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Could interest rates dip below ‘neutral’?

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By Maja Garaca Djurdjevic
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4 minute read

Janus Henderson believes the RBA will cut rates to at least 2.6 over a period of 12 months.

While the fund manager expects the Reserve Bank (RBA) to remain on hold at the current rate – 4.35 per cent – before commencing an easing cycle in August this year, it is pricing in a “more modest” than historically average easing cycle of around 175 basis points spread over 12 months.

The risk, according to Janus Henderson’s latest update, is to the downside, with a rising probability that the RBA may have to move earlier and slightly faster than the firm’s base case.

“In this scenario, the RBA starts moving in August 2024, with a total of 250 bps of cuts, to below neutral interest rates,” Emma Lawson, Janus Henderson fixed interest strategist – macroeconomics, said.

Last month, the RBA released its new format monetary policy statement, modestly downgrading its GDP forecasts, as well as its CPI expectations, but maintained that there is a high degree of uncertainty.

Recent data has substantiated this uncertainty, with increases in unemployment to 4.1 per cent, wages at 4.2 per cent year-on-year, and retail data rising by a less-than-expected 1.1 per cent month-on-month.

“We see the very near-term RBA pricing as relatively in-line with expectations,” she said.

“However, the expectation of policy rates held above neutral over a period of years continues to underestimate the cyclical risks. We currently consider the Australian yield curve as undervalued at points in the curve. We hold a long duration position and look to add to it on any worsening of the economic outlook.”

In light of the intricate macroeconomic landscape, Janus Henderson said its credit strategy leans towards high-quality, investment-grade issuers with resilient business models, solid earnings power, and conservative balance sheets.

“We have been actively and selectively taking advantage of the attractive yields on offer in highly rated corporate bonds and structured credit, particularly in the primary markets where transactions have come with new issue concessions," said Lawson.

“While we believe that the cumulative impacts of restrictive financial conditions will become evident, we are mindful of a healthy starting point of above full employment and sound corporate fundamentals. As such, we remain open-minded to a wider range of potential economic outcomes including those involving a soft-landing.”

Recognising potential opportunities in discounted valuations, Janus Henderson also sees the prospect for capital gains beyond existing yields, providing attractive risk-adjusted returns for patient investors with a medium-term horizon.

“We continue to judiciously seek out, create and access such opportunities, while simultaneously preserving significant capacity to take advantage of opportunities arising through future market dislocations.”

View on rates mixed

AMP’s Shane Oliver, who had previously voiced concerns about the RBA potentially “going too far”, acknowledged this week that while it’s still early to confirm, there is a growing sense that the RBA’s November rate hike might have been an overreaction to the less favourable inflation data from the September quarter.

This month, the RBA is not due to meet until 19 March after it cut the frequency of meetings from 11 to eight in line with the RBA review’s recommendations.

Weighing in on the ongoing too high for too long” debate, Anneke Thompson, chief economist, CreditorWatch, said that the local central bank is “highly unlikely” to ease monetary policy prior to the US and UK markets.

Last month, Deutsche Bank said in its most recent research paper that the RBA’s most recent inflation outlook “looks too conservative”.

The financial institution’s chief economist for Australia, Phil O’Donaghoe, believes the RBA is exercising too much caution despite recent history suggesting that inflation could actually drop “much more quickly” than the bank anticipates.

“That would mean RBA should be cutting more and earlier, rather than less and later,” O’Donaghoe told InvestorDaily at the time.