Robert Mead

It was way back in May 2013 when PIMCO first uttered the phrase “The New Neutral” in relation to Australia’s cash rate. At that time, we estimated the “New Neutral” rate for Australia to be about 3%. We stand by that view.

Today, over 4 years later, the RBA explicitly referenced 3.5% as their estimate of the neutral nominal cash rate, while also acknowledging significant uncertainty around this estimate.

The clear takeaway from both of these estimates of neutral rates is that versus the pre-Global Financial Crisis (“GFC”) period, we should expect interest rates to be significantly lower than historical cycles.

Additionally, we also know that Australian households have binged on debt since the GFC, taking advantage of lower and lower mortgage rates. More recently, borrowing rates have started to increase for certain borrower cohorts due to regulatory changes designed to limit the potential for systemic risk.

From PIMCO’s proprietary studies, we know that Australian borrower confidence is dominated by two factors: first, the level of borrowing rates; and second, recent changes in house prices. Given the latest housing and interest rate data, it appears we may be approaching an important inflection point, which will limit the flexibility for increases in policy rates.

Given these dynamics, the start of any hiking cycle in Australia will not be possible for at least 6 to 12 months, so it is important to consider the likely global economic dynamics expected to be in place at that time. The Chinese Party Congress will have been concluded before the end of 2017 and in PIMCO’s view there is a high probability of additional economic growth volatility. Also, the level of the Australia Dollar will be key. The RBA reminds us that the depreciation of the Australian dollar since 2013 has assisted Australia’s economic transition which is true, however it is also important to note that the Australian dollar has appreciated by over 15% since early 2016.

Investment Implications: When considering any investment, the expected destination valuation is very important, but even more important is the path and the time required to reach the destination valuation. When it comes to Australian interest rates, we believe the hurdle for RBA action (either higher or lower policy rates) remains high and just like the Federal Reserve, when the time eventually comes to neutralise policy, the path towards the “New Neutral” will be a slow and measured one.

By Robert Mead, Managing Director and Co-head of Asia-Pacific Portfolio Management

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