Australia’s recession risk ‘incredibly high’, fund managers warn

The risk of Australia experiencing a recession is on the rise according to economists with households under increased pressure and interest rates unlikely to drop any time soon, according to investment managers.

Lazard Asset Management portfolio manager Warryn Robertson said inflation is likely to remain high in Australia due to the sheer amount of monetary supply that was injected during the pandemic.

“This creates a problem for the central bank as they will be walking a tightrope in terms of managing that monetary policy environment,” Mr Robertson said speaking in a recent Morningstar conference.

“We think the risk of a recession is rising and is incredibly high. We have incorporated a recession into our forecasts. Markets we think will remain volatile.”

Vanguard similarly believes the probability of a recession occurring in Australia has risen.

“When we think about recession in Australia, we put the risk at 50 per cent, that’s risen from 40 per cent in the prior period. In the US, we think the risk is 90 per cent and that’s the start of a recession not necessarily a conclusion,” said Gregory Davis, chief investment officer at Vanguard.

PIMCO co-head of Asia Pacific Portfolio Management Rob Mead said that Australia is fast approaching a mortgage cliff for fixed rate mortgages which would place further pressure on households and the economy.

The fixed rate mortgage cliff has primarily been driven by covid and the policies in place at that time, particularly in mid 2021.

“As we can all remember, the RBA went down to ten basis points. The other thing that happened is our banks were offered the term funding facility - money for three years at ten basis points. Not surprisingly we saw [fixed rate loans] creep up. That got to almost 50 per cent in the middle of 2021 and it’s been in decline ever since,” said Mr Mead.

By the end of 2023, over 50 per cent of outstanding fixed rate mortgage loans with the big four banks will have rolled over. This translates to around 17 per cent of all housing loans.

“We’re now at the absolute peak of those mortgages switching over. This is important because most of those loans would have had a 2.5 per cent interest rate attached to them and so as they move into floating rate territory they’re going to have around a 5.5 to 6.5 per cent rate applied,” said Mr Mead speaking at the Morningstar Investment Conference last week.

“So that cliff is very powerful and definitely something the RBA will be looking at. It will definitely be a driver of how tight monetary policy needs to be moving forward.”

Based on previous analysis of recent periods, a four per cent interest rate would put the average Australian household under the most pressure its ever been under in terms of the proportion of disposable income being applied to interest repayments, according to PIMCO.

“With rates now at 3.85 per cent, we’re now right on that cusp,” said Mr Mead.

“[Regardless] of whether there’s another rate hike or not, we’re now in that zone of what is required to really start to impact the real economy. Obviously it takes time for some of these policy mechanisms to flow through but we do think that policy has moved far enough to start to have a real impact.”

Mr Mead also warned that higher interest rates were highly unlikely to be “a short term storm that businesses and households can simply ride out”.

“The idea that interest rates will miraculously come down and miraculously we’ll get a soft landing, we think that’s fool’s paradise,” he said.

As rates have gone higher and consumers have been reluctant to stop spending, we think that soft landing that the RBA has been hoping for we’ll be very difficult to achieve. That means that recession is now our base case, not only for the US but for Australia as well.”

AMP deputy chief economist Diana Mousina also believes that concrete evidence of the impact of rate hikes is now starting to flow through to the economy.

“Employment growth, housing lending, building approvals, retail spending and consumer and business confidence indicators are all weakening. Inflation is declining from its highs and there is no sign of a wages breakout,” said Ms Mousina.

“This backdrop gives the RBA room to keep interest rates steady and at an elevated level and assess the impacts from previous rate hikes. There is no urgency for the RBA to lift the cash rate at the next meeting in June and we don’t expect any further hikes in this cycle.”

A deeper recession for the US a possibility

PIMCO head of agency mortgage portfolio management Dan Hyman said a recession is now looking likely for the US as well.

“That’s now our base case and if you look back at historical hiking cycles that’s typically how they end, they cause a recession,” said Mr Hyman speaking at a Morningstar event.

“[However], this time we think there’s potential for it to go a bit deeper.”

Central banks are done with most of the tightening through rate hikes, especially in the US where we think the US Central Bank is likely to pause from here. It’s also important to recognise that the tightening isn’t done. We have Central Banks around the globe raising interest rates. We also have quantitive tightening still taking place.”

The US Federal election could also have a significant impact on how a recession in the US could play out.

“As we head into an election year and a potential recession, there is less room to respond with fiscal policy. There is one side of the political isle who has less incentive to respond with a stimulus package in the event of our downturn to help support declining growth,” said Mr Hyman.

“So while our base case is for a modest recession, the possibility of a deeper recession is still there.”