Text on screen: Hugh Holden, Account Manager
Holden: Hi, I'm Hugh Holden and I'm joined today by portfolio manager Rob Mead. And Rob, everything we're hearing from central banks around the world continues to emphasise their focus on getting on top of inflation. Here in Australia, the Reserve Bank has raised the cash rate to 2.35%, which is getting close to what we would consider the neutral cash rate.
But bond markets are pricing significant additional tightening from here, taking the cash rate to close to 4%. So what does that mean for the Australian economy?
Text on screen: Rob Mead, Co-head of APAC Portfolio Management and Head of Australia
Mead: The news is not great Hugh, unfortunately, especially for the most levered part of the economy, the household, which is clearly vulnerable. I think the really important and interesting observation at the moment is though, even though we've got, as you mentioned, 2.35%, there's a bit of an aquaplaning effect happening in terms of the policy traction. Because there's such a large number of fixed rate mortgages while they're slowly converting to floating, it's taking some time. So at the moment about 2% of the fixed rate mortgages switch to floating each month. Now that'll ratchet up to close to 6% a month in Q2 next year. So we do think this policy traction will start to really take effect as we move through the back end of this year into next year.
As you mentioned, more rate hikes coming accompanied by some of this move from from fixed rate to floating rate. So we do think at 4% it's going to be very hard for the RBA to out-hike the market.
Holden: Okay. And so what does that mean then from an investment perspective?
Mead: Well, I guess the flipside is that the good news for investors as distinct from the borrowers, is that the yields have moved up considerably and in many cases to levels that most investors are unaccustomed to. So now by taking a small combination of moderate duration plus some high quality credit, the yields available are now in the 5 to 6% range and numbers that we haven't seen for a very long time.
And it's not a matter of reaching for yield. It's a very high quality investment. The other thing that's really important, though, is it recalibrates the hurdle rate for doing anything else. So for investing in hybrids, for investing in residential or commercial real estate, for trying to capture dividend yield, investors need to think about if I can get 5 to 6% by owning very low risk securities, what should my hurdle be for taking more risk?
Holden: Great. Well, thanks, Rob. And I think the messaging remains consistent there. Try to focus on higher credit quality. And if you have been underweight bonds, it could be timely to continue moving back towards a more neutral setting there.
If you do want any more information, please visit our website at pimco.com.au.