Following the release of CPI figures this week, Mutual Limited’s CIO Scott Rundell looks at how markets have reacted and the short-term outlook.
Australia’s inflation rate, as measured by the Consumer Price Index (‘CPI’) surprised to the high side for the September Quarter. Headline CPI rose +1.20% QoQ vs +0.8% QoQ in the June Quarter, and a touch above consensus estimates of +1.1% QoQ. The annual run rate fell to +5.4% YoY from +6.0% YoY at the end of June, but was higher than expected with consensus at +5.3% YoY.
The most significant contributors to the rise in CPI was fuel (+7.2%), caused by higher crude oil prices, which rose +27% through the September quarter. Housing remains an inflation headwind, with rent up +2.2% over the quarter, adding to the +2.5% growth observed through the prior quarter. Utility prices rose +4.2%, reflecting higher wholesale prices being passed through to retail customers. Each of these three core drivers, fuel, rent and utilities will likely remain inflationary headwinds given underlying structural imbalances.
While some components ran hot, others eased back more than the aggregate, or rose at a more moderate rate, including food prices (+0.6%) and childcare (-13.6%), the latter aided by changes to the Child Care Subsidies, which came into effect on July 10th.
In August the RBA revised their CPI forecasts with CPI not expected to be within the bank’s 2.0% – 3.0% target range until late 2025, pushed out from mid-2025 per in their previous forecasts. Given the above lack of tolerance and latest data, a hike to 4.35% at the next meeting, on Melbourne Cup, is all but a given. Consequently, 90-day bank bills are +10 bps higher at 4.33%.
Also read: Bonds versus Equities: Five Reasons to Buy Bonds
Market reaction to the new data has been predictable with yields across the curve higher, with the front-end underperforming the back end. Market pricing for a rate hike at the November meeting has jumped from low 20% area prior to the CPI print to 61% afterwards. The higher rate outlook weighed on equities initially, with the ASX 200 suffering some temporary sticker shock, down -0.4% on the open, before recovering its composure to be back square on the day (last couple of hours of trading). With odds of rate hikes firming, the AUD strengthened against the USD, knocking on the door of 0.64.
Investment insights…there has been a recent questioning in the narrative about whether now was the time to add duration risk with yields at levels not seen in over ten years.
We’ve urged a cautious approach to anyone considering embracing this narrative given our fears that inflation would linger. The data has spoken, and the risk is real, so to anyone who will listen, stay frosty, stay on your toes, floating rate notes remain your friends in this environment.
The increased prospect of higher cash rates will underpin a renewed income tailwind for floating rate note funds, while fixed rate funds, exposed to duration risk, have further pain to endure over the cycle.
