The Reserve Bank of Australia (RBA) is unlikely to tighten monetary policy as aggressively as current market pricing suggests, and investors and borrowers should prepare for a cash rate peak of around 2.5% in this cycle, according to Western Asset Australian Bond Fund Portfolio Manager Anthony Kirkham.
Western Asset is a global active fixed income manager and part of the Franklin Templeton group.
In a recent update on inflation and interest rates, Kirkham says the firm’s expectation is that the RBA’s cash rate target, which is currently 0.1%, will be at 0.75% by the end of this year and then move towards 1.5% to 2% by the end of 2023.
These expectations are predicated on a continued recovery in Australian economic growth, the absence of another COVID variant that challenges vaccination, or a substantial economic shock caused by geopolitical tensions.
“Our view that the RBA will not move as aggressively as market pricing suggests is tied to the economic risks inherent in the heightened level of debt today, both at government level and on the consumer balance sheets,” Kirkham said.
“High house prices and therefore high housing loan commitments have pushed household debt to very high levels.
“This contributes to our expectation that the cash rate will peak at around 2.5 per cent in this cycle.”
Kirkham says that in Australia inflationary pressure is not as stark as it is in other countries, with the annual core inflation measure, returning to just above the mid-range of the RBA’s target band of between 2% and 3% in the December quarter.
“Various factors, including the resumption of economic activity post-lockdown alongside the ongoing impacts of border closures restricting labour, and enterprise bargaining agreements that limit many industries ability to bargain for wage increases, mean that the RBA may not achieve its inflation, employment and wage growth objectives on a sustained basis until second half of 2022,” Kirkham said.
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“We remain thoughtful about the secular headwinds that pre-dated the pandemic and expect that public debt levels which have grown across most developed countries, dependency ratios that have worsened as demographics changed, and the impact of technological advances on employment which have been accelerated, will start to reassert themselves. In the medium term, fiscal policy is also likely to be an impediment to growth, turning from stimulatory, to being a drag in the US and here in Australia.”
Kirkham said current market conditions present opportunities for active fixed income investors. Overly aggressive pricing and volatility offer scope for active duration and yield curve management, as well as sector and security selection.
There are opportunities in high-grade corporate bonds. Selective exposure to issuers in sectors that have benefited from supportive policy offer attractive risk-adjusted returns.
“Overall, we believe that current yields are attractive for existing and prospective bond investors. Continued volatility is expected to provide ongoing opportunities to generate alpha through active management,” Kirkham said.
