EACH quarter the Reserve Bank releases its economic forecasts as part of a monetary policy statement.
Most investors are happy to see a few headlines and take the rest as given.
For bond investors, though, these forecasts are very important.
They tell us what the RBA expects – and sets parameters for what might trigger a rate move over the next quarter.
In May, inflation was forecast to finish the year at 4.5%.
In August this was revised to 3.9%. Now it is back at 4.5%.
Why the revision in August? Well, the Q2 CPI had just come out at 0.8%, helped by falling oil prices.
Prices then turned around in Q3, pushing inflation up to 1.2%.
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We could smooth it out and call it 1% on average – but the RBA is currently in the business of fine tuning, and keen to regain its damaged inflation credentials.
So up goes the forecast and up go cash rates.
For what it’s worth, we see Q4 inflation at around 0.7% to 0.8%, meaning inflation will end the year at 4.2%, rather than 4.5%.
If we are right, then the rate hike was not needed.
More importantly, this makes the chance of a February hike very low.
Beyond February, inflation should remain sticky around 0.8% to 0.9% a quarter, meaning rate cuts are off the table for most of 2024.
By the middle of next year, US rate cuts may well be on the table, helping bonds find more support.
The RBA expects inflation to hit 3.6% by mid-2024, a forecast we roughly agree with.
That’s still above their preferred 2-3% band, but would reclassify inflation as “high to uncomfortably high” – though manageable. (We don’t expect the RBA to be quite so explicit, however).
The next few months will reveal what kind of damage this pre-Christmas hike has had on the economy.
As always, we will be watching leading indicators and leaning heavily on our equities team to get an insight into retailers this Christmas.
For now though, our models and our macro outlook are bond friendly.
Yields, despite their comeback this month, remain attractive on a medium-term basis.
Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.
Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.
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