13
Apr
2012

ANZ hikes rates – RBA will seriously look at a 50 bp cut in May

The ANZ hiked its mortgage rate by 6 basis points in response to higher funding costs, largely in the wholesale market.  Like any business that wants to maintain profitability by putting up its price of dog food, hamburgers, washing powder or carpet when input prices rise, the banks are simply operating in a rational way.

Now perhaps banks and interest rates are slightly different to the market for dog food, but as long as there is sufficient competition and price gouging is not occurring, it’s simply the market operating as it should.

For the RBA, the move from ANZ sends a powerful signal that for monetary policy to move to an even slightly accommodative setting, a cut of more than 25bps is needed on 1 May.  With mortgage rates around 10 to 15bps higher than at the start of the year and the economic news notably weaker, a 25 cut will not be sufficient to boost cash flows, confidence and lock inflation in the target band.  There is no certainty that a 25 cut in May would even be passed on in full, making such a move close to useless when the economy needs a bit of a kick start.

The RBA needs to cut 50 basis points in May.  It knows the Budget will be tight; it knows market conditions are skittish; it knows there is spare capacity building in the Australian economy; it will know after the March quarter CPI on 24 April that inflation is well contained.

Thankfully Glenn Stevens is super-pragmatic.  He just might come to the view that a little more monetary stimulus is needed in the current economic and market environment and try to convince the Board that a 25 cut isn’t enough.

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13
Apr
2012

Mortgage Rates and the ANZ: Hysterical reaction in historical perspective

The media coverage of the 6 basis point rise in ANZ’s mortgage rate is bordering on the hysterical.  Some context please.  On a $300,000 mortgage, the 6 basis points is $2.69 a week or 38c a day.  Sure, no one likes paying more for anything, but it’s not the move that will pole-axe consumer demand.

It is also worth remembering that the current level of mortgage rates is still around 1.1 percentage points lower than those prevailing when the “interest rates will always be lower under us” Liberal Party was last in power in November 2007.  We should note here that 6 months after the Liberal Party lost office in the 2007 election, mortgage rates got to 9.6% as the RBA tried to reel in the inflation pressures unleashed by pro-cyclical fiscal policy as Howard tried to buy favour with the electorate.  The current mortgage rate is about 2.1 percentage points lower than that.

The other very, very, very, very important thing to recall is that the RBA will take the moves in retail interest rates into account when setting official rates.  The recent increases in retail rates are a factor that will compel the RBA to cut official rates more than otherwise in the months ahead.  Get set for a 50 cut in May and probably more cuts in the second half of 2012.

So no more hysteria because there will be true interest rate relief in the months ahead.  It would not be surprising to see mortgage rates below 7% and perhaps on their way to 6.5% within the next 12 months.

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11
Apr
2012

Employment jumps in March after crashing in February, jumping in January, crashing in December

The March employment report was a pleasant shock after months of generally soft economic news.  Employment rose a nice 44,000 in March after monthly changes of -15,400; +48,100; -36,600 and -3,700 in the prior 4 months.  The numbers are clearly very choppy, but it is a great to the statistical noise in the data turning up for this month at least.  I hate to say it, but I will – let’s look at the April employment result in a month’s time to see if the March jump in jobs is just statistical volatility or a change in trend.

That said, total employment growth over the past year was a puny 0.3%, more than a full percentage point or more than 100,000 jobs lower than the long run average.  That sort of trend for employment growth fits almost perfectly with the recent national accounts which showed that GDP rose at a floppy 2.3% through 2011 having been stuck below a 3% pace for almost 4 years.

The unemployment rate was steady at 5.2% in March and it has been all but unchanged in the last 6 or so months having previously risen from below 5% early in 2011.  The unemployment rate is still near historical lows but is still more likely to edge up given the ongoing sub-trend growth.

The monthly jobs report will be viewed by the RBA with some relief although its judgment about what to do next will no doubt influenced by the raft of activity indicators which point to GDP growth remaining below trend, at least in the near term. 

The monetary policy implications of the better data must tilt the balance a little towards a 25 basis point rate cut in May and away from 50, but there is still plenty of water to flow by in the next 19 days until the RBA meets.   A look over the horizon would still point to the RBA cutting 50 basis points given global and market trends, plus the fiscal tightening in place.  

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10
Apr
2012

More Poor Data – A Pragmatic RBA Will Cut 50 in May

Consumer sentiment fell 1.6% to 94.5 points in April – a level around 10% down on the average of the past decade.  Mining boom or not, consumers are gloomy and when that is the case, they usually scale back their spending and overall economic growth will be subdued.

At the same time, the number of housing loan approvals fell 2.5% in February after falling 1.1% in January confirming an on-going under-performance of the housing sector.  In concert with the seasonally weak house price data, there is no doubt that housing in all of its guises of finance, prices and certainly new construction, is weak.

With global markets now starting to again question the financial viability of the governments of Spain and Italy, the risks for the Australian economy from global events are huge and almost uniformly to the down side.  Commodity prices are falling , US and German bond yields are falling back to fresh all time lows and recent US data suggest that some of the strength in the US around January was simply the result of a warm winter.

As the RBA undertakes some self-assessment of its recent record, it would acknowledge that it has misread the economy.  The decision not to cut at any of the first 3 RBA Board meetings of 2012 was based on a notion of improving credit markets (no longer the case);  trend GDP growth (disproved with the December quarter national accounts); the low unemployment rate (which ignores the drop in employment and participation); and concerns that wages and inflation are threatening to the high side (we’ll see, but a gutsy call given all of the other news).

So what should the RBA do now?

The May RBA Board meeting will mull over a 25 or 50 basis point rate cut.  A cut of 25 basis points would be only a baby step to support growth and keep inflation in the groove when a giant leap is needed.  It seems that whatever the RBA does, the banks will keep some of the move to maintain profitability.  If the RBA cuts only 25 and say 10 or 15 basis points are passed onto to borrowers, the net move in retail interest rates since December would be zero – despite the undoubted and material deterioration in the economy and market conditions.

This is not good enough.

This means that a pragmatic and realistic RBA Board would cut by 50 basis points.  The RBA with Glenn Stevens as Governor has shown it will act on monetary policy without fear, self-doubt or favour and pragmatically act when economic and market circumstances change.  It hiked interest rates during the 2007 election campaign, it slashed rates 100 basis points at the outset of the GFC when the market was torn between it going 25 or 50. 

The RBA always gets it right – eventually.  It can play catch up with the stroke of a pen writing 50 instead of 25.

Which leads me to think that this time, at the 1 May Board meeting, it will cut by 50 basis points to move retail rates to a slightly accommodative stance.  Going 25 is too small given the poor economic data and the downside risks ahead.

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9
Apr
2012

Markets React Joylessly to RBA’s Words, Not Actions: UPDATE x 3

UPDATE:  3.30pm 10 April

A week and an hour after the RBA announced it’s decision to hold the official cash rate at 4.25%, financial markets continue to move as if the rate cut was delivered.  Or have they?

The market moves are now as follows from just before last week’s RBA announcement:

  • The AUD is currently trading around 1.0305 – up from late last week, but still around 1.35 cents below the pre-RBA announcement. 
  •  The major price action has been in interest rate markets.  The 3 year bond yield has plummeted to 3.26%, some 24 basis points lower than before the RBA announcement, while the cash rate in 1 year has also fallen to 3.26%, some 25 basis points lower than before the RBA decision. 

These are big moves – there may be more to come.  Bond markets always rally in countries where the central bank keeps policy too tight for too long – Australia is no exception.

_____________________________________

UPDATE:  12.30pm 5 April

It’s time to take profit on half the trade.

The non-rate cut from the RBA on Tuesday didn’t deceive the markets – they collectively know that the economy is bumbling along well below trend; that inflation is about as threatening as Barnaby Joyce in a maths competition; and the global economy is more inclined to weakness in the year ahead.

The AUD is currently 1.0270 – it still should weaken over the medium term, but it is around 1.7 cents below the pre-RBA no-cut level.

Interest rate markets keep rallying after the RBA shock – the 3 year bond yield has dropped to 3.39%, some 11bps lower than before the RBA announcement while the cash rate 1 year forward has fallen to around 3.38%, some 13bps lower than before the RBA announcement.  The market is increasingly convinced that the RBA will now have to do more cutting over the year ahead to realign its inflation target.  

As mentioned below, financial markets can reward and punish the best and worst of forecasts when looked at in their narrowest form.  It must have been painful for those getting the RBA call right on Tuesday – that there would be no easing – and positioning for a higher AUD and higher interest rates only to see the reverse happen.

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UPDATE:  12 noon; 4 April

We now have the AUD free-falling to 1.0275; the 3 year bonds are still at 3.45% despite a bearish lead from the US – so still well in the money; and the cash rate 1 year forward is 3.44% – an extra couple of ticks in the money from the pre-RBA announcement of yesterday.

Interesting to see the market seriously question the actions from the RBA in terms of holding monetary policy too tight for too long and of course, now pricing in a more aggressive catch up that will inevitably follow in the months ahead.

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Market are so very interesting

Just before the RBA announcement at 2.30pm today, the market had the chance of a 25 basis point rate cut at around 35%.  The Australian dollar was around 1.0440; the 3 year bond yield was 3.50% and one year into the future, the market had a cash rate of 3.51% priced in.

When the RBA left rates steady, one might expect the AUD to strengthen and for interest rates across the yield curve to rise given that there was roughly a one-third chance of a rate cut that clearly did not materialise.

Go forward a few hours, the AUD has fallen to 1.0370; the 3 year bond yield is lower at 3.45% and the market is now pricing in a 3.46% cash rate one year from now.

It’s almost as if a rate cut was delivered!

So pity the poor traders who got it “right” with no rate cut from the RBA… while the others, positioning for a cut are crying all the way tot he bank.

No wonder there some sour grapes coming from the joyless commentators who misread the markets and the RBA assessment of conditons that rates would be cut soon, if not today.

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8
Apr
2012

A Testing Week for the RBA

The RBA belligerence in refusing to cut interest rates so far in 2012 will be tested with some top tier local data this week.

The ANZ job advertisement series gets an update on Tuesday and after some reasonably firm readings in the last few months, a further increase in job ads would be an encouraging sign that the deterioration in the labour market was about to end.  A weak result will spell trouble for the labour market and signal higher unemployment in the months ahead.

There are also readings this week on business confidence and consumer sentiment.  The business sector, outside mining, has been glum and the readings of confidence consistent with a very sluggish rate of growth – or in some industries, falling output.  Mining confidence, of course, is still near euphoric as prices and volumes of their output remain high.  Any slippage in the readings for confidence would be disconcerting.

For consumers, the mix of falling house prices, soggy share prices, a softer jobs market and still reasonably high interest rates have conspired to lock sentiment at levels well below historic averages.  Another result where the index is below 100 points would spell on-going subdued growth in spending from consumers.

The biggy for the week will be the labour force data on Thursday.  Employment creation has slowed to around zero in recent months, in line with the ongoing below trend rate of GDP growth which has been an unfortunate occurrence for the past 3 or so years.

The monthly employment numbers are extremely volatile – in the last 5 months, the change in employment has been -15,900; +46,200; -37,500; -3,400; +11,800.  We are due to see a +15,000 to +20,000, a result that would still fit with a soft trend.

One way to judge the employment result for the month is to judge what you might expect for job creation with GDP growth at 2.3%.  The last four months show a net loss of 10,200 jobs.  This clearly is overstating how soft the economy is.  More likely, employment is growing by a few thousand a month, on average, as the economy muddles along.  As a result, it would not be unreasonable to expect a rise of 15,000 to 20,000 in March employment as pay back for the prior weakness and to return to trend.  Such a result would be consistent with a soft rate of economic growth. 

All up, the data this week will put the blow torch to the RBA and its judgment that neutral monetary policy settings are appropriate for an economy continually growing below trend.  The RBA will be hoping, as we all will, to see some solid results in the data.  If not, the May rate cut will either need to be 50 basis points or be followed up with several more cuts in the months ahead.

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7
Apr
2012

A Striking Contrast: Australian and US Jobs Data

The employment reports for the US show a chronically dismal state of affairs for US workers and those currently unemployed.  And this despite a recent upturn in job creation and a near 2 percentage point fall in the unemployment rate in the last couple of years.

In the latest data released Friday, the US labour force was 154.707 million people and of those, were 8.2% or 12.673 million people were unemployed.  The workforce participation rate was 63.8%.

Australia has a labour force of 12.076 million people, the unemployment rate is 5.2% or 632,000 people and the workforce participation rate is 65.2%.

Lets slice and dice these numbers to show some what I think are staggering contrasts between the economies and labour markets of the US and Australia.

If the US had Australias participation and unemployment rates; there would be an extra 3.47 million people in the labour force: the number of people unemployed would be 4.45 million people lower and the level of employment would be around 7.9 million people higher.

 

If we apply the US labour force participation and unemployment rates to Australia, the level of employment in Australia would be a staggering 611,000 lower, the number of people unemployed would be 990,000 or some 358,000 more than currently registered.

And dont forget there has been a quite substantial improvement in the US labour market in the last 2 years or so with employment growing at a reasonable pace and the unemployment rate falling from a peak rate of 10%.

There are many issues that fall out from this contrast.  Here are a few.

Most importantly is the importance of economic growth.  Keep growing the economy and employment will remain resilient.  The stimulus during the GFC in Australia worked a treat, it kept the economy growing and supported employment.

Also important is a smashing of the notion of the benefits of US style labour market flexibility.  To be sure, the US labour market has more flexibility than in Australia,  much more, but look at the cost.  Flexibility to sack people and cut wages delivers flexibility to default on mortgages, to stop spending and to undermine productivity.  There is also a paper in the offing for those wanting to look at the dreadfully inefficient, high cost German workforce and compare it with the US at the moment.

It all goes to show that Australia continues to be a shining light in the global economy, despite the recent bout of RBA induced growth under-performance.

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5
Apr
2012

Markets React Joylessly to RBA’s Words, Not Actions: UPDATE x 2

UPDATE:  12.30pm 5 April

It’s time to take profit on half the trade.

The non-rate cut from the RBA on Tuesday didn’t deceive the markets – they collectively know that the economy is bumbling along well below trend; that inflation is about as threatening as Barnaby Joyce in a maths competition; and the global economy is more inclined to weakness in the year ahead.

The AUD is currently 1.0270 – it still should weaken over the medium term, but it is around 1.7 cents below the pre-RBA no-cut level.

Interest rate markets keep rallying after the RBA shock – the 3 year bond yield has dropped to 3.39%, some 11bps lower than before the RBA announcement while the cash rate 1 year forward has fallen to around 3.38%, some 13bps lower than before the RBA announcement.  The market is increasingly convinced that the RBA will now have to do more cutting over the year ahead to realign its inflation target.

As mentioned below, financial markets can reward and punish the best and worst of forecasts when looked at in their narrowest form.  It must have been painful for those getting the RBA call right on Tuesday – that there would be no easing – and positioning for a higher AUD and higher interest rates only to see the reverse happen.

______________________________________

UPDATE:  12 noon; 4 April

We now have the AUD free-falling to 1.0275; the 3 year bonds are still at 3.45% despite a bearish lead from the US – so still well in the money; and the cash rate 1 year forward is 3.44% – an extra couple of ticks in the money from the pre-RBA announcement of yesterday.

Interesting to see the market seriously question the actions from the RBA in terms of holding monetary policy too tight for too long and of course, now pricing in a more aggressive catch up that will inevitably follow in the months ahead.

______________________________________

Market are so very interesting

Just before the RBA announcement at 2.30pm today, the market had the chance of a 25 basis point rate cut at around 35%.  The Australian dollar was around 1.0440; the 3 year bond yield was 3.50% and one year into the future, the market had a cash rate of 3.51% priced in.

When the RBA left rates steady, one might expect the AUD to strengthen and for interest rates across the yield curve to rise given that there was roughly a one-third chance of a rate cut that clearly did not materialise.

Go forward a few hours, the AUD has fallen to 1.0370; the 3 year bond yield is lower at 3.45% and the market is now pricing in a 3.46% cash rate one year from now.

It’s almost as if a rate cut was delivered!

So pity the poor traders who got it “right” with no rate cut from the RBA… while the others, positioning for a cut are crying all the way tot he bank.

No wonder there some sour grapes coming from the joyless commentators who misread the markets and the RBA assessment of conditons that rates would be cut soon, if not today.

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3
Apr
2012

Yet More Economic News to Jolt the RBA

Two more bits of economic news today – two more reasons to look at the recent RBA action with incredulity.

The Performance of Services Index registered a reading of 47.0 points in March, up a tiny 0.3 points from February.  A reading below 50 means the sector is contracting and for 5 straight months now, this index has been below 50.

The international trade data showed a second straight deficit on the balance of goods and services as exports crashed and imports levels were only slightly down.

Since August 2011, the value of exports has fallen a whopping 13% and the trade balance has gone from surpluses of around $2 billion, to deficits of around $0.5 billion.  Some of this is due to a weak world economy (memo RBA – this is one of the mechanisms by which Australia is being impacted from the Eurozone recession and the deceleration in growth in China) and some from the strong and over-valued Australian dollar.

Now there is not much policy makers can do about the world economy – it’s a given.  And there is only a partial influence on the AUD from policy makers in the world of a freely floating exchange rate, but one mechanism that drives the Aussie dollar is interest rates.  And as we all know now, Australia’s interest rates have been locked in by the RBA at a rate miles above those in most other countries.

This is honey to the high yield investor bees.

It’s one reason why around a staggering, mind numbing, 80% of the government bond market is held by foreigners – the yield is so very high.  When these foreigners bought the $160 billion or so of bonds, they bought the AUD driving it higher.

A lot is still to be written and discussed about the RBA actions since the start of 2012, but with each installment of news, the words are getting less kind.

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2
Apr
2012

RBA Statement In Blue and Red

What I have done is highlight in blue to strong news in the RBA Statement, while red highlights the weak news.

Why on it didn’t cut today is anyone’s guess.

The RBA Statement:

At its meeting today, the Board decided to leave the cash rate unchanged at 4.25 per cent.

Recent information is consistent with the expectation that the world economy will grow at a below-trend pace this year, but does not suggest that a deep downturn is occurring. Several countries in Europe will record very weak outcomes, but the US economy is continuing a moderate expansion. Growth in China has moderated, as was intended, and is likely to remain at a more measured and sustainable pace in the future. Conditions around other parts of Asia softened in 2011, partly due to natural disasters, but are not showing signs of further deterioration. Some moderation in inflation has allowed policymakers in the region to ease monetary policies somewhat. Commodity prices declined for a few months last year and are noticeably off their peaks, but have been relatively stable for a while now, at quite high levels.  Australia’s terms of trade have peaked, though they remain high. 

Financial market sentiment has generally continued to improve in recent weeks and capital markets are supplying funding to corporations and well-rated banks. At the margin, wholesale funding costs are tending to decline, though they remain higher, relative to benchmark rates, than in mid 2011. But the task of putting European banks and sovereigns onto a sound footing for the longer term remains large and Europe will remain a potential source of adverse shocks for some time yet.

In Australia, growth in domestic demand ran at its fastest for four years in 2011, driven by private spending. Nonetheless the balance of recent information suggests that output growth was somewhat below trend over the year. There are differences in performance between sectors, and considerable structural change is occurring. Labour market conditions softened during 2011, though the rate of unemployment has been little changed for some time.

Interest rates for borrowers remain close to their medium-term average. Credit growth remains modest. Housing prices have shown some signs of stabilising recently, after having declined for most of 2011, but generally the housing market remains soft. The exchange rate has remained high over recent months, even though the terms of trade have declined somewhat.

In underlying terms, inflation was around 2½ per cent in 2011. CPI inflation was higher than that but will fall over the next quarter or two. It is currently expected that inflation will be in the 2–3 per cent range over the coming one to two years. This forecast abstracts from the effects of the carbon price and also embodies an assumption that productivity growth in the economy increases somewhat as a result of the structural change now occurring. At its next meeting, the Board will have the opportunity to reassess the outlook for inflation, taking into account not only data on demand and output but also forthcoming information on prices.

The Board eased monetary policy late in 2011. Since then, its judgement has been that, with growth expected to be close to trend, inflation close to target and lending rates close to average, the setting of monetary policy was appropriate. The Board’s view was also that, were demand conditions to weaken materially, the inflation outlook would provide scope for easier monetary policy. At today’s meeting, the Board judged the pace of output growth to be somewhat lower than earlier estimated, but also thought it prudent to see forthcoming key data on prices to reassess its outlook for inflation, before considering a further step to ease monetary policy.

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