Reserve Bank of Australia pauses rate hikes again

On the latest edition of Market Week in Review, Investment Strategist Alex Cousley and Sophie Antal-Gilbert, Head of AIS Portfolio & Business Consulting, discussed recent headlines from the U.S. Federal Reserve (Fed) and the Reserve Bank of Australia (RBA). They also chatted about opportunities in fixed income investing and reviewed the latest developments in the Asia-Pacific region.

RBA holds rates steady, but another hike possible in August

Antal-Gilbert and Cousley began their conversation with a look at the recently released minutes from the Fed’s 13-14 June meeting, where U.S. central bank officials opted to skip a rate increase for the first time since early 2022.

The minutes showed that Federal Open Market Committee (FOMC) members believed a couple additional rate increases might be required in order to slow down the U.S. economy further, Cousley said. "The U.S. has seen a bit of a rebalancing in the labour market, as wage growth has cooled a little without the expense of job losses, but there’s still plenty of work to be done," he remarked. Case-in-point: On 6 July, payroll-services firm ADP reported that the U.S. private sector added nearly 500,000 jobs in June, Cousley said, noting this represents a much stronger gain than the Fed would prefer.

Turning to Australia, Cousley said that after surprising investors at the last two meetings with interest-rate increases, the RBA elected to keep rates unchanged at its 4 July meeting. Cousley explained that the Australian economy is slowing quite a bit, and that the pause in rate hikes – the RBA’s second this year – should give the central bank more time to assess the economic impacts of its rate-hiking campaign.

"It’s important to understand that the Australian mortgage market is very different than in the U.S, where 30-year fixed rate mortgages are standard. In Australia, variable rate mortgages are the most common, which means that rising rates can have a significant impact on borrowers," he stated. As a result of the aggressive tightening undertaken by the RBA since last year, many households are now starting to experience fairly dramatic increases in their mortgage payments, Cousley said, explaining that this has triggered a slowdown in consumer spending.

With inflation still well above target, he added that the RBA could still deliver one more rate hike this year, but said that in his view, the central bank’s cash rate is probably very close to peaking. Whether or not the RBA hikes rates in August will probably hinge on the inflation report from June, due out at the end of this month, Cousley noted. "If the consumer price index (CPI) comes in higher than expected, then we’ll probably see a rate increase in early August," he stated.

Unpacking the opportunity set in fixed income

The discussion shifted to fixed income, with Antal-Gilbert asking Cousley where he sees potential opportunities for fixed income investors at the moment. Cousley said that he still sees good opportunities in government bonds, noting that valuations are pretty attractive in most developed markets.

In addition, Russell Investments’ measure of contrarian sentiment is also supportive, he said. "When we look at this indicator, we’re seeing that the market is fairly one-sided, in that most investors think rates will go up further. So, the catalyst for rates to move lower is actually not that high," Cousley explained. Lastly, he noted that with recession risks likely elevated over the next 12 months, central banks may have to cut rates if an economic downturn hits – likely by more than markets are currently expecting.

Is sustained 2% inflation possible in Japan?

Antal-Gilbert and Cousley wrapped up the conversation by assessing recent developments in the Asia-Pacific region that are applicable to investors around the world. One key area of interest is Japan, Cousley said, noting that the country is one of the few developed markets where he views government bond valuations as unattractive.

After 25 years of trying to lift inflation to a 2% target rate, it appears the country is reaching a point where sustained inflation of 2% could be possible, Cousley said. He noted that services inflation is moving toward 2% in Japan, and that the country’s broad reopening late last year has helped boost consumer prices. This could potentially lead to adjustments in the Bank of Japan’s monetary policy, he noted.

Cousley said that the other big story in the Asia-Pacific region is economic growth in China, which has fizzled after a strong start in the first quarter of the year. "A fair amount of economists had been projecting a growth rate of 5.5%-6% this year, but at Russell Investments, we were sceptical of numbers like these. Now, we’re seeing market expectations shift back to 5% growth this yea – which has been our expectation all along," he remarked.

Cousley said that with Chinese growth decelerating, many analysts are expecting more stimulus to be announced this year – perhaps as soon as the next Politburo meeting, which takes place later this month. "China’s property-market sector is still struggling, with property developers still under stress, so it seems reasonable to expect some more stimulus there," he stated, adding that whether this stimulus comes in July or later on remains to be seen.

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