–  DECEMBER 2019 INSIGHTS BY THE CURVE TEAM –

Highlights

  • The RBA left the cash rate on hold at 0.75% in November as was widely expected.
  • Markets have priced in another interest rate cut for May next year where last month it was considered closer to a 50/50. 
  • Despite the RBA’s best efforts to remain optimistic about the outlook, data for the retail and consumer segments of the economy remain weak.
  • Risks remain skewed to the downside.

Rates Recap

  • After three rate cuts in 7 months, the RBA left the cash rate unchanged at their December meeting as was widely expected .
  • The RBA continues to hold an easing bias as risks, both locally and globally, remain skewed to the downside.
  • The RBA’s rhetoric is optimistic with another mention of a “gentle turning point” showing up in their statements.
  • A thawing of geopolitical tensions, with US-China trade negotiations and Brexit approaching resolutions, has seen a more ebullient mood permeate through global markets.
  • A run of soft local data has seen the recent positive shift in sentiment retrace and bonds rally.
  • While the cash rate remained unchanged over the past month, both the 3yr and 5yr swap have given up 14bps of yield.
  • We have seen similar moves overseas, with the US 2 year yield losing 5bps while the 10 year has declined 10bps.
  • For these moves to be reversed, we will need to see follow through on the progress made on the geopolitical issues followed by positive data.

RBA Assessing All Options

The RBA left rates on hold this month, meaning the 0.75% cash rate will remain until February. Whilst the RBA board meeting this month passed without much fanfare, the main update to the outlook for monetary policy came during speeches by Governor Lowe and Deputy Governor Debelle.

The speeches highlighted two major themes in current monetary policy. The first, that the board faces changes in relation to stimulating the consumer economy and wages. The second being the possibility of the Board implementing monetary policy tools yet to be seen in this country.

Addressing the first, the Australian economy is operating at two very different speeds. The trade balance was strong and in surplus once again, despite being lower than recent months. Data for net exports as a component of GDP was sound, as was government spending. The weakness in the economy is in the household sector, as tax cuts and lower interest rates have allowed households to save more and lower their debt, which has left spending in the doldrums.

There is an element of contradiction presented here. Traditionally, a lift in the rate of savings and reduction in debt are positive things for the economy. Over the medium term the add to financial stability of the household and by extrapolation the wider economy. So it begs the questions that if over the medium term there are upside risks to household balance sheet stability then why aren’t consumers choosing to spend? This is the question the RBA is battling with and the answer appears to lie in the speech by Guy Debelle the morning of Governor Lowe.

Wage growth in Australia is low and in decline, even the RBA expects low levels of growth in nominal wages, as Deputy Governor Debelle stated in his speech:

“the strong employment outcomes in recent years has not generated the pick-up in wages growth that might otherwise have occurred. At the same time, I have highlighted the increased prevalence of wages growth in the 2s across the economy. A gradual lift in wages growth would be a welcome development for the workforce and the economy. It is also needed for inflation to be sustainably within the 2–3 per cent target range.

If nominal wage growth is around 2 and inflation is taking several years to return to the target 2-3% band, then any real wage growth isn’t on the horizon. Meaning a significant uplift in disposable income that consumers would need to increase spending are unlikely in the immediate short term, given the current climate.

This then leads to the second theme of monetary policy for the month- what tools not being used currently could be used by the Reserve to address this. Governor Lowe in his November 26 speech went into great detail outlining the options available to the board should the economy continue to soften and ‘unconventional policy tools’ be required. Continuing from analysis he conducted during his tenure at the Bank of International Settlements, he outlined the four policy tools available other than changing the cash rate. These were:

  • Negative interest rates
  • Extended liquidity operations
  • Asset purchases – quantitative easing (QE)
  • Forward guidance

All of these options have been used elsewhere in the world on occasion and it can be argued the RBA already engages in Forward Guidance and Liquidity Operations. The two items of great debate are negative rates and QE programs.

If consumer spending is the current drag on the economy, QE would be the most likely tool to address this. Negative rates have had their likelihood in Australian made virtually zero, as Governor Lowe described negative rates as ‘extraordinarily unlikely’. We will take that at face value. That leaves only QE programs, namely the Reserve Bank buying government or semi-government securities. The question still remains how does this translate into stimulating positive consumer behaviour. There is a dissenting view that it simply does not. There is no reason to think that a further reduction in interest rates wouldn’t see the savings rate continue to rise and debt levels reduced further. It seems the only way to stimulate wages and drive an increase in disposable income for spending is through structural changes to the economy that increase productivity. These items are well outside the realm of control of the RBA, so for now, the board will simply do what they can.

However, as recently as today when Governor Lowe was quizzed about recent GDP figures, he reiterated that the effects on recent monetary policy changes have long variables lags so the economy needs to be patient and wait to see the evidence of their previous cuts to filter through the economy.

Outlook for Interest Rates

The RBA suggesting we are at a “gentle turning point” does not reconcile with recent data. This recent data has led to current pricing anticipating a fall in the cash rate by a further 25bps in May and hitting a terminal point or bottom by the end of 2021, with an implied cash rate of  0.36. This is still above the current threshold the RBA have set for themselves before further unconventional policy measures would be employed.

Current rhetoric by the RBA has 2 further cuts required before they would consider implementation of asset purchase programs. Governor Lowe was clear on this point:

“Our current thinking is that QE becomes an option to be considered at a cash rate of 0.25 per cent, but not before that…. My fifth, and final point is that the threshold for undertaking QE in Australia has not been reached, and I don’t expect it to be reached in the near future.”

 Again, that must be taken on face value. As Lowe described in his speech forward guidance is a policy tool in itself, the statement above is a simple example of this.

Cuts to the cash rate over recent months have changed consumer sentiment and behaviour. Households have chosen to pay down their mortgage and save a higher percentage of their income. Rate cuts are seemingly being perceived as signals of deterioration, so these are seen as the prudent things to do to stabilise the household balance sheet for headwinds to come. A further reduction in the cash rate or implementation of QE would likely continue this effect.

The alternate case must be considered though. The RBA have stated on multiple occasions we are at a “gentle turning point” . With no meeting in January there is now two months for the effect of recent rate and tax cuts to continue to filter though the economy. There is a non-zero chance that spending in recent sales events and over the Christmas holiday period could have a positive effect on the economy and we might finally see their “long and variable lags” come to fruition.

Australian Economic Highlights

  • Growth was below estimates in Q3, with the economy only growing by 0.4% as the weakness from the second quarter continued. The annual pace of growth remained low at 1.7% and is likely to undershoot the RBA’s estimate this quarter.  

  • Inflation pressures remains weak in Q3, with both headline and core inflation printing in line with expectations. The headline index was up 0.5% which saw the annual rate edge up to 1.7%, while the trimmed mean was up 0.4%, leaving the annual rate unchanged at 1.6%. Both were in line with the RBA’s forecasts.

  • Employment data was above estimates in October, with a loss of 19,000 jobs over the month. The unemployment rate lifted slightly to 5.3% with the participation rate eased back 0.1% to 66.0%. 

  • In a continuation of its recent slide, the ANZ job ads fell a further 1.7% in November. It continues the recent trend of softening job ads that are now down 15% since their May 2018 Peak..

  • Business confidence returned to 0 in November, losing the 2 points gained in October. Business conditions remained flat at 4 points for November. The crucial Employment index also remained steady at 4 points for the month.

  • Consumer confidence rose in November and defied its recent run of soft prints. The index posted a 97.0 reading, which was a 4.5% rise over the October low. This year, every month where a rate cut occurred there has been a drop in confidence, followed by a bounce the next month.

  • Retail sales had another poor quarter in Q3 with total retail volumes falling for the third time in the past 4 quarters to be down over the past 12 months. It is the first time retail sales volumes have gone backwards since the 1990s recession.
  • After a mixed run of data, housing finance was slightly up in October. The value of new credit to owner occupier’s continue to rise but by a reduced rate, printing at 0.4% for the month resulting in the smallest annual change since 2014. Growth in outstanding credit continues to slow as mortgage holders continue to repay their loans quicker thanks to interest rate cuts.

  • Australia continues to post robust trade surplus’s, chalking up another $4.5bn in October. Despite a relatively high surplus, this represented the smallest surplus since December. The declines were largely centred on reductions of commodity exports, which are rescinding from recent highs.

  • Building approvals resumed the recent downtrend with a 7.0% decline in October. Despite the bounce they are still down 19% over the year and almost 50% from their peak.

Matthew Dunshea

Client Relationship Manager