Australian financial markets aren't priced for an RBA hike next month, which leaves current positioning "somewhat vulnerable" if the central bank does hike as Morgan Stanley expects on the back of a potentially "hot" CPI report this week.
"An August rate hike would complicate the outlook and come at an inopportune time for equities," says Morgan Stanley Australia equity strategist, Chris Nicol.
"Whilst inflation is remaining stickier and in services at least still rising, the evidence of some slowdown in domestic-facing sectors, like housing activity and discretionary consumption, has been building.
He says a further hike with an expected hawkish bias in outlook is likely to "prompt extended weakness in domestic trading conditions and encourage further thrifting in behaviour – this would "challenge earnings" in the 1HFY25.
But the current sanguine approach to credit-quality risks evident in elevated bank trading multiples would also have to be reconsidered and bleaker housing activity signals that we flagged will "continue to flash."
An August hike would also put upward pressure on the Aussie dollar, reducing the gap in policy restrictiveness for Australia relative to other G10 central banks.
"For much of this year we have seen a consensus bias to want to look through any impact from tighter monetary policy and jump any earnings gaps to the next stage of the cycle," Mr Nicol says.
"Should our additional rate hike call become consensus, the potential harder landing that comes with that is not priced into earnings multiples, in our view, and
would pressure index direction."
In terms of positioning, Morgan Stanley's model equities portfolio is underweight banks, consumer, and housing-linked sectors. Its overweight sectors are resources, non-bank financials, global healthcare, and it also like select quality growth stocks.
