[music]

>> Welcome to the Bloomberg Australia

podcast. I'm Chris Burke coming to you

from Melbourne on Wednesday, June 17th.

>> [music]

>> Australian mortgage holders finally got

a reprieve this week as the RBA hit the

pause button after three rate hikes in a

row. So, are they just taking a breather

or are there more hikes still to come?

And how are investors positioning for

what's next? To find out, we're joined

by Adam Boy, head of Australia portfolio

management at global investment giant

Pimco. [music] Adam, welcome back to the

podcast.

>> Thank you for having me.

>> Excellent. So, um

as we saw the the Reserve Bank left

rates on hold at 4.35%

this week. That was a step back from

their quite aggressive rate hike cycle

that's made them something of an outlier

among major central banks this year.

What was your biggest takeaway from that

decision?

>> Look, I think Chris, the best way to

characterize the the the decision was I

think the RBA is still alert to

inflation risk, but they're no longer

alarmed.

Um you know, if you cast your mind back

to the beginning of the year when they

started, even before that when they were

talking about

rate hikes, um there were several things

they were very concerned about. I think

all the data through 2026 so far

suggests they didn't have to be as

concerned as they were back then. So,

they were worried about the labor market

re-tightening. Um it hasn't. You know,

the unemployment rate's gone back up to

4.5. They were worried about sticky

components of inflation that have

actually come in better. They were

worried about accelerating household

spending, consumer spending, which has

actually been moderating. So, a whole

raft of things that they were concerned

about, um I think it's fair to say they

didn't have to be as concerned as they

were.

Um and the data since then and and has

been responding to higher interest rates

and and softening. So, um alert but uh

no longer alarmed is the way I'd

characterize it.

>> So, what do you think they need to be

alert to still? What are the biggest

challenges Australia's economy is still

facing?

>> I think the biggest challenges at the

moment is this tension between higher

inflation and a lower growth outlook.

>> Mhm.

>> Um and you know, if you if I think

that's a real challenge for the RBA. A

lot of the components of inflation that

are keeping it elevated at the moment,

they can't control. So, they don't

control oil prices and fuel prices.

They don't control electricity prices.

They don't control administered prices

and and council rates and all those

things that have been going up and

and um contributing to this elevated

inflation um currently. Um

at the same time, they can control other

aspects and try and pull average

inflation back down to the band. And the

way that they do that is tighten

monetary policy, slow growth, loosen

labor markets. And we can see that

happening. The economy's responding to

um to higher rates, but it that's the

risk. That's the challenge. You know, if

you push too hard, um you can lose

control on the downside of of growth and

and the labor market. You don't do

enough, then you get second-order

impacts on on inflation and and feeding

into sticky inflation that's harder to

fix in the future. So, that is the key

challenge at the moment for the RBA and

I think the economy is this tension

um

>> [clears throat]

>> and getting back into some sort of

equilibrium, um higher inflation and and

slower growth.

>> Yeah, and uh Governor Michelle Bullock

did actually speak to that kind of uh

that that dynamic yesterday in a press

conference when she did actually say,

you know, you've got to expect this this

slowing in the economy and and people

shouldn't be alarmed about that because

that's what actually has to happen in

order to to bring inflation down.

Um

so, what's your big call? Um are we

going to see another hike this year or

uh are they done?

>> Look, yeah, we think they're done. You

know, there's always near-term risks,

but but mainly the the next term you

kind of the near-term risks are mainly

external, you know, where how the um you

know, the conflict in the Middle East is

resolved, where oil prices and fuels

kind of end up. That's kind of a

near-term risk, Uh um but everything

domestically tells us they're done.

They've done enough. Um you know, I

think um you know, they've got back

policy back to 4.35. This is the peak of

the last cycle when we had a cycle.

Actually,

both last hiking cycles um prior to this

one peaked in the fours.

Um and the last time we had a policy

rate of 4.35, we had a 2-year per capita

recession. And we can already see in the

data the the impact of um you know, on

on household spending, on consumer and

business sentiment, on house prices. Um

all the interest rate sensitive

components of the economy are

responding. We think that'll be plenty

to do um to do enough uh inflation to

come back into target as we as we cross

over into next year.

>> So, is there a caveat though on on what

on how the US-Iran uh deal unfolds

um in in terms of where you think rates

are going this year?

>> Always a caveat with ex- external shocks

like that. Um once again, RBA can't

control that, but you can imagine

scenarios where they'd have to respond

to that. Um you know, arguably, they've

already had to respond a little bit more

aggressively than maybe they envisaged

last year.

Um but in an in an extreme example

where, you know, we get oil prices

spiking back up to 150 or um you know,

God forbid higher,

that is an environment that will pass

through to inflation. An RBA

[clears throat] that's already sensitive

to elevated inflation may feel um it

necessary to respond to that and ensure

that inflation expectations remain

anchored. Um we don't think that's going

to happen. Our base case is they've done

plenty. Um the domestic economy is

already responding and slowing. Um but

you can envisage situations, tell

scenarios where external shocks happen,

and central banks feel um feel compelled

to respond.

>> So, you see the next move is down for

the RBA?

>> See the next move is down, but not for a

while. Um you know, it's going to take a

little while to bring uh uh inflation

back

into that two to three percent target,

but we think we'll have a lot of clarity

on that by the end of the year. You

know, by the end of 2026, we think it'll

be very clear that the economy is

slowing, that inflation is coming down,

but they may not be able to to lower

rates until the second half of 2027. So,

an extended period of of rates where

they are

in a restrictive stance slowing the

economy. Next move we think is most

likely down, but probably not to the

second half of next year.

>> Okay, so so no so no rate cut for

Christmas.

Um

>> Very unlikely, I think.

>> Uh PIMCO is one of the world's biggest

managers of fixed income. Um look, most

of us actually own bonds without really

realizing it because they sit inside our

super funds.

Australian super, for example, our

biggest pension fund.

Their balanced fund has roughly 15%

invested in fixed income I last looked.

Adam, for listeners who aren't bond

experts, can you give us an idea of what

role bonds are playing in our

portfolios?

Why do, for example, super funds hold

them and and how they performed as an

investment this year?

>> Yeah, great question. So, I would say at

any point in the cycle there's two good

reasons why people hold bonds. Um first

of all is income. You know, bonds pay

coupons and provide steady source of

return through income.

Um and then the second point at any

point in the cycle is the

diversification benefits. So, you should

expect bonds to do well when the risky

parts of your of your broader portfolio

are underperforming and struggling. So,

that

under that sort of reliable return

through income and the diversity they

provide to the riskier parts of your

portfolio at any point in the cycle is

why people hold bonds.

At this particular point in the cycle,

though, um the additional reason people

hold bonds and why we're seeing inflows

into bond funds is that um is for the

potential for capital appreciation as

well as the income you're getting. Um

so, as I said, with a an RBA um where we

think at a peak in the policy cycle, as

interest rates come down, bond returns

go up. Um and so, through a cycle,

you've got income and diversity. At this

point in the cycle, you've got also got

the potential for capital appreciation

on your bond portfolio when interest

rates come down in the future.

>> [music]

>> And obviously, bond markets throw up uh

some really important signals uh that uh

maybe uh not everyone is aware of. What

are What are those markets saying right

now about the economic outlook and and

where rates are headed?

>> So, in Australia, the bond market is

pretty much pricing um well, near term,

the chance that RBA have to lift rates

again. You know, so there is a chance

the bond market is pricing in the chance

that they have to hike one more time.

Mhm. Uh but then, for uh several years,

uh policy to remain at around current

levels for a couple of years. Um

so, sitting up around, you know, 4 and a

quarter, 4.35, somewhere around where we

are now for several years.

Um so, we That's where we think the

mispricing is. As I said, near term,

there is some risk. You can You can

envisage scenarios where they have to

hike one more time, which we don't think

they will, but you know, you have to be

humble a little bit, particularly when

the risks are coming from offshore.

Longer term, that's where we think

markets have mispriced. We don't think

rates can stay policy can stay up above

4% for several years. We think the

impact on growth will be quite material.

Um but at least that's what the the

market's telling you. Um you know,

chance of another hike, but then rates

on hold for for several years.

>> And just on a global comparison, um I

mean, Bloomberg reported this week um

Matt Burgess in our Melbourne bureau

reported that uh Australian well

strategist are saying that Australian

debt right now offers the most

compelling opportunity among among major

developed markets. Would you agree with

that? And and what's driving that view?

>> Look, we would agree Australian bonds,

high quality Australian bonds offer one

of the most attractive opportunities in

in the developed

in the developed market for for global

bonds at the moment. Couple of things

driving that. Um, as I said from a

pricing perspective

and monetary policy, we don't think the

RBA can keep rates on hold where they

are for several years. So, if you

subscribe to that view and you think

interest rates will come down over

several years, then that's the potential

for capital return you're going to get

from Australian bonds. So, we like it

from a monetary policy pricing

perspective.

On the fiscal side also much more

favorable dynamics in places like

Australia. Um,

so you can you see places like the US

where they're running 6 to 7% deficits

and other parts of the world where

deficits are very high and and

governments are having to be very

thoughtful in the way they issue their

bonds as to be able to get the supply

bonds away to investors. Very different

dynamics in Australia. I know we wring

our hands about debts and deficits in

Australia, but for context, you know,

Commonwealth government debt to GDP is

going to peak below 40%. In other parts

of the world that's well above 100.

Our deficits at the moment are you know,

maybe 2% coming down to 1%.

Places like the US, places like other

parts of the world are high single

digits.

Um, so from a fiscal perspective, it's a

much more attractive bond market. And

then the technical demand supply is

really um, attractive. As I said, not as

much supply here as as other parts of

the world because of the better debt

dynamics. But then demand is very

strong.

We've seen global investors reallocating

to fixed income, I think globally

um,

because interest rates were

and the asset class looks cheap relative

to its history. And places like

Australia probably getting more than

their fair share of the allocation that

we usually would as part of that flow

because of you know stable political

institutions, rule of law and all those

things that that make long-term

investors comfortable deploying capital

in a into a country. So, you know, when

we look at the actual demand for new

bond issues,

you know, it's several multiples more

than

what's actually coming to market in

terms of supply and that's across

Commonwealth government bonds, state

government bonds and investment grade

corporate bonds.

So, very attractive from a monetary

policy pricing perspective, attractive

fiscal dynamics and very attractive

technicals for supply and demand.

>> Yeah, that's there's some really

interesting perspectives there too to

think about.

Okay, so inflation still a bit too high,

growth losing momentum and we have those

good old geopolitical tensions remaining

a wild card.

>> Yeah, so markets pricing the the price

the potential for a rate hike certainly

not PIMCO's expectation in Australia.

>> So, when you're talking to investors,

even ones you're talking to this week,

how how are they navigating this

environment? I mean, where are they

where are they putting money to work and

what what are they most worried about as

we head into the rest of the year?

>> Look at as I before as I said long-term

investors I think

we always sort of in our conversations

with with clients and and investors

starting point of valuations is really

important. So, you know, when investors

are looking at broad

you know, broader multi-asset portfolios

starting point of valuations matter.

So, when we have in conversations with

investors we're always emphasizing

there's very few asset classes out there

that you can say are genuinely cheap at

the moment. You can't say that about

equities,

maybe pockets and sectors but not

broadly.

Um I don't think you can say that about

property markets. I don't think you can

say that about many commodity markets.

You can genuinely make that case for

high-quality fixed income around the

world. Interest rates have adjusted very

high. Um [snorts] and uh relative to

history of the asset class, looks cheap.

Um

which means that forward-looking returns

are very favorable for that asset class

um

relative to other asset classes. So,

that's our starting point. Um and as I

said, certainly um you know, when we're

talking to investors,

whatever your bond allocation was in the

last couple of years, it should be

higher now. Um and um and you know, when

you're looking at your your multi-asset

portfolios,

um a starting point of a healthy

allocation to fixed income makes a lot

of sense. And we're certainly seeing

those flows.

>> If you found today's conversation

insightful, be sure to follow the

Bloomberg Australia podcast wherever you

listen. And check more reading on

Australia's economy, politics, and

people at bloomberg.com.

This episode was recorded on the

traditional lands of the Wurundjeri

[music] and Gadigal people. It was

produced by Paul Allen and edited by

Ainslie Chandler. I'm Chris Bourke, and

we'll see you next week.