Rates are rising in the US, but it is less clear when Australia will follow suit. At our recent Investment Forum, we hosted six of Australia’s top investment strategists to discuss when the Reserve Bank of Australia (RBA) might hike, and to ask several other key questions, including where they are seeing value as we enter the more mature stage of the cycle.
The case for remaining on hold
The ability of households to service higher mortgage rates appears limited in an environment of sluggish wage growth and rising household costs. For these reasons, panellists agreed that the Reserve Bank of Australia (RBA) looks set to keep the cash rate on hold for 2018.
“The cash rate drives mortgage rates, and the consumer looks pretty fully invested there,” said Anthony Kirkham, Head of Investment Management at Western Asset Management. “The RBA can’t really move the cash rate until wages move. (Governor) Lowe has made it clear he is sitting on his hands for the rest of the year.”
Vimal Gor, Head of Income and Fixed Interest at BT Investment Management agreed, “Nothing to see here. Until we get unemployment falling and wages picking up, the RBA is on a wait-and-see brief.”
Sunny Bangia, Deputy Portfolio Manager at Antipodes Partners expressed concerns around clusters of mortgage debt, particularly in high-income areas. He noted that by Antipodes Partners’ estimates, 50-60% of mortgage debt is in high loan-to-value ratio (LVR) mortgages. Further, the higher LVR mortgages (80% and higher) and high debt-to-income mortgages (six times and higher), make up around 10% of mortgage stock or $165 billion. This appears particularly vulnerable to Antipodes Partners.
The case for hiking
Brett Gillespie, Head of Global Macro at Ellerston Capital, described his view on Australia as “sanguine” noting he has pushed back his expectations for a rate hike from May or August to August or November. “The market has 17 basis points (bps) of rate hikes priced for 2018, so not hugely different to us. Western Australia continues to recover, and our forecast is for unemployment to hit 5% around the middle of the year. I think that is enough for the RBA to hike, despite wages still being low.”
Does the RBA need to see wages pick up before hiking rates?
Matt Sherwood, Head of Investment Strategy at Perpetual Investments: believes that “it is important not to look at Australia through a US lens. We were very late to disinflation; we will be late to reflation and inflation. In the meantime, Australia is arguably in the midst of a housing unwind, so Governor Lowe will be looking at below-target inflation and a consumer with high leverage and no real wages growth - despite some apparent tightening in the labour market. Lowe must ask himself, “do I really want to front run all those risks with policy tightening?” The balance of risk says he will wait for wages growth first.”
Inflation is now on our doorstep
Scott Haslem, Chief Investment Officer at Crestone, observed that, "until recently, the economic conversation was fixated on secular stagnation and disinflationary forces, such as disruption, globalisation, ageing demographics and a lack of wage pressure. All of a sudden, the view seems to have shifted to inflation being on our doorstep".
You can read the full breath of investment ideas from Crestone’s Roundtable Discussion here
I wonder if many of those quoted above may be underestimating the probability of an RBA rate hike in the short term? For a number of reasons, there is a real possibility that in the months ahead there could be a jobs boom in Australia, leading to a significant fall in the rate of unemployment which could in turn prompt the RBA to increase rates, perhaps as early as July. One point to keep in mind is that following on from the most recent move by the US Fed Reserve, US interest rates are now higher than local rates for the first time since 2001, when one Australian dollar was worth less than 0.60 USD. It is possible that strong commodity prices might limit the downside to the AUD this year, but it is hard to see how strong commodity prices is negative for the Australian jobs market. The combination of solid commodity prices and a weakening Australian dollar could be a 'Goldilocks' scenario for the Australian economy, and it is not unreasonable to conclude that such an economic backdrop could provide a substantial boost to the local job market.