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Hedge Clippings | 10 November 2023

Maybe Hedge Clippings' punt last week that Tuesday's RBA board meeting would result in another pause was wishful thinking. It was certainly out of step with the majority of well respected economists, even if Mark Bouris agreed with our view, which perhaps should have been a warning in itself. The RBA's November Statement on Monetary Policy, released earlier today, was pretty clear on their thinking: A continuation of the bank's determination that the current level of inflation is not only too high, but the reduction to the Board's target of 2-3% must be hastened.

At this stage, the bank's forecast is that inflation (currently 5.4%) will be around 3.5% in a year's time, and "a little below" 3% by the end of 2025. Assuming - possibly incorrectly - that monetary policy is being set to meet the forecasts - in other words that the forecast is also the RBA's target - then the question is when or if the economic "tipping point" will occur? At what point will higher interest rates have a sufficient impact on consumer spending to reduce inflation? And at what risk to the economy in the form of a recession?

While nearly everyone with a mortgage - at least those on variable rates or about to come off a fixed rate - will be affected by Tuesday's decision, it's only about 35% of the total housing market of 10.3 million homes, with a further 30% of homes rented, presumably with a fair proportion of the latter also impacted by higher rates.

Much is written about the "mortgage cliff" but only 30% of those mortgages are fixed, and although well up on the levels of 30 years ago, it is still only going to affect a minority of the total. Added to the fact that only more recent loan limits are "maxed out" and it emphasises the blunt instrument that the RBA has in monetary policy when tackling inflation, and its many and varied causes - all out of the RBA's control.

Retired RBA governor Philip Lowe was fond of using the "narrow path" analogy in his post meeting statements, but Michele Bullock studiously avoided the phrase, although sticking to the central message that inflation is too high, too persistent, and therefore falling too slowly. Bullock's preferred theme - if repetition of a single word is a guide - is "uncertainty", mentioned four times in the penultimate paragraph of her post meeting (pre-cup) statement. Multiple uncertainties regarding the lags in the effect of the previous 12 rate rises on business and the economy in general, and wages and employment in particular. Uncertainty over the outlook for household consumption, uncertainty over the implications of the conflict in Gaza, and uncertainty over the outlook for the Chinese economy.

Even with all that uncertainty, the Board remains certain about one thing: "A determination to return inflation to target, and to do whatever is necessary to achieve that outcome." Which means that if the tipping point has not yet been reached, there could be further rate rises around the corner.

Over in the US, while the Trump circus is playing out in a New York courtroom, the Fed's Jerome Powell is also indicating a willingness to hike rates beyond their current 22 year high at their next meeting due in December. This is in spite of the fact that US inflation came in at 3.7% year on year in September, well down from its recent high of 9.06% in June 2022, and with forecasts of further reductions to come, thanks to falling oil prices when October's figure is released next Tuesday.

Meanwhile in China, CPI fell by 0.2%, mainly on the back of food prices falling 4%, particularly pork, the price of which has fallen over 30% y-o-y. Good on "handsome boy" Albo for his efforts and in helping Aussie lobsters and wine back on the menu, but we suspect while it will help our exports, they're not a sufficiently staple item on the shopping list of most of the population of 1.425 billion to impact China's inflation.

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 Inflation is higher. But is it 'materially' higher?

That's the big question

Pendal

October 2023

AUSTRALIA'S latest inflation data was higher than expected.

The September quarter inflation number came out at 1.2% for both headline and underlying (trimmed mean) measures. This was above expectations of 1.1% and 1% respectively.

In terms of headline inflation, it's now fair to say the current pace is about 4% annually.

Last quarter it was 0.8%, dragged 0.2% lower by fuel prices. This quarter was 1.2%, dragged 0.2% higher by fuel.

The increase in underlying inflation would be of greater concern for the Reserve Bank.

A quarterly rate of 1.2% would not have been welcomed.

Under the hood

Looking under the hood would add to the RBA's concerns.

Market services remain stubbornly high. Housing inflation remains at over 2% a quarter, driven in part by utilities.

At least rents have now caught up with leading indicators at 8% annually.

Anyone who recently received their council rates will not be surprised by the 4.4% increase there. At least it only happens annually.

Government subsidies once again had an impact.

The government is already suppressing utility prices and now also childcare prices - though the childcare changes are permanent. Childcare costs were down 13%, subtracting 0.1% from this quarter's CPI.

Here you can see a breakdown of the ABS's latest inflation data:

What's material?

Focus now turns to the RBA's November 7 board meeting.

We have two communications recent communications to consider.

The RBA's latest minutes mentioned a "low tolerance" to upside inflation surprises.

And in her maiden governor speech, Michelle Bullock mentioned "the board will not hesitate to raise the cash rate further if there is a material revision to the outlook for inflation".

The question is - what is material?  

In August the RBA forecast year-end inflation to be 4.1% and 3.9% underlying. It's early days, but Q4 is expected to be around 0.9%.

This would leave headline at 4.3% and underlying at 4.1%.

The RBA will release updated forecasts in its next monetary policy statement on Friday November 10 (though it will reference them in their rate decision beforehand).

Is 0.2% higher "material" or a breach of the "low tolerance"? That will be the big question come November 7.

Markets have 60% chance of a hike in November and a cash rate 0.35% higher by early next year.

At these levels there is no clear trade, since it will be line ball.

If pushed, I think Michelle Bullock will be keen to show her inflation fighting credentials by putting in one hike, even though she was probably hoping today's number would let her off the hook.

If the market gets close to pricing two hikes in the next few weeks we will go long duration. But until then today's reaction seems sensible and fair.

Long bond yields largely ignored Wednesday's moves. Ten-year bonds remain around 4.75%.  

As always, they will rightly or wrongly be more captive to US bond moves and the latest iteration of oil prices.

Author: Tim Hext, Portfolio Manager and Head of Government Bond Strategies

Funds operated by this manager:

This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at December 8, 2021. PFSL is the responsible entity and issuer of units in the Pendal Multi-Asset Target Return Fund (Fund) ARSN: 623 987 968. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient's personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com