More fiscal, less monetary stimulus: What this means for your portfolio


With sweeping lockdowns and a rampant Delta strain, the optimism that was slowly bubbling in June soon dwindled. Economic activity is set to contract, yet in response, the Reserve Bank of Australia announced no change in course: It will maintain its current trajectory. But the government continues to roll out support measures, meaning the core message from the RBA was more fiscal and less monetary stimulus. 

In this PIMCO August Trade Floor Update, I discuss my key takeaways from the most recent RBA meeting and what this means for investors. I also share three core portfolio themes emerging as a result:

  1. Paring back duration and interest rate risk
  2. Being underweight Aussie banks versus global banks
  3. Looking into state and semi-government bonds


Edited Transcript

David - Hi everyone, and thank you for joining us for today's August Trade Floor Update. My name's David Erdonmez and today I'm joined by Portfolio Manager, Adam Bowe. Adam, thanks for joining us.

Adam - Thanks for having me, Dave.

David - Adam, if we think back to the July RBA meeting, there was obviously a lot of anticipation about the announcements that were due to come out of that meeting. Since that time, we've had lockdowns across the country, with a spike in the Delta variant. How did we see the August meeting and what were some of the take-outs from that meeting?

Adam - I think, as you said, COVID's had a big impact since that July meeting. We've seen a series of cascading lockdowns across the capital cities in Australia, and in particular quite a prolonged one in Sydney. So it's having a meaningful impact and we're almost certainly going to see a contraction in economic activity through the third quarter. But what we saw out of the last RBA meeting, and what investors need to take away is that this time round, we're going to see more fiscal and less monetary. We've seen some expansion and reintroduction of some of the support packages from the state governments and the Federal government, but the RBA in their August meeting stuck to their guns. They said they're still going to move along their path of slowly, and at a measured pace, reducing stimulus. They've already let their term funding facility mature; they're letting yield curve control roll down the curve and eventually mature; and they've announced they're going to start to taper their asset purchases into September. And they stuck to that message. So I think the punch line for investors is: more fiscal, less monetary this time around.

David – Let’s take that conversation further to discuss our recent cyclical outlook. In that, we talk about peak growth and peak policy. Moving on from the monetary policy conversation: how are we positioning portfolios at the moment? We've had a decline in the 10-year bond yield since July of around 30 basis points. We've had equities that have risen. We've also got lockdown orders now in some of the states and we're talking a lot about vaccination rates. How does this all come together when you are thinking about portfolio construction, and what are some of the key themes in our portfolios at the moment?

Adam - I can talk to a couple of recent adjustments in our portfolio exposures with that background in mind: i.e., where we're moving into an environment of more fiscal and a pullback in monetary. What that means for portfolios and markets is really important in the context of our recent lower interest rates. So a couple of key themes. In terms of duration or interest rate risk, we've more recently started to pare that back and reduce duration or interest rate risk in portfolios versus benchmarks. It’s pretty attractive to do that now in the context of more bond supply on the fiscal side, and in the future, somewhat fewer purchases from the RBA. So we think these are reasonably good levels to reduce our interest rate risk.

Another key sector theme, which I think will play out over the coming months, is to be underweight Australian banks versus global banks. We've liked global financials for quite a while. With the expiry of the term funding facility, Australian banks are going to have to start to tap more expensive sources of funding, and this will be slow moving. It won’t happen overnight but we're going to see more bond supply from the Aussie major banks. In terms of global financials, a good case in point is European financials, which we've liked for a while. They've just come through a really strong earnings season. So I think we're going to start to see some compression in spreads for global financials relative to Australia, particularly some of those attractive European names.

The third theme in terms of sectors would be semi-government or state government bonds. Given greater fiscal support from the state governments funded through bond issuance, along with fewer purchases from the RBA, we're starting to see some spread widening in state government bonds. This was one of the most attractive sectors last year – one of our biggest positions as we came through the pandemic – and spreads really compressed as the RBA started to purchase aggressively through the last 12 months. We've pared back that position close to benchmark weight now, but I think that's it starting to look like an opportunity again as spreads start to move wider and we're seeing more fiscal and less monetary support.

David - Thanks, Adam for those comments and thank you all for watching. Please visit pimco.com.au for further commentary regarding our outlook and some of our investment solutions. And please reach out to your PIMCO account manager if you have any further questions.

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PIMCO Diversified Fixed Interest Fund
Australian Fixed Income

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Adam Bowe
Portfolio Manager
PIMCO

Adam is an executive vice president and fixed income portfolio manager in the Sydney office. Prior to joining PIMCO in 2011, he was responsible for global macro research and trading at Tudor Investment Corporation. He was previously a director and...

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