Recession a line ball as Australia groans under a massive debt load

This time last year, PIMCO Portfolio Manager Adam Bowe told Livewire that there was a 50/50 chance that Australia would slip into recession. March GDP figures show that the economy grew at just 0.1 per cent, the slowest rate since December 2020.

Today, Bowe says interest rates are sufficiently restrictive, and the chance of recession remains a ‘line ball’. If you look at New Zealand, which is currently in recession, policy rates are materially higher than in Australia. However, Bowe says it is naive to look at the level of monetary policy and imply that policy is easier and, therefore, the implications for growth are less.

“If you look at Australia, 4.35%, you’ve got to adjust for how much debt households run. At every level of interest rates, Australians pay more interest on their debt because they have more debt,” he explains.

"Households in Australia have never paid this much interest as a percentage of their household income. If you add into that tax, the amount of interest and taxes that households pay relative to their income has never been so high."

With the economy only just growing, Bowe believes there is still a chance we slip into recession. 

However, there is a silver lining, and as you look further out into the future, he believes the outlook starts to improve.

“The further you look out, we should start to see some tailwinds emerge, just modest tailwinds. We’ve got some tax cuts coming in next quarter in Australia. We think we’ll at least start to see interest rate cuts around the end of the year, and inflation will come down. So that cost of living versus wage growth starts to become a bit more bearable as well,” he says.

Australian house prices are detached from the rate cycle

The property market seems to be defying interest rate forces, with home values notching up 15 consecutive months of gains. Bowe expects this trend to continue, and he believes the property market has become detached or less sensitive to interest rates.

“To me, this is a supply problem relative to immigration. We’ve got very strong population growth, over 2.5% per annum, which is incredibly strong relative to our history and other countries.”

The challenge is that state governments can’t match growing demand with new housing supply at the same time that the construction industry has experienced many defaults due to rising labour and material costs.

“Even if we magically had state and federal government policies match, we probably wouldn’t have the construction companies to build the homes. So this will be a decade-long problem that we will have to solve, and there’s not much that interest rates can do about it.”

Keeping income simple (and liquid)

Bowe says there are structural reasons behind the growth in private markets, and while PIMCO can invest in these assets, he believes the most compelling opportunity is in public markets.

“You don’t have to reach aggressively down the risk spectrum to get attractive yields now. You can generate income in daily liquid funds,” he says.

Two or three years ago, when policy rates were on the floor, Bowe said the yields he could offer clients in their spectrum of funds ranged from one per cent to six per cent. Today, the opportunity set in those same funds, without changing any guidelines, is between six per cent and 15%.

“I’m getting invited on to retirement income panels again which I hadn’t been for years.”

Bowe says fixed income today has something to offer all investors, whether that’s portfolio diversification, real income, or inflation protection. That’s an exciting proposition for a sector under significant pressure just a few years ago.

To access the full interview click on the player below or tune into the Rules of Investing on your favourite podcasting platform.

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Timecodes

• 0:00 - Introduction
• 1:53 - How far through the fight against inflation are we?
• 2:36 - Which countries are leading the pack?
• 4:16 - US election - why you can’t ignore it
• 5:36 - Stepping back from the day to day noise
• 6:55 - Will Australia experience a recession?
• 9:07 - Interest rates are hurting households
• 10:34 - The outlook for unemployment
• 12:17 - Are rates tight enough in Australia?
• 14:33 - Public versus private markets
• 17:19 - Opportunities in fixed income
• 22:45 - A time to be patient
• 25:10 - What investors are getting wrong about markets right now
• 26:41 - The tables have turned for fixed income

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