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In their 2016 outlook for the domestic economy, PIMCO portfolio managers Rob Mead and Adam Bowe discussed the ongoing transition away from mining, the rebalance of the labour market and the capital structure of the major banks.
Australia’s economic expansion is likely to continue into 2016, they said, which will mark a quarter of a century of uninterrupted economic growth, however the PIMCO portfolio managers do foresee some headwinds beyond that.
“It certainly has been a remarkable run, particularly when you consider that only three isolated quarters during that period have experienced a contraction in real GDP, and one of those was related to the 2011 Queensland floods,” Mr Bowe said.
“With the extent of the macro headwinds Australia faces and the scope of the structural change in the economy as a consequence, we should be alert to the risk of a recession,” he said. “When you are riding a bike very slowly, it is much easier to topple off.”
However, Mr Bowe added that over the next six to 12 months, PIMCO sees plenty of evidence that the economy will be rebalancing rather than recessing.
“That continues to be our baseline forecast for 2016,” he said.
Mr Bowe said we are about three years into the structural rebalancing away from the mining sector and still have a couple of years to go.
“So the headwinds from lower mining investment, slower growth in China and lower commodity prices will continue to blow in 2016 and likely beyond,” he said.
Mr Mead highlighted that the rebalancing of growth away from mining to the housing sector has already peaked and will likely become a less powerful force going forward.
“The Australian consumer is already the most levered in the world, housing prices have increased significantly across the major Australian cities, macroprudential controls are limiting the capacity of banks to lend to the investor segment of the market and mortgage rates have risen from their lows,” Mr Mead said.
“This doesn’t necessarily imply a significant correction to property prices, but it does limit the ability of the housing sector to contribute to growth in the coming years.”
Meanwhile, Mr Bowe believes Australian banks still have some catching up to do in terms of capital raisings, given the changes to mortgage risk-weights and the higher targets for overall capital levels.
“That said, the increased costs of funding are largely already reflected in credit spreads across the entire capital structure,” he said.
“Importantly, though, even if the cost of capital is steady, the shift in the funding mix as banks attempt to meet the new capital targets will put some additional pressure on bank margins, which will most likely be passed on to borrowers.”
Because the RBA focuses on the actual market borrowing rates when setting policy, this ongoing bank margin pressure is likely to place a firm cap on the two per cent cash rate in 2016, Mr Bowe said, adding that, given other stresses in the economy, an easing bias is also likely to be maintained.