PIMCO is becoming increasingly constructive on Australian bonds, arguing that the market's expectations for interest rate hikes are too high given the slowing local economy.
Adam Bowe, PIMCO's head of Australian portfolio management in Sydney, said Australia's rate hike cycle is already "fully priced into the market," while cracks in the economy are beginning to show.
Speaking on Monday, he said this makes Australian bonds look quite attractive, particularly in the 5-to-10-year portion of the yield curve.
"Australian bonds are attractive in their own right, and they are even more attractive relative to other markets," Bowe said.
He also noted that the Federal Reserve and the Reserve Bank of Australia "are trying to bring inflation back to target without breaking the economy, but I think the cracks are more evident here."
Bowe has been bullish on Australian bonds since mid-year, expecting the RBA will ultimately be forced to pivot toward rate cuts to support a cooling economy.
Still, short-term policy risks remain elevated.
Traders expect the RBA to raise rates after concluding its two-day policy meeting on Tuesday, pushing the cash rate to its highest level since November 2011.
Swap data shows the market sees a three-in-four chance of two rate hikes next year, which would push the benchmark rate above 5% for the first time since 2008.
However, PIMCO believes the Australian economy cannot withstand such a rate trajectory.
Bowe warned that while capital spending in data centers may keep the economy resilient over the next few years, deeper "structural vulnerabilities" exist among Australia's heavily indebted households.
He said the ratio of tax burdens and mortgage repayments to income has already reached near record highs, making it difficult for consumers to cope with a 5% cash rate.
"If they keep going, especially on rates, if it gets to around 5%, I think the risk of a recession is real," Bowe said.
Given that yields are already attractive and there are signs of slowing economic growth, Bowe said, "I have a constructive outlook on Australian bonds."
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