The three things PIMCO is watching as Australia hangs in the balance

The “pain point” of the RBA’s rate hiking cycle has now been reached for Australian households. 

While the central bank’s latest meeting saw no further increase, I believe the following three factors are critical in determining what happens next:

• Potential “exuberance” from consumers on the back of a pause, which could see a worrying rise in spending and house prices
• Global banking sector stress
• Australia’s quarterly inflation print, which is due at the end of April.

Reflecting on the fallout from the banking sector turmoil in the US and Europe, I see few direct effects on Australian banks – which are well-capitalised, effectively regulated, and have strong balance sheets. But there are implications for the local finance sector and other areas of the market.

Because at the end of the day, tightening monetary policy is intended to cause some breakage. It's not intended to cause a financial crisis, but there will be more breakage to come and investors need to be very wary of that.

In the following interview, I assess the events that unfolded in March – including the demonstration of core bonds’ power – and what this means for portfolio allocations in the short- and medium-term.

Transcript

Valtwies: Welcome to this month's trade floor update. Rob, we've just seen the RBA pause for the first time in almost 12 months. Have we hit the peak?

Mead: Well, John, we've been saying for a long time now that 3.5 to 4% was going to be the range where households really felt some mortgage pain. Part of that is just how much of their disposable income every month would be needed to be allocated to interest payments.

So we're in that zone. Whether or not we're at the peak is going to depend on a few things. First of all, if there's too much exuberance around this pause and consumers start spending again, house prices start going up again, that'll be a little disconcerting. We'll also be looking carefully at any more banking stress around the world. And of course, everyone's going to be looking at the inflation print come the end of April as a very important indicator for where we go from now.

Valtwies: So these global banking stresses were obviously an important import for the RBA, but what does it mean for the Australian banks?

Mead: Well, I think there's a couple of important takeaways. First thing is that Australian banks are extremely well capitalised, they're very well regulated, they have very strong balance sheets and good management. So I don't see concerns in a direct fashion coming from some of the events we saw around the globe.

But there are some very important learnings for all investors and some of the drivers of the financial stress that we saw was really as a result of a refusal or a regulatory regime that didn't force mark to market. So to the extent that applies to any other investment type that has refused to mark to market through this massive change in interest rates that we've seen over almost 12 months.

Those are the things to be wary of because at the end of the day, tightening monetary policy is intended to cause some breakage. It's not intended to cause a financial crisis, but there will be more breakage to come and investors need to be very wary of that.

Valtwies: So with that backdrop, what are the investment implications?

So I guess March has been a really interesting month to observe markets and as we've been saying for quite a while now, bonds are somewhere in that zone of being fair and people should be thinking about getting back to strategic targets in terms of their overall asset allocation.

And what we saw in March was just how powerful core bonds could be as a diversifier in a portfolio. Obviously, we saw a very significant rally across the entire yield curve, really around the globe in all bond markets. So making sure that there's that true diversification, understand what the bond markets is telling us in terms of that risk appetite or risk aversion that's starting to materialise and just making sure that your portfolios have sufficient liquidity to ride out any of these, even if it's a short term storm, maybe it ends up being more medium term in terms of some of those market stresses.

Valtwies: So there you have it. Bond yields are looking compelling. The outlook is uncertain. So when you're looking for resilience in your portfolio, as was on display in March, bonds are playing that important role of defense and diversifies in a broader portfolio of assets. 

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