Australian Bond Exchange

Australian Bond Exchange Weekly Update

Friday 26th May

Key Points

  • Westpac’s Leading Index of Economic Activity forecasts slow economic growth (1%) in 2023, reporting a 20% drop in housing approvals in the first quarter of the year
  • Sticky inflation across major economies, including the higher than forecasted figure of 8.7% inflation for the UK, is impacting investor sentiment, and “spooking” the markets 
  • AMP Chief Economist claims property is no longer the key to “transformational wealth”, at least until the RBA begins to cut the cash rate and interest rates fall 
  • Investors shift from higher-risk, higher-return products that are subject to market volatility to lower-risk fixed income investments like bonds. 

Global Cash Rates & Inflation* 

         *Data accurate as at 26.05.2023

On Wednesday, the release of the Westpac-Melbourne Institute Leading Index of Economic Activity showed nine consecutive months of slower than usual (below-trend) economic growth.  

This report, which outlines key trends in the economy to forecast future growth, noted that despite increasing demand for housing and historically low rental vacancy rates, dwelling approvals experienced a decline of 20% in the first quarter of this year.  

In order to meet the demand for housing and start to reduce one of the primary drivers of inflation in the market at the moment, more housing needs to be built.  

However, with approvals for new developments on the decline, and immigration on the rise, the chance of increasing supply and accelerating economic growth in the short-term is unlikely. As such, Senior Economist Matthew Hassan from Westpac forecasts growth of just 1% in 2023, with a similar performance for 2024. 

Inflation still an issue for major central banks 

As mentioned previously, after essentially turning off the global economy to stop the spread of COVID, low economic growth, high inflation and rising interest rates have emerged in many major economies.  

The UK is potentially dealing with one of the stickiest inflation dilemmas, as although the Office for National Statistics reported an ease in inflation this week, now 8.7% down from 10.1% in March, the figure was well above the forecast and has “spooked” the markets. 

High inflation makes it hard for markets to predict what’s next, with monetary policy operating at a lag, and fiscal policy (such as the 2022/2023 Federal Budget and recent Victorian budget) injecting more money into markets already dealing with record high inflation rates. 

This slow economic growth and high inflation is also combined with a tight labour market where unemployment is at historic lows. Although it rose from 3.5 to 3.7% in the twelve months to April, rising wages and the fact that banks are not passing on the RBA’s cash rate hikes in full have caused some uncertainty in the market.  

Property no longer the silver spoon 

According to AMP Capital Chief Economist Shane Oliver, relying on property as the silver spoon that will consistently generate high returns is no longer a short-term option.  

“You’re not going to become super wealthy through housing,” he said. “You won’t make that transformational wealth that people have made over the last 30 to 40 years.” 

He continued, “property down cycles into 2009, 2012 and 2019 only saw prices sustainably bottom once interest rates started falling, and rate cuts are still a way off yet.” 

Will the RBA pause in June? 

The Reserve Bank of Australia (RBA) has spent the past year steadily increasing the cash rate in a bid to reduce consumer spending and return inflation to the target range of 2-3%.  

According to the Australian Financial Review, the consensus is that the RBA will pause in June, with only 9% of the market backing a rise. Recent data released by the ABS showed a slight increase in unemployment. This, coupled with the May rate hike, should see the labour market soften as supply and demand level out. When consumer prices recede, inflation will be returned to target. 

However, there are other views that the RBA is far from done with cash rate hikes. In speaking with the members of parliament economics committee earlier this week, many suggested that Governor Philip Lowe is “not that confident” that the cash rate has reached its peak, emphasising that the RBA will do what needs to be done to tame this lingering inflation. 

Investors taking advantage of higher yields and lower risk 

This week the Financial Times reported a significant market shift in investor sentiment towards the fixed income market. According to the Times, Morningstar data showed that although $332bn flowed out of the US market last year, more than $100bn has been invested in the four months to April.  

At the recent Milken Institute conference, the Times also heard from the global head of fixed income at Capital Group, Mike Gitlin, who predicts bond markets could benefit from this shift. “I think you’ll see $1tn flow back into the bond market in the next few years,” Gitlin said, “I think it’s coming and I think you’ll see it accelerate.” 

Comparing the recent influx of capital into fixed income, to the shift from actively managed funds to lower cost passive funds that track an index, investors are taking advantage of the higher-than-average yields as well as the passivity and predictability that bonds and fixed income investments bring in such strange economic times. 

In the investment space, market prices fluctuate based on the volume of buy and sell trades, which are often driven by investor sentiment. As the modern world is interconnected via global financial markets, corporations and debt, this means that when political issues arise abroad it can influence financial markets here at home.   

Equities; highly volatile and easily influenced 

In the case of the US debt-ceiling, the lack of progress in negotiations on how Biden and Congress will resolve the issue has seen the ASX drop 

Unlike equities, fixed income investments with set maturity dates have a set principal value, provide regular payments based on a fixed interest rate (also called a coupon rate), and return the principal paid at the maturity date in most scenarios.  

Although equity investors can be paid dividends by the company they have bought equities (shares) in, the majority of equity investors generate most of their returns from sell trades (capital gains), based on the market price of the equities (shares). 

As the value of equities fluctuates based on the volume of buy and sell trades, which are often driven by investor sentiment, this market is highly volatile. Further, as the modern world is interconnected via global financial markets, corporations and debt, this means that when political issues arise abroad it can influence financial markets here at home.  

Investors switching from equities to fixed income are capitalising on lower-risk, lower-return financial instruments like bonds, to “hedge their bets” in uncertain economic times, and provide some confidence in the return on their investments. 

What’s coming up: 

  • Today the ABS will release information on the Retail Trade, and the results of this report outlining consumer spending is likely to inform the RBA’s next rate decision. 
  • On Tuesday 30th May, the Australian Bureau of Statistics (ABS) will release Building Approvals data for April here, which will likely impact the RBA’s next decision. 
  • Next Wednesday 31st May at 9.30am, the RBA will appear before the Senate Economics Legislation Committee to discuss the budget estimates. You can watch it here. 

*Data accurate as at 26.5.2023 


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