Australian Bond Exchange Weekly Update
Friday 16th June 2023
- Unemployment drops to 3.6%, despite the RBA’s attempt to soften the market by increasing the cash rate 400bps since last year. Another hike is now predicted for July.
- Consumer sentiment at “recession lows” as Australians struggle with a cost-of-living crisis, further complicated by a lack of supply in housing and a looming mortgage cliff.
- Consumers see real estate as a less appealing ‘savings’ option, with more preferring shares despite fixed income providing a lower-risk investment option.
- U.S. holds the cash rate between 5-5.25% as they wait to determine whether inflation will return to target. Meanwhile, the UK has a similar struggle to Australia, in battling slow GDP growth, high inflation, record low unemployment and rising wages.
Global Cash Rates & Inflation
- The RBA Cash Rate is 4.1%, raised 25bps last Tuesday. Annual inflation (quarterly) sits at 7% with the next Consumer Price Index (CPI) release – the measure of inflation – due for the 26th July.
- The BOE Cash Rate is 4.5%, with the next decision to be made on the 22nd June. The central bank may hike again to ease the very high UK inflation rate (CPI) of 8.7% in the year to April.
- Federal Reserve cash rate remains between 5-5.25%, decided this week. US inflation (CPI) data was also released, sitting at 4% in the year to May, the smallest yearly increase since March 2021
- The ECB increased the EU cash rate (deposit facility) today as expected by 25 bps to 3.5%.
Risk perceptions shift, leaving fixed income investors chuffed
This week unemployment levels, slow GDP growth, sticky inflation and “recession low” levels of consumer sentiment were top of mind as key economic data was released.
On Thursday, the Australian Bureau of Statistics (ABS) released unemployment data that showed a drop to 3.6% in May from 3.7% in April. For the first time in Australia, 14 million people are employed, which is an inflationary pressure that some suggest make a rate rise in July almost certain.
The Westpac-Melbourne Institute Consumer Sentiment report released on Tuesday supported this view, with sentiment levels at “recession lows” for the past twelve months, predominantly due to concerns around inflation, expectations of rising unemployment, and the impact this would have on their family finances over the next year.
The ‘time to buy a major household item’ also fell 6.5%, with buyer sentiment extremely low on the mortgage front. Despite expectations for house prices remaining positive, the looming mortgage cliff for those on fixed rate mortgages is cause for concern, especially as according to RateCity variable rate mortgage holders (who haven’t refinanced to a lower rate) could be facing repayments of up to 7% per annum.
What’s perhaps most interesting in this report, however, is the shift in consumer perception that real estate is no longer the ‘wisest place for savings.’ According to the report, only 5% nominated real estate (near all-time record lows), while 8% nominated shares.
As shares are typically more volatile and can carry higher risk than fixed income products and corporate bonds, fixed income investors are likely feeling chuffed with their decision to invest in ‘defensive assets’ that provide predictable and stable returns.
The global inflationary battle between supply and demand
Inflationary pressures are making it difficult for Central Banks to return inflation to target and fight this global cost-of-living crisis. Despite being in lockstep for some time, the US, EU, UK and Australia are now fighting similar inflationary pressures with varying results.
The U.S. is the only region of the four to get inflation below the cash rate and increase unemployment levels, signaling that they are on track to return inflation to target.
On the supply side, services price inflation is leading to a “sticky” inflation dilemma, as the disruption of global supply chains during the COVID pandemic, (and more recently the war in Ukraine) restricted production and drove up the prices of imported goods like food and oil.
On the demand side, a lack of supply in essential services, like housing, is pushing up prices of assets, consumer goods and services despite slower economic growth. Further, historically low unemployment levels and a job vacancy rate twice as high as what was considered normal before the pandemic are increasing wages, as businesses fight for staff.
U.S. cash rate paused, while UK prepares for more hikes
The U.S. Federal Reserve chose to maintain the cash rate (policy rate) this week, at a level between 5-5.25%, in response to new data that saw inflation ease from 4.9% in April to 4% in May. The Federal Reserve noted that they remain “highly attentive to inflation risks” and that in their next decision, “will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation.”
The pause isn’t a guarantee that the U.S. is done with hiking rates, but more a sign they are acting cautiously in anticipation of future data, that will confirm whether inflation is on track to return to the 2% target.
In the UK, GDP figures released on Wednesday showed a slight growth in services (0.26%) from March to April, however, falls in production (-0.04%) and consumption (-0.04%) saw monthly GDP growth increase by just 0.2%.
This slow growth, coupled with the highest inflation rate of all G7 countries (8.7%) has given market commentators the impression the UK cash rate could reach 5.5% by Christmas.
It’s time to exit the “cash trap” and enter fixed income
For another consecutive week, bonds have been promoted in the news by well-respected investors as a potential investment solution during these strange economic times.
Sticky, pernicious inflation and slow economic growth are creating an investment environment that favours lower risk asset classes, like fixed income.
Wall street veteran Bob Michele sees switching to bonds as the safest option for his capital. According to Bloomberg.com, he believes that cash returns are “starting to evaporate” and that if you switch to bonds you will have “locked in not only the carry but will also get some capital appreciation”.
2023 is shaping up to be a very exciting year for fixed income investors, so if you’d like to speak with an investment adviser about how you can benefit from this shift, give us a call on 1800 319 769.