Curve Monthly Insights, June 2015

 Curve Monthly Insights

  • The RBA decided to leave the cash rate on hold at 2.00%.
  • Despite some signs of improvement in household demand and employment, the RBA is still worried about the outlook for the Australian economy.
  • Confidence still holds the keys to recovery. The Federal Budget was better received than last year’s which should see a further rebound in confidence.

Rates RecapMonthly Market Moves

  • The RBA elected to maintain the cash rate at 2.00%, in line with market expectation
  • In the accompanying statement following the decision, Governor Stevens kept in a soft but patient easing bias
  • The US interest rate curve has started to steepen once again in anticipation of the FOMC getting closer to raising their overnight cash rate in line with their goal to normalise interest rates
  • The market is currently expecting this normalisation to get underway in the second half of 2015. This is very important for Australia as it will have a significant implication for our own setting of monetary policy
  • Further depreciation of the AUD is seen as “likely and necessary”

Australian Economic Highlights

  • GDP grew by 0.9% in Q1, up from 0.5% in Q4. The annual pace was lower at 2.4% against expectations of 2.1%. The result suggests that momentum in the economy remains weak but is buoyed by a lower AUD.
  • CPI increased by 0.2% for the second straight quarter in Q1, which was just above market expectations of a 0.1% rise. The increase saw the annual rate decline further to 1.3% from 1.7% in Q4. The core rate once again remained more stable, rising by 0.6%, slightly above expectations with the annual rate edging higher to 2.40%.
  • After a solid run over the first quarter, the employment data softened in April. Total employment fell by 2,900 with a sharp decline in full time failing to be offset by a rise in part time employment. The unemployment rate edged up to 6.2% after the participation rate remained unchanged at 64.8%.
  • Job Ads rebounded in May according to the ANZ Job Ads report with the result of 2.5% remaining unchanged from April.
  • Business conditions increased in May with the NAB Business Conditions index pushing up to 7 after slumping in April.  Business confidence also increased to 7 along with Conditions.
  • Consumer confidence rose by 6.4% from 96.2 in April to 102.4 in May.  It is the first time since February this year that  the index is above 100 points, which means that optimists outnumber pessimists.
  • The pace of Retail Sales growth eased a touch in May with a 0.2% rise. Growth in the sales for the quarter ex inflation were once again positive, albeit a little slower at 0.7% for Q1 against a rise of 1.5% in Q4 last year.
  • Housing finance was mixed in May with the number of owner-occupier loans up 1.9%. The value of occupier loans also rose 0.5% while the value of investor loans declined by 3.4%.
  • The steady growth in the RBA’s credit aggregates continued in April with lending to investors still growing much faster than owner occupiers. The annual rate declined slightly to 6.1%.
  • The rise in House prices continued to be driven largely by the Sydney housing market, with total capital city prices up 1.9% in Q4, 0.1% above expectations. The annual pace eased from 9.0% to 7.1%.
  • Australia’s trade deficit was more positive than expected at $1,231 million which was narrower than the previous month after March was revised to $1322 million.
  • Building approvals continue to jump around, this time going negative at -4.4% in April against 2.8% in March.
  • Motor vehicle sales remained  buoyant in April, rising 0.7% once revised. The original result was negative at -1.15%

Economy Awaiting Transition

The Australian economy exceeded expectations in the first quarter, producing growth of 0.9% which was better than the most optimistic forecasts. While this is a great overall result, the composition of growth highlights the Australia economy is still to make the transition away from mining led growth. Furthermore, the data to date suggests the road to transition could be a little bumpy over the months ahead. 

The main driver of growth over the first quarter was once again net exports, which accounted for around 55% of total growth with the rise in inventories accounting for a further 33%. The larger than expected trade deficit for April shows this situation cannot last for ever and other elements of growth need to come to the fore in order for the Australian economy to continue its run of more than 2 decades of uninterrupted growth. 

Here in lies the problem, where is the growth going to come from to fill the gap left by mining? (insert capex chart somewhere here, can talk you through it). The latest capex survey shows that the expected decline in mining related activity will accelerate in the coming financial year. The survey also showed capital expenditure plans in other sectors are actually in decline, rather than growth as the RBA had been hoping for given the level of support currently offered up by accommodative monetary policy. Trade Balance Blow Out

With other forms of capex unable to fill the void by mining, consumption and building construction are two other area of growth that are hoped will help fill the void. Consumption appears to have received an immediate boost from the Governments small business tax measures announced in this years budget if anecdotal evidence is anything to go by. However this will only bring forward future demand, similar to the cash handouts during the GFC. Further stimulus will then be required to fill that void down the track. 

The RBA have also stated they do not want an increase in consumption to be driven by debt, so consumption growth will be limited by wage growth and consumers propensity to dip into savings to fund discretionary purchases. Building construction, while currently on the rise and assisting with growth, is still only a small component of growth and will run into its own headwinds over the months ahead. The banks are already being forced by the regulators to discourage investor lending in an effort to cool the housing market. 

CapexThe decline of mining and ongoing uncertainty over what will fill the growth void means overall growth is likely to remain below trend for some time.

Outlook for Interest Rates

Aus IR FuturesFollowing their decision to cut the cash rate in May, the RBA has been reluctant to state an official easing bias in their rhetoric through the various subsequent communiqués we have received. With the cash rate at 2.00%, the RBA seem reluctant to cut the cash rate any further. They would prefer to see the currency extend its decline, resulting in a lower overall setting of monetary policy without having to lower the cash rate.

It is the RBA’s expectation they will be able to achieve this outcome with the help of the US Federal Reserve and the Federal Open Market Committee (FOMC). It is the RBA and broader markets expectation that the FOMC will lift their overnight cash rate up from 0% later this year as they embark on a program designed to normalise their interest rate curve. All other things being equal, this process should also help to lift the USD, thus placing further downward pressure on the AUD. Should all this go as planned, then the RBA will be able to achieve the lower overall setting of monetary policy without having to lower the cash rate further. 

Inherit uncertainty and the fact that much of this move is likely to have been priced in, means the market is still pricing in a strong probability the RBA will have to lower rates at least once more. This will likely be the case until the FOMC finally announces its decision to cuts rates and the AUD does actually begin to fall further. 

Ultimately even if the FOMC does lower rates and the AUD does fall, Australia’s growth profile is going to remain weak for some time. Meaning that even if the cash rate does not fall any further, the current accommodative setting of monetary policy is going to be left in place, until such time as the growth profile improves, or unacceptable levels of inflationary pressure start to build.