FLAU - Antipodeans Tread Closer To The Finish Line

2023-05-09 02:30:00 ET

Summary

• From the fiscal standpoint, the tight labor market, coupled with higher commodity prices, has significantly improved Australia’s federal budget deficit.
• Like Australia, the job market in New Zealand has been very resilient.
• Australia and New Zealand have significantly tightened financial conditions since the start of their hiking cycles.

By Karol Sindera

We believe current interest rates in Australia and New Zealand present an attractive investment opportunity.

After pausing in April, the Reserve Bank of Australia decided to restart its hiking cycle and raise its cash rate by 25 basis points to 3.85% while keeping forward guidance hawkish. This came as a surprise to the markets, given that the country's first-quarter consumer inflation report came in softer than expected and broadly in line with the central bank's stated objective of a 2 - 3% target by mid-2025.

RBA Governor Philip Lowe acknowledged that "very tight" labor conditions, elevated services and energy inflation, and a recent rebound in the housing market were the main drivers behind the increase. High-frequency data also indicated an uptick in population growth triggered by net overseas migration, which could boost inflation even further. However, when looking at the latest economic forecasts for growth and inflation, we believe this could be the last hike in the current cycle.

From the fiscal standpoint, the tight labor market, coupled with higher commodity prices, has significantly improved Australia's federal budget deficit. Even using conservative assumptions, the outcome has skewed toward better results. This should support Australian government bonds, swap spread instruments, and semi-government bonds, especially within the New South Wales and Victoria regions, which may undergo more strict discipline to revamp their budgets after local elections.

Meanwhile, in New Zealand, the central bank raised rates by a hawkish 50bps at its last meeting, bringing the official cash rate to 5.25%. Like Australia, the job market in New Zealand has been very resilient. The latest report shows a record level of employment and persistent annual wage growth. However, the latest CPI print confirmed that inflation has passed its peak. Although price increases remain above the Reserve Bank of New Zealand's target range of 1 - 3%, early signs of a slowing pace support the RBNZ's hiking another 25bps and then taking a pause.

Overall, Australia and New Zealand have significantly tightened financial conditions since the start of their hiking cycles. As higher rates continue their work through the economy via transition mechanisms, we believe government bonds from New Zealand along with semi-government bonds from Australia present an attractive investment opportunity due to their high-quality yield pick-up.

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