RBA Holds Firm as Inflation Moderates: Navigating the Bumpy Road Ahead
At their May meetings, both the U.S. Federal Reserve (Fed) and the Reserve Bank of Australia (RBA) decided against adopting the more hawkish policy stance that markets had priced in. This restraint sparked a rally in bond markets following the meetings and indicated that the threshold for any future rate increases is higher than some market participants anticipated.
Central banks exercise caution in the face of inflation surprises
Despite encountering stronger-than-anticipated jobs and inflation data this year, both the Fed and the RBA have maintained a cautious approach, contrary to market expectations of further rate hikes.
The decisions of these central banks were influenced by several key factors:
- Balanced mandate considerations: As inflation moderates, both central banks are adopting a more balanced approach in fulfilling their dual mandates of price stability and full employment. This balanced focus is crucial now that inflation, though reduced, remains above target levels (see chart below).
- Stable inflation expectations: Despite the fluctuations in short-term inflation rates, longer-term inflation expectations—both market-based and surveyed—have remained remarkably stable. This consistency in expectations for long-term inflation is a vital element in the central banks' current policy stance, allowing them to adopt a wait-and-see approach.
- Contraction in inflation drivers: The factors driving inflation are increasingly focused on specific sectors like housing, which are influenced more by supply-side issues than by broad economic demand.
- Pause in disinflation: Although the process of disinflation has paused, there has been no significant resurgence in inflation rates, allowing central banks the flexibility to maintain current interest rates without tightening further.
Underlying inflation remains above target
The nuanced approach of the Fed and RBA suggests that while additional rate hikes remain a possibility, their likelihood is lower than many fear. The central banks' current priority appears to be the preservation of employment gains rather than combating inflation aggressively. This scenario tilts the balance towards maintaining current rates or potentially cutting them should economic conditions deteriorate, offering a strategic advantage for bond investors.
Investment strategies in a high-rate environment
With interest rates remaining elevated, their impact on the economy is significant and likely to suppress any immediate need for further hikes. This situation offers investors a chance to lock in higher yields and potentially benefit from future rate cuts being priced into the market. Bond funds are currently offering an attractive yield ranging between 5% and 6%, presenting a compelling case for investment.
In summary, the cautious approach by the Fed and RBA reflects a complex balancing act between fostering economic stability and managing inflationary pressures. While the journey back to the inflation target will likely be uneven and challenging, we believe that the RBA’s next move remains more likely to be a rate cut than a rate hike.
Find out more about how to access today’s attractive opportunities in bonds here.
Featured Participants
Disclosures
This publication contains general advice only and has been prepared without taking into account the objectives, financial situation or needs of investors. Because of this, before acting on any advice in this publication investors should obtain professional advice (including, if applicable, from a financial adviser) and consider whether the advice is appropriate having regard to their objectives, financial situation and needs.
Past performance is not a reliable indicator of future results. This publication is issued by PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246 862.
This publication may include economic and market commentaries based on proprietary research, which are for general information only. Investment management products and services offered by PIMCO Australia Management Limited ABN 37 611 709 507, AFSL 487 505 of which PIMCO Australia Pty Ltd is the investment manager (together PIMCO Australia) are offered only to persons within Australia and are not available to persons where provision of such products or services is unlawful or unauthorised.
PIMCO Australia believes the information contained in this publication to be reliable, however its accuracy, reliability or completeness is not guaranteed. Any opinions, estimates or forecasts reflect the judgment and assumptions of PIMCO Australia on the basis of information at the date of publication and may later change without notice. No representation, assurance, or guarantee is given that any opinions, estimates or forecasts will materialise, or investments will provide any level of returns. This publication should not be taken as a recommendation of any particular security, strategy or investment product. All investments carry risk and may lose some or all of its value. To the maximum extent permitted by law, PIMCO Australia and each of their directors, employees, agents, representatives and advisers disclaim all liability to any person for any loss arising, directly or indirectly, from the information in this publication. No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission of PIMCO Australia. PIMCO is a trademark of Allianz Asset Management of America LLC in the United States and throughout the world. ©PIMCO, 2024.