Curve Monthly Insights, September 2015

Curve Monthly Insights

  • The RBA left the cash rate on hold once again in September at 2.00%.
  • Ongoing volatility drew a comment from the RBA in their accompanying statement, however appears undeterred by it so far.
  • Growth in the second quarter disappointed and time is running out for the economy to make the transition away from mining led growth.
  • The market now has a cut fully priced for early next year with a follow up cut a 50/50 chance.

Rates Recap

  • The RBA left the cash rate on hold at 2.00% once again in Screen Shot 2015-09-07 at 1.05.15 pmSeptember as was widely expected.
  • The message from the RBA’s accompanying statement was in line with what they said the previous month. However they did make specific mention of the recent spike in volatility.
  • The RBA didn’t seem too concerned so far with an “in passing” like comment, saying equity markets have been considerably more volatile of late, associated with developments in China, though other financial markets have been relatively stable”.
  • The RBA and the market still expect the FOMC to start normalising interest rates in the coming months with many now expecting them to get underway sooner rather than later.
  • Equity markets have taken the biggest hit so far while the Treasuries have remained well bid keeping yields down even with the prospect of a high cash rate on the near term horizon.

Time for Transition Ticking Away 

The latest growth figures for the Australia economy highlighted it is still struggling to make the transition away from mining led growth. This month’s Curve Monthly Insights marks the fourth consecutive quarter we have reported on the growth statistics and highlighted that this lack of transition is a key risk to the Australian economy.

The latest growth figures showed the economy grew by a meagre 0.2% over the first quarter, with the annual rate slowing Australian Real GDPto 2.0%. A hit to export receipts saw the saviour of growth over previous quarters actually detract from growth leaving a timely boost in government spending to fill the gap and keep the economy in the black for another quarter. Government consumption jumped 2.2% over the quarter to be 4% higher over the year, dwarfing the rise in household final consumption which disappointed with a rise of 0.5% to be up 2.5% over the year.

The big problem the RBA has is that it spent the mining boom years suppressing the traditional drivers of growth such as consumption, services, construction and non-mining investment to make room for the mining boom. There was such demand for resources, particularly labour, that if other sectors were left un-tempered, the RBA would have risked inflation getting out of control. Now the RBA is struggling to re-ignite the animal spirits of those sectors it spent years suppressing, to fill the Australian Current Prices GDPgap being left by mining. One of the big reasons is confidence. While growth is still positive, to many it still feels like things are tough out there. It becomes quite obvious that the economy is weaker than the headline statistics suggest when we take a look at GDP at current prices, meaning that they aren’t adjusted for inflation. This shows that the economy is running even further below average levels than the inflation adjusted figures tell us. The Australia Bureau of Statistics even highlighted that nominal GDP only rose by 1.5% in the 2014-15 financial year, the weakest growth in nominal GDP since 1961-62. Given we live in a nominal world, not an inflation adjusted world, is it any wonder many feel like things are weaker than the numbers are telling us?

Adding to this dilemma is the fact that time is running out for those other traditional drivers of growth to fill the void. While the mining sector slowdown has been underway for some time, the effects have yet to be fully felt. Looking at the latest Capital Expenditure numbers, we can see even though there was a small improvement in the latest expectations for CAPEX for the year ahead, total CScreen Shot 2015-09-07 at 2.05.30 pmAPEX is going to be around 25% lower than it was last year. The gap left is going to be very hard to fill, given to date, other drivers have shown little sign of stepping up to fill the void that is now upon us. The RBA continues to tell us that “the economy is likely to be operating with a degree of spare capacity for some time yet”. The risk is that this degree of spare capacity continues to grow not fall, eventually placing pressure on employment.

Outlook for Interest Rates

So far the RBA has lowered the cash rate to 2.00% in the face of the looming culmination of the mining investment boom, to give other sectors of growth time to wind up and help fill the gap. So far the housing industry has been the main beneficiary of these low rates which has also helped lift construction from very low levels. The impact on other sectors thus far has been much less noticeable. The RBA has also been looking to the AUD to play its role as a natural shock absorber for the national economy, boosting those currency sensitive Australian current interest rate futuressectors as it has declined. Despite remaining stubbornly high for an extended period, the AUD is now trading below 0.70. The RBA hoping that the US Federal Open Market Committee will follow through on its plans to raise their benchmark interest rate in the coming months to place further pressure on the AUD. In turn this is expected to help provide more support for the economy by making the overall setting of monetary policy more accommodative.

With all of the recent volatility, there are questions over whether or not the FOMC will actually follow through with their plans, potentially electing to wait until things calm down before acting. This would put pressure on the RBA to do more which is why the market currently has another rate cut fully priced in for early 2016. There is also around a 50/50 chance that they may have to act again by the middle of next year which could see the cash rate at 1.50%. The base case is however that the FOMC will eventually hike rates, meaning the RBA will be able to sit pat and take more time to assess how the economy is evolving, rather than having to cut rates further. The bigger risk is that the other sectors of growth in the economy fail to fire in time to fill the void left by mining and if the government doesn’t provide more support then the RBA will be forced to act. It certainty is an interesting time in Australia’s economic history as we approach the record for the longest run of economic growth ever, with only 9 quarters to go to claim the title from the Netherlands.


Appendix: Australian Economic Highlights

  • GDP grew by 0.2% in Q2, down from 0.9% in Q1. The annual pace was slower at 2.0% against expectations of 2.2%. Growth in the economy was particularly weak in Q1 with domestic demand only 0.5% for the quarter.
  • CPI increased by 0.7% in Q2, which was just below market expectations of a 0.8% rise. The increase saw the annual rate rise from 1.3% to 1.5% after it was expected to rise to 1.7%. The core rate once again remained more stable, rising by 0.6%, slightly above expectations with the annual rate easing to 2.3%.
  • Volatility continues to plague the employment data however the trend remained unchanged in July. Total employment rose by 38,500, split across both full time and part time jobs. The unemployment rate jumped from a revised 6.1% (previously 6.0%) to 6.3% after the participation rate jumped from 64.8% to 65.1%.
  • Job ads rebounded in August according to the ANZ Job Ads report. Job ads were up 1.0% after a weaker than expected rise of 0.5% the previous month.
  • August threw up a mixed read on Business Confidence and Business Conditions. The NAB Business Conditions index hit its highest level in 6 year, jumping from 6 to 11 while the Business Confidence index continued to decline, falling from 4 to 1.
  • Consumer confidence showed some positive signs in August with the index rising 7.8% to 99.5 with the survey taking place ahead of the most recent spike in market volatility.  The outlook for the economy both here and abroad continues to weigh on confidence with a result below 100 points indicating pessimists still outnumber optimists.
  • The pace of retail sales stumbled in July, posting a fall of 0.1% against expectations of a 0.4% rise. The jump the previous month which was boosted by tax measures announced in the May Federal Budget was revised down slightly to 0.6%.
  • Housing finance bounced back in June with owner occupiers dominating the growth. The number of owner-occupier loans was up 4.4% while the value of occupier loans rose 5.5%. Investor lending was weaker once again with the value of investor loans down by 0.7% over the month.
  • Faster prepayments by mortgagees weighed on the RBA’s credit aggregates. Total outstanding credit recorded growth of 0.4% in June which saw the annual rate of growth slip below 6% for the first time this year.
  • The pace of house price appreciation continued to moderate in Q1, with total capital city prices up 1.6%, short of the 2.0% increase that was expected. The annual pace also fell short of expectations, coming in at 6.9% against 7.4% expected.
  • After blowing out in Q2, Australia’s trade deficit narrowed in the first month of Q3. July’s trade deficit well inside expectations at $2.5bln.
  • Building approvals continue to be plagued by volatility, this time rising by 4.2% in July after a revised fall of 5.2% the previous month. The annual growth was largely unchanged at 13.4%.
  • The weakness in Motor vehicle sales returned in July, falling by 1.3%. Despite the fall, the annual pace of sales remained 3.7% higher than a year ago.

David Flanagan – Director Interest Rate Markets