RBA Holds Cash Rate: March 24

Global equity markets have ended the first quarter on a high note, with investors optimistic about the prospect of interest rate cuts later in the year. The MSCI World Index was up over 10% this quarter (Chart 1) as long-term bond yields fell slightly in March and traders dropped earlier bets for as many as seven US rate cuts in 2024. Chinese stock performance has tempered since last month’s high, but still showed signs of further recovery as government support continued to prop up the equities market. The S&P/ASX200 climbed 3.27% in March, in line with the MSCI World Index, while US markets continued to show resilience despite an increase in real personal consumption (PCE), which rose 0.4% month-on-month in February. Core PCE inflation is now very close to target which on one hand is a positive for the disinflation trend that will encourage the Fed to move away from its tight policy stance. On the other, the 3-month rate of change of core PCE is an indication that inflation might be reaccelerating and the underlying strength in the US economy could spark concern of a second wave.

Fixed income markets have been trending sideways in the first quarter. However, the Bloomberg Barclays Global Aggregate Index was slightly up 0.8% in March (Chart 2) while long term-bond yields dipped. The index has yet to recoup its 2022 losses as central banks maintain tight monetary policy. BCA Research conducted an insights survey asking their readers’ views on the US economy and monetary policy with interesting findings. Most respondents expect the US recession to begin in the second half of this year (37%), while an even greater number (45%) expected this to occur in early 2025. This suggests readers are more optimistic about the 2024 outlook for the US economy than at the end of last year, when roughly 75% of respondents indicated a recession is likely before the end of 2024. Financial conditions have eased, and economic data remains strong which has coincided with hotter than anticipated inflation prints. This may bring hawkish surprises from the Fed, which would be bad news for stocks and bonds. As such, most survey respondents expect the Fed to deliver less than three rate cuts. With the risk of a second inflation wave still looming, it is likely that policymakers will choose to maintain a cautious approach to policy easing.

Outlook for Australia

The Reserve Bank of Australia (RBA) board opted to again keep the cash rate on hold at 4.35% during its March meeting. It was also the first time the central bank has decided to drop the mention of a possible rate hike in the recently published meeting minutes. It noted that the balance of risks to the outlook were now “a little more even”. It stated that “it was appropriate to characterise the policy outlook as one in which it was difficult to either rule in or out future changes in the cash rate target”. Members noted that output growth had slowed further in the December quarter (with inflation down to 4.1%), largely as expected with weak household consumption growth amid elevated interest rates and the cost of living that had weighted on real incomes. Of note is that underlying demand for housing remained brisk relative to supply, contributing to rising values and rents, particularly as population growth remained high. Rent-linked inflation and high residential construction costs still contribute heavily to overall CPI; however, they are moving in the right direction. A look at the yield curve (Chart 3) may provide some indicators for the outlook in Australia.

The term yield curve refers to the relationship between the short and long-term interest rates of fixed-income securities issued by central banks. The yield curves above show some inversion in short-term maturity bonds (2Y vs 1Y), a relatively flat curve in the mid-term (5Y vs 2Y) and normal convexity in the long-term vs short-term maturities (10Y vs 2Y). Under normal circumstances, the yield curve should be upward-sloping since debt with longer maturities typically carries higher interest rates than nearer-term ones. The yield curve inversion above suggests that the near term is riskier than the long term which is why those near-term rates are higher. Yield volatility on the short end of the curve is more strongly linked to uncertainty regarding monetary policy and an inverted yield curve has been viewed as an indicator of a pending economic recession. Since 1955, equities have peaked six times after the start of an inversion, and the economy has fallen into recession within 6-24 months. The RBA is hopeful that inflation will be brought in line with its target and the long vs short-term yield curve displaying normal convexity is promising. However, the curve should continue to be monitored as an inverted yield curve has signalled every recession since 1955.

Portfolio Positioning

As market sentiment fluctuates each month with policymakers carefully observing economic data to determine monetary policy, investors should remain focused on long-term investment objectives. Preserving capital through maintaining a multi-asset class portfolio that is sufficiently diversified across all asset classes, regions, sectors, and fund managers is imperative.

LBP maintains its slightly defensive positioning for the first quarter of 2024, seeking relative value in private debt to provide investors with a stable income stream given the current level of global yields. Private markets also typically have a lower sensitivity to market movements that can help smooth returns. There remains a meaningful allocation to listed and private equities, and real assets while we continue to explore strategies in alternative investments to provide further portfolio diversification.

LBP continues to stress that a robust investment framework, and remaining invested through the cycle is integral to preserving wealth, and that investors should emphasise the long-term goals of income generation and capital appreciation. With markets unable to keep their story straight consistently, it is best to avoid trading on short-term movements as time has shown that the greatest threat to real wealth comes from being underinvested in the long run.