Curve Monthly Insights.
- The RBA left the cash rate on hold in April at 2.00% despite some uncertainty around the outlook for interest rates.
- RBA Governor Stevens didn’t mince words when discussing the AUD in his accompanying statement.
- The FOMC eased its stance further on its interest rate normalisation aspirations.
- Despite a steady cash rate, overall monetary conditions have tightened, putting pressure on the RBA.
- Despite steadily growing expectations, the RBA left the cash rate on hold at 2.00% in April.
- The major shift in Governor Glenn Stevens accompanying statement was around the appreciation of the AUD over the past month.
- While the AUD is only one element that contributes to the overall setting of monetary policy, an unwarranted rise in the value of the currency would not be welcomed by the RBA.
- The appreciation of the AUD has seen the market move to price in a greater probability of a rate cut from the RBA which has seen the AUD yield curve flatten as a result.
- The fact the FOMC continues to slowly adjust the pace of their interest rate normalisation aspirations has pushed the USD down, putting further upward pressure on the AUD.
- Interest rates in the US have reacted accordingly with the entire interest rate curve in the US falling over the month. Equities, however continue to defy gravity as the free money gravy train continues to flow.
Since cutting through the noise last month, we have seen a little more clarity over the past month. There has been more stability in market price action relative to what we became accustomed to earlier in the year and some broader trends are being reinforced in the data. The problem is that the clarity is reinforcing the longer term trend of underlying weakness in the global economy. There are also growing signs the local economy, after faring better than expecting in Q4 last year, is losing some momentum.
What is clear globally is that Central Banks will continue to do all it takes to restore sustainable growth. The ECB has once again said it will do all it can to support growth while the FOMC is slowly backing away from their interest rate normalisation aspirations. Negative rates are also becoming the norm. The Bank of Japan joined the ECB and many of the non-EU European central banks in taking rates negative. While it has an initial benefit of weakening the currency, it wasn’t sustained with the Yen continuing to firm against the USD.
The FOMC’s more dovish stance is the most important development over the past month as it has implications for our own setting of monetary policy. The FOMC has made it pretty clear, as we pointed out throughout the last month, that they want to avoid hitting the brakes too early. They would rather allow the economy to get up a greater head of steam as the problem with going too early is, they run the risk of undoing all the hard work and have limited fire power to get it going again.
Shifting expectations on the trajectory of the US cash rate has seen bonds rally, driving yields lower and the USD has come under pressure. The weakness in the USD has been more apparent than in the appreciation of the AUD over the past month. At one point the AUD was almost 9 cents off its recent low, trading briefly above 0.77. This has caused some angst at the RBA with Stevens not mincing words in his accompanying statement following the RBA’s April meeting.
The local data over the past would also be weighing on the RBA’s mind. Retail sales were unchanged for the second time in the past three months, with January’s growth of 0.3% the only sign of life since November last year. The trade balance has remained in excess of $3billion for the 5th straight month even after an improvement in export receipts for commodities on higher volumes. The most important trend though, has been the weakness in the employment statistics over the past three months. After a robust 2015, employment growth from December through to February has been non-existent.
The rise in the AUD and the evolving trajectory of the domestic economy is giving the RBA plenty to think about.
Outlook for Interest Rates
The interest rate environment in Australia continued to evolve over the past month. Overall monetary conditions continued to tighten over the month despite the RBA leaving the cash rate on hold. Ongoing funding pressures that have been evident in recent debt market deals has resulted in further repricing of lending across a number of borrowing categories. This most recent round of re-pricing has largely gone under the radar as it has been focused on business and investor lending. One large regional bank did announce a substantial increase to owner occupier loans, a category that the majors has refrained from targeting just yet.
The appreciating AUD has also contributed to tighter monetary conditions, a fact that drew particular comment from Glen Steven in his accompanying statement to the decision to leave the cash rate on hold earlier in the month. Steven’s didn’t mince words when it came to the AUD, saying:
“The Australian dollar has appreciated somewhat recently. In part, this reflects some increase in commodity prices, but monetary developments elsewhere in the world have also played a role. Under present circumstances, an appreciating exchange rate could complicate the adjustment under way in the economy”.
This is the RBA’s way of saying “should the AUD threaten the rebalancing of the economy, we will need to act”. Since the meeting the AUD has pulled back a touch and is sitting 2 cents below its recent high. It is clear the RBA thinks the AUD should be lower and would prefer that to be the case. However in isolation, the AUD would need to have a sustained run higher to trigger any response.
As for the overall setting of monetary policy, the AUD can’t be viewed in isolation. When taking into consideration the higher AUD, increased interest rates for borrowers and a deterioration in recent data releases, it is easy to see why the markets expectations for an interest rate cut has become more aggressive. The market now has an interest rate cut fully priced in for late this year with a 1 in 3 chance of a follow up move early next year. The risks are certainly skewed to the downside but I think it is still too early to say a cut is a done deal.
While funding pressures have increased, they have stabilised more recently at their higher levels. The AUD has also stopped rising for the time being and while the FOMC will not be normalising the rates at the pace they first envisaged, another hike is still likely later this year. This should help limit the upside pressures on the AUD. The recent deterioration in the data is a bit of a worry but it would take a more significant deterioration to cause concern. So the base case is the cash rate is still on hold for the foreseeable future; however, the risk of a cut is increasing.
Appendix: Australian Economic Highlights
- Growth managed to beat expectations in Q4 with GDP rising by 0.6%, down from 1.1% in Q3 with the annual rate firming from a revised 2.7% to 3.0%. Household consumption was 0.8% higher over the quarter, accounting for two thirds of total growth as the services sector continues to do the heavy lifting for the economy.
- CPI increased by 0.4% in Q4, which was just above expectations of a 0.3% rise. The increase saw the annual rate edge higher to 1.7%. The core rate was a little firmer, rising by 0.5%, right on expectations with the annual rate easing to 2.00%.
- The employment data was soft for the third straight month in February. Total employment was up by 300 jobs with a swing towards full time. Despite the weak growth the unemployment eased from 6.0% to 5.8% thanks to a 0.2% fall in the participation rate to 64.9.
- The ANZ job ads remained volatile in March with a small rise of 0.2% failing to offset the sharper 1.2% decline the previous month.
- The NAB business conditions index showed further improvement in March, with profitability and trading conditions once again helping to boost overall conditions. Business confidence also improved despite enduring turbulence in the global outlook and renewed political uncerntainty.
- Consumer confidence continues to struggle to gain momentum with last months bounce short lived with index falling back below the key 100 level in March. Consumer perception of their own finances as well as the long term outlook for the economy weighed on sentiment however near term confidence in the economy improved.
- Much like consumer sentiment, retail sales are struggling for momentum and were unchanged for the second time in three months in February. Retails sales have only grown by 0.3% over the past three months which is not a great sign for broader domestic demand.
- Housing finance improved somewhat in February after heavy declines in the first month of the year. The number of owner-occupier loans was up 1.5% with the value of occupier loans rising 1.7%. Interestingly, investor lending posted a substantial increase of 4.1% which would have caught the eye of the regulators.
- Investor’s outstanding debt also ticked up by the most in 6 months in March according to the RBA’s credit aggregates. Lending to owner occupiers remained steady while business lending increased a touch.
- Australia’s trade deficit continues to be a pain point for the Australian economy. The deficit printed at nearly $3.5bln in February, $1.0bln more than expected. January’s deficit was also revised up from $2.9bln to $3.2bln.
- Building approvals continued to see-saw in February, posting a rise of 3.1% with apartments accounting for all of the gains. Despite the volatility the trend continues to point south with approvals down 9.0% compared to a year ago.
- The growth in motor vehicle sales took a breather in February with total sales declining by 0.1%. The sale of passenger vehicles were actually up 0.8% but it wasn’t enough to offset a decline in SUV and other vehicle sales.