility there.
More recently in our own backyard, the RBA came out with an incredibly upbeat statement about the Australian economy: Wages are growing, unemployment rate may go further down, still confident about people's buffers in terms of their savings, Terms of trade very supportive, in fact inflation expectations are going up even further in terms of the forecast.
But yet [the RBA] felt that 25 basis points was enough even though the market was pricing 50.
We're still thinking that through but I think the most important takeaway is that the terminal rate still needs to be well above neutral. At 2.60 we're in the neutral zone. We think there's more rate hikes to come and to use the RBA's words, navigating this narrow path and keeping the economy on an even keel is becoming that much more complicated and difficult.
Valtwies: Rob, you've talked about this narrow path, as the RBA also stated. How do investors think about navigating this environment?
Mead: Yes, I think the way to think about it would be 3.5% as a terminal rate would be, we think, about the minimum required given that inflationary backdrop and given that inflation in Australia still hasn't peaked. If we have to go all the way up to 4% or maybe north of 4%, we're talking about recession.
And so for investors that are thinking about growth outcomes they should be preparing their portfolio allocations for scenarios that may very well include a recession. So that means much more about moving back towards structural targets, whether that be 70-30 or 60-40 in terms of that risk asset versus defensive assets split. It means being very cautious around earnings expectations. It means being cautious around illiquidity and especially investing in highly levered structures.
So all of these things suggest that with bond yields where they are, the hurdle rate for investing in riskier assets is much higher, especially when you're thinking about 6% plus potential returns from fairly low risk investment opportunities. That should really calibrate the rest of a portfolio allocation.
Valtwies: Well, thanks, Rob, and thank you for joining us. To learn more about our views and analysis on markets, please visit pimco.com.au.