August 2019 (Rate Decision & Analysis)
The RBA left Official Cash rates unchanged at 1.00% at its meeting today.
Over the course of the last week, markets have been pricing in the prospect of the cut to an even money bet. So the broader RBA comments will be interesting this month given the easing bias currently in vogue.
The discussion has remained around given the recent two cuts a chance to work. In that context it was interesting to see that RBA Governor Lowe forecast that we should “expect an extended period of low interest rates”. The focus remains too on the level of inflation, we can expect cuts in the future if inflation targets of 2-3% range are not achieved.
With the RBA focus on inflation, recent data from the ABS and analysis by Fidelity International was interesting. Their investigation tracked price movements in sub-categories in the consumer price index (“CPI”) since 2000 as shown below:
Official CPI has gone up 57 per cent in this near 20 year period. In the context of the RBA’s wants, on an average basis it is within its specified target range.
The challenge is the allocation of prices, or “needs” and wants” as Fidelity International puts it. Most of the need items have increased well above CPI – secondary & tertiary education, healthcare, childcare etc. This has obviously put huge pressure on households, as whilst wage growth has exceeded CPI over the same period, there is a greater concentration of spending to the expensive needs categories.
This in part explains the challenge for our retail economy, with consumers looking to access “wants” cheaper and more efficiently that before. Organisations or Governments that replicate innovation that drives more cost effective “needs” accessibility will be the winners in the long term.
In part too, this explains that despite the record low interest rates, we are seeing mortgage arrears trend up slightly as well.
Last month, we discussed the stakeholders urging the use of cheap debt to fund large infrastructure programs. This month, the ratings agencies bit back and highlighted the need for balance. S&P Global Ratings is one that has urged the Federal Government to maintain its AAA credit rating. Whilst acknowledging that this would be at the expense of injecting fiscal stimulus into the economy.
We talked about the political challenge for Federal Government, with the promise of returning the Budget to surplus. However, with monetary policy easing no longer a material option, an economic shock or two will test that resolve.
A key success factor for Government to get return on investment whilst at the same time giving the stimulus that the economy will need. Spending for the sake of fuelling the economy in the short term (remember the $40 Billion largely wasted on Schools and Recreation post GFC?) won’t cut it.
The country needs it best minds on any fiscal stimulus, with infrastructure spending that yields a return at its heart. Hopefully the politics can take a back seat in this regard.
Another new low for market rates as we show below.
|Cash Rate||180 Day Rate||10 Year Bond|
The bench-marked and traded 3 Year Swap Rate now well below 1.00%, with the 5 year heading that way too.
What does this all mean? Judging by markets they have taken on Governor Lowe’s comments. The current Swap rates indicate that the cash rate will sit not higher than 1.0% over the next 5 years.
This is more evidence that this yield environment is generational. When the next tightening cycle eventually starts again, there will be have to lots of warnings about the “tough old days” of 5 or 6%. Sorry Baby Boomers, your old stories of 17% will be well and truly archived.
Against this weak stories of the economy, the ANZ-Roy Morgan Consumer Confidence Index remains up over its long term average. More evidence again that the interest rate story is also a global one.
The Property sentiment continues its optimistic outlook. Melbourne alone had a great last weekend, with a clearance rate at over 75% albeit from smaller volumes.
As the data from CoreLogic below shows us, Sydney and Melbourne are back in positive territory over the past two months. The 0.2% lift in Brisbane was the first consecutive rise since November last year too and there is some momentum there. Anecdotally, there is interest in a range of property categories as yields in other asset categories continue to dwindle.
Perhaps the lag trend to Regional areas is softening too.
As the CoreLogic data shows further below, it will be interesting to follow values whether the improvement is sustained. In rolling the data forward, an improvement will show up in the 12 month changes which should start to diverge away from the “since peak” results.
After a stable period, Australia’s currency fell against the U.S. Dollar. This was in part driven by the RBA’s focus on low interest rates. At some point, the fundamentals said that it will have to have a material impact on our dollar.
Right now, we are at levels not seen since the GFC. For those in the market wanting favourable currency conditions, now is your time to shine. Conversely, there are always losers and higher input costs from a weaker dollar might find its way into some price increases.
July 2019 (Rate Decision & Analysis)
For the second month in a row, the RBA dropped official Cash rates by 0.25% to 1.00% at its meeting today.
Markets had been pricing in the strong prospect of the cut to another record low. I am beyond looking at the economic history books for guidance.
The headline discussion has remained around local issues, such as progress in reducing unemployment and progress towards growth and the inflation targets. However, global influences are dominating the thinking right now.
Our exchange rate is one, with the RBA wanting to avoid any upward pressure on our dollar. This is especially challenging with most central banks easing interest rates worldwide. In other words, you don’t get the bang for your buck in terms of stimulus when competing with other countries too.
As RBA Governor Dr Lowe reminds us, “we trade with each other, not Mars”.
One of the beneficiaries of these low rates is Government, with States going into debt to fund large infrastructure programs. The RBA in fact has been very vocal in the opportunity to take advantage of cheap rates to fund infrastructure projects, adding that monetary policy is losing its bite (no surprises there).
This may however be a political challenge for Federal Government, balance cheap money with the promise of returning the Budget to surplus.
Again, we will see how banks react. There has been a flurry of activity with lenders after last month, and some have already played their hand with balancing out their fixed and variable interest rate offers.
These low cash rates put pressure on bank margins, they will need to balance the political pressure and their need to protect profits which have been sliding over the last year.
If I said last month rates were low it certainly wasn’t the bottom as we show below.
|Cash Rate||180 Day Rate||10 Year Bond|
In an era of surprises, we even saw the commonly bench-marked and traded 3 Year Swap Rate below 1.00%.
Australia is obviously not alone in terms of money markets with bond yields collapsing across all established markets. This of course has many economists concerned about what lies ahead, especially with growth slowing in China.
There are however more signs that this yield environment is approaching generational proportions. Take a strong economy such as Austria. Following demand from a few years ago, they have just released a 100 year bond with a fixed coupon of 1.10%! For many investors, this at least provides certainty especially if you compare this to Germany’s -0.25% return on a 10 year bond.
In terms of spending on infrastructure, State Governments in Australia could look to China. The graph below (Courtesy RBA) shows that their local government bond market has grown rapidly, overtaking the US in recent years. It is now the largest municipal bond market in the world.
The central Government is still strongly supporting this program, though there are signs that the infrastructure pipeline could be slowing down. This is what builds uncertainty to China’s partners around the world.
Australia’s currency is still soft against the U.S. Dollar, but stabilising. It is down just over 5% over the last year. This was probably less than I had expected, especially given the historic position of our interest rates – well below the U.S.
Strong commodity prices and our narrow current account deficit have offset the imbalance in interest rates, and with the Fed’s next move likely to be down, this could put some upward momentum into our dollar. As always with currency positioning, this suits some and not others.
The Property sentiment continues its optimistic outlook.
Clearance rates are not always the most relative statistic, though they are a barometer of activity and the CoreLogic data continues to show an improvement.
Again, anecdotally, we have seen more demand and stronger results in many instances for vendors.
The Melbourne and Sydney markets in particular are showing signs of life.
June 2019 (Rate Decision & Analysis)
For the first time since August 2016, The RBA dropped official interest rates by 0.25% at its meeting today.
In the end this was not a surprise to many, with the market pricing in the strong prospect of the a 0.25% (25 basis points) cut to the official cash rate.
The discussion has been centred around muted growth and business investment, household consumption and inflation numbers. More broadly, as we outline in Money Markets below, the official cash rate is now more relevant as market interest rates have already fallen down around them in anticipation.
This was against a post election burst in positive energy reflected in a stronger share market.
Now the fun begins as we see how banks will react. Mortgage holders may have to temper their expectations, as we do not expect that lenders (ones that are competitive currently at least) to pass on the full amount of the cut.
Alternatively, many lenders have led with fixed interest rate offers as the lever for sharper rates. In a low interest rate environment, this may be a trend that continues in the medium term much like overseas.
The yield curve in Australia was technically inverted as the table shows. However, we have had to create history to drive that – with the 180 Day Market Rate at it lowest ever point in recorded history.
|Cash Rate||180 Day Rate||10 Year Bond|
It did get me looking at the history books which took me to a time in 1974 when the short term was actually over 21%.
The current rates are almost unimaginable if you, like me, studied any traditional economic theory. If a futurist had told me we would have rates at this level in 2019, I would have imagined an unprecedented level of economic carnage.
The risk to our economy moving forward is that we do not have the lever of monetary policy. This was a fear always shared by the traditional economists but there has been a chorus of support from many business leaders too.
We are at an interesting in the financial cycle. The graph below (Courtesy ANZ Research) shows the gap between the Cash Rate and the 10 Year Bond Rate over the last 30 years. The 10 Year Bond is now at the lowest level in history. Traditionally, this would suggest that the outlook for the economy is negative.
There is certainly precedent for this as we look back in history, though I am not convinced this time. The paradigm for interest rate policy is different worldwide, with central banks much more proactive in using monetary policy as a tool to manage economic health.
We must also consider the debt bubble fear, with many countries feeling that they cannot increase interest rates at present regardless of the other economic variables.
A big reason that gives the RBA to lead such low rates is the relative health of the Australian dollar. The dollar’s strength is supported by the robust commodity prices and our rapidly falling current account deficit. This narrow deficit means that we are less exposed to the traditional currency weakness that is associated with low interest rates.
In other words, we are almost able to fund ourselves.
Property is out of the political spotlight (amazing how fast we move on) and anecdotally the sentiment is up. The last month’s worth of data below obviously include pre-election figures – so the following month will provide some insights.
A guide of post election activity is via the latest auction clearance rates. The last week saw Melbourne continue to be above 60%, whilst Sydney clearance rates broke the 60% mark for the first time in a long time.
The updated Corelogic data shows a slowing correction.
With some early signs of confidence returning – it is timely to look at more Corelogic data to put a marker of longer term trends.
Dwelling values have fallen by 8.2% from their peak, and the stark results in Perth, Darwin and parts of Regional Queensland are important reminders that property can be volatile.
We have commented previously about the lag rise in many Regional areas, but it is also worth reflecting that over a five (5) year period they haven’t out-performed capital cities.
The next three months of so of data across the entire economy will be worth a look.