MARCH 2017 INSIGHTS BY THE CURVE TEAM –

Highlights

  • The RBA left the cash rate on hold again in March for the seventh straight month, leaving the cash rate at 1.50%.
  • The RBA remains cautiously optimistic, buoyed by the bounce in growth.
  • However the RBA is acutely aware risks to financial stability would be caused by a substantial further increase in debt levels.
  • The data is in and suggests that the FOMC will be hiking rates when they meet later this week.

Rates Recap

  • The RBA left the cash rate on hold for the seventh straight month in February with the cash rate remaining at 1.50%.
  • Governor Lowe and the RBA Board continue to expect growth to pick up and inflation to return to the target band over time.
  • The short end of the curve remains anchored by the cash rate with only small moves in BBSW over the month.
  • The longer end of the curve has steepened significantly with long rates in Australia following the US rates higher.
  • Increasing expectations of a rate hike from the FOMC when they meet later this week has seen Treasuries sell off across the curve, driving yields higher.
  • Another month of supportive data, confirming both the uptick in inflation and the ongoing strength of the employment market gives the FOMC little option but to hike rates again.
  • Despite renewed strength in the USD over the month, the AUD has held up quite well and is only down 1 cent from this time last month.

FOMC Set To Hike

Much like our own central bank, the US Federal Open Market Committee makes its monetary policy decisions based on a dual mandate. In the US, the FOMC is charged with achieving full employment and price stability. The goal of full employment is somewhat subjective as there is no offical measure of full employment while price stability is seen as achieving an annual pace of core inflation ‘around’ 2%.

Many argue that the US employment market is already at full employment, with the unemployment rate falling to 4.7% according to the latest data. If we are at full employment we should be starting to see wage price growth pick up from here. The question is that if wages start to rise, will we see some of the millions of Americans that have left the labour force since the GFC, start to look for work again?

The inflation picture also suggest that the price stability has already been achieved and if not, it is very close. The core inflation rate according to the consumer price index has already risen above the key 2% level. However the FOMC’s preferred measure, the personal consumption expenditure index, is sitting a mere 0.1% below the 2% target.

Based on that data alone, it is easy to draw the conclusion that if the current trend continues, the data will support the current suggested FOMC dot plot path of the Fed Funds Rate, which indicated three tightenings this year. Failure to act could in time also have consequences as noted by Janet Yellen earlier this month who said:

“Our policy aims to support continued growth of the American economy in pursuit of our congressionally mandated objectives. We do that, as I have noted, with an eye always on the risks. To that end, we realise that waiting too long to scale back some of our support could potentially require us to raise rates rapidly sometime down the road, which in turn could risk disrupting financial markets and pushing the economy into recession.”

That statement along with the data builds a very good case for the FOMC to act when they meet later this week. If they do decide to hike later this week, it still gives them ample time to hike twice more, without having to hike too aggressively in the back half of this year.

Outlook for Interest Rates

The RBA once again elected to leave the cash rate unchanged at their March Board meeting and based on the accompanying statement, there has been no change at all to the outlook for monetary policy. The statement saw only minor amendments to the one that was released following the February board meeting and characterises the RBA as cautiously optimistic with an acute awareness of potential risks to financial stability.

While the RBA’s official stance hasn’t changed, the economic backdrop to their outlook continues to evolve. The most noticeable piece of news was the Q4 GDP release that was released the day after the RBA’s board meeting and showed that growth bounced back strongly following the unexpected decline in Q3. The bounce was enough to push the annual rate of growth back above the RBA’s forecasts.

That piece of information alone would suggest a subtle shift in the outlook. However the composition of growth had many suggesting that the magnitude of the bounce would be hard to sustain. The bounce in commodity prices contributed heavily to the outcome, as did a solid increase in consumer spending, both of which are unlikely to be long term substantial contributors to growth.

The bounce in commodity prices is expected to ease over the coming months as Chinese demand easing and additional supply continues to come on line. The pull back could be exasperated if the USD resumes its uptrend should the FOMC hike later in the week and upgrade its outlook. Meanwhile for consumer spending to continued at an elevated level, consumers would either need to continue to run down savings or increase debt, neither or which are sustainable. Alternatively we would need to see a substantial increase in wages.

At the same time, the heat in the housing market is building at a rapid rate. The RBA has acknowledged the potential risk to financial stability that could result if we see a substantial increase in debt levels from and already elevated levels. This has seen calls from some commentators for the RBA to lean against rising house prices grow louder. As the FOMC continues to hike rates, reducing the Australia-US interest rate differential even further, these calls will only grow louder.

For the time being, the RBA will remain in wait and see mode. How overall monetary policy conditions evolve could see the RBA’s stance slowly shift.

Australian Economic Highlights

  • Growth bounced back in Q4 with GDP rising by 1.1% for the quarter. The pick up in growth saw the annual rate of growth rise to 2.4%, ahead of the RBA’s forecasts. The improvement in some sectors could prove unsustainable, casting a cloud over the outlook for growth.
  • CPI was soft again in Q4. Headline inflation was up 0.5%, short of the 0.7% rise that was expected. The quarterly increase was still enough to lift the annual rate from 1.3% to 1.5%. The RBA’s preferred measure, core inflation, just missed expectations, rising by 0.4% which saw the annual remain largely unchanged at 1.5%.
  • The employment data picked up in the new year where it left off, January saw a small beat on expectations with total growth of 13,500. There was once again a big swing towards part time which was up 58,300 while full time employment was down 44,800. The unemployment rate edged back down to 5.7% as the participation rate slipped back to 64.6%.
  • After bouncing back in January, ANZ job ads came under pressure again in February, posting a decline of 0.7%.
  • The NAB survey gave back the previous months bounce in February. The NAB business conditions slid from 16 to 9 driven by a sharp fall in trading conditions (23 to 13) while profitability and the employment index were also down. Business confidence also slid, falling from 10 to 7. Despite the falls, both measures are still above long run averages.
  • Consumer confidence printed below the key 100 level for the third straight month in January as consumers remain cautious on their own finances, especially compared to a year ago even after two rate cuts last year.
  • Retail sales started the year on a more positive note following December’s decline. Sales were up 0.4% for the month, which was in line with expectations.
  • Housing finance bounced back in January thanks to investors after a subdued December. The number of owner-occupier loans were up 0.5%; however, the value of occupier loans was down 0.2%. Investors did the heavy lifting with a huge 4.2% gain in the value of lending.
  • Australia’s trade surplus receded from its record high in December, posting a $1.3bln surplus in January, well short of the $3.8bln surplus that was expected. The trade surplus should bounce back as the weather related impact on exports fades over the coming months.
  •  Building approvals posted a small gain of 1.8% in January; however, it wasn’t enough to offset the revised fall of 2.5% the previous month. Building approvals remain well off their highs suggesting the construction boom is peaking.
  • Motor vehicle sales built on their modest gain in December with a 0.6% increase in January thanks to a 6.3% jump in SUV sales. Despite the increase, sales are still lower than they were 12 months ago.
David Flanagan

David Flanagan

Director: Interest Rate Markets