Australian Markets Weekly

Last Friday saw the third annual pre-Xmas interview of the RBA Governor by the Australian Financial Review. The headlines were: “Governor wants an $A at 75cents” and “RBA pushes back on rates cuts”.


The Governor’s Christmas Message

Last Friday saw the third annual pre-Xmas interview of the RBA Governor by the Australian Financial Review. The headlines were: “Governor wants an $A at 75cents” and “RBA pushes back on rates cuts”. While the message about the $A continues to be that the Bank still wants a significantly lower currency, a full reading of the text suggests an important change by the RBA on the monetary policy front, whereby the Bank is now considering what more it could do to boost confidence and the economy. This is a question that will be examined in the New Year, in light of what the data (and presumably liaison evidence) over the Xmas break say about the momentum of the economy.

We examine the key aspects of the interview in detail below.

This week sees the holiday season begin to set in, in Australia, though not before the government presents its Mid-Year Economic and Fiscal Outlook statement (at 12.30pm today). We won’t cover this in detail, given the results will be released in the next few hours, other than to say that there should be no surprise that the weaker Australian economy and declines in the terms of trade will see the 2014-15 deficit revised substantially higher to around $40b according to this morning’s Australian, the target for a return to surplus in 2017-18 pushed back, and the revised forecasts for the economy outline a slightly higher unemployment rate.

According to the press, some 175 government agencies will be merged or abolished and foreign aid will be further cut to fund new spending initiatives, though appropriately in our view, the government will not seek further cuts to offset the effect on the budget of slower growth and the weaker terms of trade.

Thereafter, there is very little on the data front until early January, though there will be keen interest in reports of how the important Christmas shopping season is progressing for retailers. Most pressing for market pricing for both currencies and interest rates, however, will be near-term developments in global stock markets and oil prices, which again were sharply weaker on Friday night.

Markets appear to be reflecting a combination of much weaker oil prices (mainly on increased supply), though the speed of the moves also appears to be driving risk off behaviour and position liquidation. Lower oil prices are driving bond prices sharply higher as inflationary expectations are pared. Energy stocks are sharply weaker and are a negative for the currencies of significant energy producers such as Australia, but a positive for the JPY. At the same time, risk off behaviour seems to be leading to liquidation of positions in the EUR and equities more generally. It still does not appear that market developments reflect the pricing of sharply weaker economic growth, though there is the risk that to some extent that could become self-fulfilling should equity markets continue to decline sharply. For now, look for the weakness in equities and the $A to continue in the near term.

Some significant changes in RBA thinking

Not as far as the $A is concerned, mind you. The Governor reaffirmed in Friday’s AFR interview that the AUD remains overvalued; that he expects the currency to be lower than current levels in a year’s time; and when probed to nominate a preferred target for the currency, suggested somewhere closer to US$0.75 than US$0.85 seemed more appropriate given the substantial fall in Australian commodity prices and the terms of trade. NAB retains its bullish view of the US$ and bearish view of the $A, targeting an end 2015 level of US$0.78 and an end 2016 level of US$0.75.

The most interesting part of the interview, however, was what seems to be a potential significant change in the Bank’s thinking on the monetary policy front. Reflecting on last year, the Governor noted that he believed the best contribution that the Bank could make to improved confidence in the economy was the message that Australian interest rates would remain stable (at low levels). However, on more than one occasion in this interview, the Governor effectively poses the question, is there something more that the Bank could be doing to boost confidence and through that, economic growth.

The Governor appears to be frustrated by the lack of “animal spirits” in the economy and is the questioning the momentum in the economy at the present time. [Over the last year, however, the Bank has been comfortable with the momentum and transition in the economy that has been occurring]. He concludes that the question is there something more the Bank could be doing to boost confidence will be examined in the New Year (after two more months of data, given there is no Board meeting in January). This data and the full forecasting round after the Q3 national accounts will enable the Bank to update its view on the momentum in the economy. While the Q4 CPI, would ordinarily be seen as a key element of the picture, the confidence revealed in the interview of continuing low inflation due to low wages, suggests this is not a significant element of the policy debate at the present time.
To us, it seems that elements of the Bank’s thinking are similar to that of 1996, when Governor Bernie Fraser’s Board concluded that the inflation outlook permitted the opportunity for the economy to grow a little faster (though it is important to recognise that interest rates are much lower now than they were in 1996). Recent moves by APRA to increase its level of prudential oversight of housing lending presumably assist in this regard also. The statement that Australia is not presently creating jobs as quickly as we want to is another suggestion in the same direction.

So what might the RBA do? There are a number of possible options that seem plausible:

  • Cut interest rates by 25bps in the early months of 2015, to attempt to boost confidence and strengthen momentum in the economy.  With confidence building that the Fed will also move to raise US rates in the next six to nine months, this may also help the Bank achieve the lower $A it is seeking;
  • Change the language surrounding the period of stability in interest rates, to something suggesting the Bank stands ready to lower rates to support confidence should momentum in the economy not develop sufficiently (or wane) in the near term;
  • Strengthen the language around the period of stability to quantify the period of stability e.g. on present indications, the Board considers that interest rates are likely to be unchanged for the next 12 months (or a variant of such e.g. will not rise for the next 12 months or will be stable or fall over the next 12 months).

In the face of no dramatic change in the Australian economy in recent months, it would seem a stretch for the RBA to move directly from the period of stability in rates guidance repeated at the December Board meeting to a rate cut at the February meeting, though historically it has been a mistake to finesse the timing of RBA moves, when there is a case for a change.

At this stage, NAB’s expectation is that the Bank will change its language at the February Board meeting before cutting rates by 25bps at the March meeting, though it will be important to monitor trends in the data over the coming two months and especially the NAB business survey result at the end of January.

The discussion by the Governor in this interview seemed mainly concerned with seeking to boost confidence, which might suggest a solitary and unusual fine-tuning monetary policy move. It did not seem to consider that the further fall in the terms of trade, may drive a more significant further down cycle in Australian interest rates. A couple of reasons for not worrying about such a development are the Governor’s view that;

  • the US economy is clearly strengthening; and
  • lower oil prices are generally good for global growth (though not for commodity producers).

November labour force data released last week, in broad terms, continue to suggest a relatively soft labour market in Australia, subject to the ongoing caveat, that it is hard to place too much reliance on these figures at the present time given the Statistician’s problems with the survey in recent months. A significantly stronger-than-expected 42,700 new jobs were created in November, unwinding some of what looked like a modest understatement of jobs growth in previous months. The strength of this signal however is diminished by the fact that the overwhelming proportion of the increase was in the part-time category, which is the category the ABS has had trouble seasonally adjusting in recent months. The data suggest that all net jobs created in the past six months have been part-time in nature (<35 hours per week). The unemployment rate was effectively unchanged, but rounding saw it rise to a new cycle high of 6.3% from 6.2%. More concerning, hours worked (which feeds into the income estimates of GDP have effectively been unchanged for the past six months). And youth unemployment and underemployment rates (wanting to work more hours but can’t) printed new cycle highs and record highs, respectively.

At face value, then, the data support a picture of a relatively slow labour market, where net new part-time jobs growth is insufficient to offset declining hours worked by full-time workers and where spare capacity exists (and is rising). The former suggests the risk that the economy will continue to experience below trend growth for a longer period of time than previously expected by the RBA, while the latter should reinforce the Bank’s thinking that wages do not present any undue inflation concerns.

The week ahead

After the MYEFO today it’s the RBA Minutes tomorrow – the market will look for any clues to reinforce the perception that the RBA’s thinking is changing. It’s quiet for local data this week.

However, it’s a much bigger data/event week offshore culminating in the FOMC statement Thursday morning Australian time, new Fed economic projections and a Yellen Press conference. Major focus will be on how the Fed finesses its forward guidance with expectations growing that it will drop the reference to how long rates will remain low. Elsewhere, China publishes its HSBC flash PMI (Tue), Euro-zone has manufacturing flash PMIs (Tue), along with the German ZEW (Tue) and IFO surveys (Thu). New Zealand prints Q3 GDP on Thursday.

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