At its 6 of June Monetary Policy Meeting the Reserve Bank of Australia (RBA) raised its Overnight Cash Rate (OCR) by 25bps to a new cycle high of 4.10%. The rate hike surprised investors, who were expecting additional rate hikes following the RBA’s hawkish pivot at its May Monetary Policy Committee (MPC) meeting but remained uncertain as to the exact timing of any RBA action. Justifying the rate hike, the central bank noted that “inflation was still too high” and “upside risks to the inflation outlook have increased”.
Figure 1: The RBA has hiked rates 12 times in the current cycle to a 13-year high of 4.10%; market drive interest rates continue to increase in anticipate additional rate hikes
Source: RBA, Bloomberg & J.P. Morgan Asset Management; as at 6 June 2023.
Mixed signals
Since the last RBA meeting in early May, economic data has been mixed – complicating the RBA’s attempts to balance growth worries versus inflation concerns and “achieve a soft landing”.
Growth has slowed, retail sales have softened and consumer confidence remains weak as cost of living concerns and higher interest rates weight on domestic sentiment. Concurrently, “labour market conditions have eased” with employment slowing while the unemployment rate has ticked higher – albiet from a 50-year low.
In contrast, inflation has remained elevated with the latest monthly reading indicating that “service price inflation is still very high and is proving to be very persistent”. House prices also rebounded on expectaions of interest rates peaking and the Fair Work Commission recommended an above inflation increase in the minimum wage and the award-linked pay. Observing the pick-up in wage growth, the RBA confirmed that it “remains alert to the risk that expectations of ongoing high inflation contributed to larger increases in both prices and wages.
Figure 2: Core inflation remains elevated and sticky, the housing market has stabilized on expectations of interest rates peaking and strong immigration demand
Source: RBA, Bloomberg & J.P. Morgan Asset Management; as at 6 June 2023.
Market reaction and strategy positioning
With a rate hike only partially priced in, bond yields increased by 10bps across the curve while the AUD jumped following the central bank announcement. Investors are now pricing in one additional rate hike by September 2023.
J.P. Morgan Asset Management’s AUD Liquidity strategy was well positioned for a rate hike with a low weighted average maturity and the majority of fixed securities maturing shortly. The strategy also has a significant portion in Floating Rate Notes which will reset higher in the coming months. Finally, the strategy has high daily and weekly liquid assets – which will immediately reset higher following the hike – boosting the strategies yield.
Outlook
While the RBA remains committed to keeping “the economy on an even keel”, its focus has definitively pivoted to curtailing inflation. Notably the RBA removed its long standing assertion that “inflation expectations remain well anchored”, instead it acknowledged that “high inflation makes life difficult for people and damages the functioning of the economy” and suggested the latest rate hike will “provide greater confidence that inflation will return to target within a reasonable timeframe”. The accompanying statement concluded that “some further tightening of monetary policy may be required”.
For AUD cash investors, the latest rate hike will be welcome news – with interest rates on cash investments increasing to a 13-year high. In addition, with further rate hikes expected, the yield curve remains upward sloping – offering additional yield pick-up for investors with longer investment horizons. Nevertheless, we believe that segmenting cash across a broader array of money market and ultra-short strategies is still advisable given uncertainty concerning the timing of further rate hikes and the terminal rate.
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