5
May
2012

Mr Hockey – The bet is ON!

 

Despite Mr Hockey offering to bet “the contents of his pocket” that the Budget will not contain “genuine savings”, the Shadow Treasurer has rejected my willingness to take the other side of the bet.

Here is my desire to take up Mr Hockey’s offer for a bet: http://www.marketeconomics.com.au/1917-mr-hockeys-offers-up-a-bet-but-will-he-follow-through

Mr Hockey’s squibbing on the matter is probably because he knows there will in fact be “genuine savings”.

Mr Hockey is not willing to bet that there will be a cut in real government spending in 2012-13, something that neither the Howard or Fraser governments ever achieved in 20 Budgets.  He knows there will be a cut in real Government spending in 2012-13.

Mr Hockey is not willing to look at the matter another way – taking the government spending to GDP ratio to a level below the average of the 12 Howard Government Budgets.  He knows the government spending to GDP ratio will be around 0.5% of GDP below the average delivered by the Howard Government.

To most, these would seem to be reasonable criteria by which to assess “genuine savings”.  Mr Hockey would prefer another way.

In rejecting the bet on either real cuts in spending or a lower spending to GDP ratio, Mr Hockey twittered:

Joe Hockey ‏ ‪@JoeHockey

  • @TheKouk reducing expenditure to level of forecast revenue…let’s take the table at back of Budget Papers re % of GDP. Ps well done on 50BP

Just to repeat:  Mr Hockey has set the criteria to be “reducing expenditure to the level of forecast revenue”.

Mr Hockey is framing the bet, it seems, in terms of whether there will either be a surplus or not:  That is if expenditure is reduced to the level of revenue, then the Budget is in balance and yet lower expenditure than revenue means a budget surplus.

Even though this is another squibb as a return to surplus is not necessarily a question of whether or not their are “genuine savings”, I will take up the challenge from Mr Hockey.

That said, if the Budget does not return to surplus due to a global double dip recession, for example, hitting revenue, this has nothing to with “genuine savings” in the Budget.  This is why I think Mr Hockey has defined hit bet the way he has.

Either way, BET TAKEN MR HOCKEY!

If the government does not deliver a surplus in 2012-13 in underlying cash terms, I will donate $500 to Beyond Blue.  It if does deliver a surplus, Mr Hockey, you can make a donation to your favourite charity.

Deal?

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3
May
2012

Monetary Policy: View Change

 

Since Tuesday when the RBA delivered the 50 basis point rate cut, there have been a few events to make me rejig my view on where the RBA will move the official cash rate in the months ahead.

There was always going to be downside (rather than upside) risks to my view that the RBA would cut to 3.5% “around the middle of 2012”.  Just a week ago, I thought that view was still valid.

Alas, I suspect it is now wrong and there has been a mix of issues that have emerged in recent times that smell like more rate cuts ahead.  In no real order:

  • It looks like the banks are passing on a bit less than I first thought, not just with the 50 cut this week, but with any further cuts in the months ahead.
  • Even though the Australian dollar is down a bit, it is concerning the after the cut this week it is still near 1.03 after the 50 cut and RBA rhetoric.  Maybe even lower rates are needed to push it lower.
  • The global data flow has probably been a little less favourable than one would hope for.  US leading indicators, Eurozone unemployment, commodity prices.
  • Local “mini”-data on the services sector, manufacturing and daily house prices have all been poor.
  • There is no reason to think that fiscal policy will be anything other than “tight”.  I suppose this is not new, but I reckon fiscal policy might be a little more contractionary than I first thought.

With the 50 basis point cut still reverberating around the economy, it might be premature or even a little koukie to be changing views today.  But having also got a bit of a vibe on the economy and markets in Sydney today, a change of view is in order.

The new view from Market Economics is now for a 25 basis point cut in June, taking the cash rate to 3.50% with a further two 25 point cuts some time in the second half of 2012.  This means the risk are we see a cash rate of 3.0% by year end.

As things stand now, I hope I’m wrong and that we get a near term, meaningful turn in the economy.

If I am not wrong, the turn in the data will require some remedial action from the RBA in the form of a 3.0% cash rate.

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2
May
2012

OMG! The market will be spooked if the RBA cuts 50!

 

UPDATE 2 MAY 2012

Well, the RBA went 50 and guess what?  Bond yields are around 5 to 10 basis points lower across the curve; the stock market is up a touch more than 1% and the Australian dollar is down marginally to be trading at 1.0350.

So much for spooking horses and damaged credibility for the RBA.

The only ones with damaged credibility are the market economists making these noises.

————————————–

FROM 26 APRIL 2012

There are some financial market analysts seemingly railing against a 50 basis point rate cut from the RBA next week.

Such a move, it is opined, will “spook the market”, “damage the RBA’s reputation”, “frighten the horses” and other such terms.  These might be valid and interesting projections.  But no one that I have seen has articulated what this actually means.

Will a 50 basis point cut lead to a stock market crash?  I would judge that it would boost the stock market.

Will a 50 basis point cut cause a bond market problem or threaten Australia’s triple-A credit rating?  My view would be that the yield curve would steep a bit, overall yields would be little changed and that there will be zero impact on the credit rating.

Will a 50 basis point cut cause a crisis in the Australian dollar?  The Australian dollar is currently trading around 1.0350 – having been well range bound around 1.02 to 1.06 for some time now.  A 50 basis point cut might clip a cent (or two at most) off the AUD, but this would hardly be a concern.  Indeed, it might be desirable to see the AUD fall.

Is there any other spookiness in a 50 basis point cut?  The RBA will suffer absolutely no repetitional damage – indeed, its reputation as an inflation targeting central bank might be enhanced given the inflation outlook.

I can’t see any other problems in a 50 point move.  Let me know if you can.

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2
May
2012

Interest Rates and Robert Menzies

 

Getting reliable and strictly comparable data on interest rates before the 1970s is difficult.  It is not clear whether the data available for the 1950s and 1960s are strictly comparable to those prevailing now.

The RBA web site has data for the “overnight Money Market Rate” for June of each year back to 1958-59.   http://www.rba.gov.au/statistics/frequency/occ-paper-8.html

This looks to be an interest rate akin to the overnight cash rate set by the RBA today.  If not, it must be close.

Using those data and splicing them to the more reliable recent data bases, the new 3.75% cash rate set by the RBA is a level never once achieved under Liberal Party Prime Ministers Howard, Fraser, McMahon, Gorton and Holt.

Not once.

The last time the overnight rate was around 3.75% under a Liberal Party Government’s stewardship of the economy was in June 1964.

In June 1964, Robert Menzies was Prime Minister and Joe Hockey wasn’t even born yet.

Just saying.

PS:  All that said, I will be delighted to amend or correct this work if anyone can point me in the direction of a better long run data base for interest rates.  Cheers.

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2
May
2012

Big Picture Policy Trade-Offs: Fiscal & Monetary Policy Head to Head

 

Below are a couple of very stylized scenarios for the economy, policy and markets which look at the end of 2013.  These scenarios are presented to drive home the trade-offs involved in the framing of the Budget, which will be delivered next week, and recent monetary policy decisions of the RBA.

Scenario 1:  Surplus in 2012-13

 

End -2013

GDP Growth

3.25%

Inflation Rate

2.5%

Unemployment Rate

5.25%

 
Budget Balance

Surplus $2 billion

Cash Rate

3.0%

Variable Mortgage Rate

6.5%

Australian dollar

95 cents

 

Scenario 2; Deficit in 2012-13

 

End -2013

GDP Growth

3.25%

Inflation Rate

2.5%

Unemployment Rate

5.25%

 
Budget Balance

Deficit $10 billion

Cash Rate

3.5%

Variable Mortgage Rate

7.0%

Australian dollar

105 cents

Please note that the economic outcomes in both scenarios are the same – a return to trend GDP growth around 3.25%; inflation settled in the middle of the RBA target range and unemployment to remain comfortably low at 5.25%.

Now obviously, the Government is gunning for Scenario 1 or something a lot like it.  Budget surplus, trend growth, low inflation and low unemployment.  Like it or not, that’s it.

Those suggesting that the Government not worry too much about the surplus next year are presumably implying something like Scenario 2.  Fair enough – the economic outcomes, at least in the short run, are the same.

But with an eye to policy soundness and structural issues in the economy over the longer run, a Budget deficit implies an Economics 101 trade off that sees interest rates higher than they would otherwise be and with it, the Australian dollar would probably be skewed higher as well.

This is entirely fair, but is something rarely, if ever, canvassed by those who don’t think a Budget surplus matters.

From a longer run economic management perspective, there is actually some upside from Scenario 1.

In no particular order, the lower interest rate/lower Australian dollar framework reduces the risk of hollowing out the economy or the Dutch disease prevailing when the mining boom ends.  In other words, industries getting in trouble from loss of export competitiveness due to a high currency will have some relief.

In addition, the Government will have lower government debt, the point of which is having policy flexibility when the next “finanical crisis” event unfolds.  They will have more flexibility to prudently ease fiscal policy knowing full well that in doing so, they will not be confronting any threat to sovereign credit assessments which are hurting many high debt countries right now.

Scenario 1 in the current economic mix also makes some additional room for the private sector in general and mining and related industries specifically to growth with less constraints such as skills shortages.

There is of course nothing wrong with those suggesting easier fiscal policy, but they must be asked and must acknowledge the trade off elsewhere from this strategy in the form of higher interest rates and a higher Australian dollar.

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1
May
2012

RBA sees the light and goes 50

 

Low inflation, sub-trend economic growth, global funk and financial market intransigence have seen the RBA cut rates by 50 basis points to 3.75%.

The mis-steps of recent months from the RBA have been completely addressed by the move today and allowing for 40 basis points or so to flow through to mortgage and small business borrowers, there should be some lift in confidence, cash flow and with those, economic activity in the medium term.

The RBA has shown its usual pragmatism, moving to catch up with events and news, acting without fear or favour when it comes to managing inflation pressures in the economy.   Nine point five out of ten for the RBA for not being constrained by the perception that a move of more than 25 would “spook the market” or “set the horses running”.  Well, stocks rose 0.8% today, 10 year government bond yields hit an all time low and the AUD, while it dropped 1 cent, is trading at the same level it was on Friday.  The RBA action was as spooky as Casper the friendly ghost.

The RBA Statement does nothing to cause alarm over the state of the economy.  It was simply a matter where policy needed to move to a more accommodative stance because:

  • “economic conditions have been somewhat weaker than expected, while inflation has moderated.”

The RBA is now likely to be refreshing its forecasts.  It wants to have an outlook that would have a pick up in GDP to 3%+ by the end of 2013 and for inflation to reach something around 2.5% at that time.  Whether it reckons a 3.75% cash rate will get it there remains to be seen, but today’s rate action makes it more likely.

By going 50 basis points now, the RBA is now likely to hold fire in June, although global economic and market events may change this.  That said, it still seems likely that a further tweak lower in the cash rate will be required sometime after that:  Cash to bottom out at 3.5% sometime in the next few months.

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