Australian dollar: Give us a minute!

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Macro Afternoon

Today sees the release of the RBA minutes from this month’s Board meeting and there is a really strong chance that shortly after their release at 11.30 (EDIT previously I wrote 2.30pm) rates are a little higher than where they are this morning.

Yesterday I was talking to an old colleague about the rally in interest rates and he characterised it as a Bill Evans induced rally. That is, he felt that the market had run a little too far on the back of Westpac’s change in their interest rate call last Friday.

I admit I have some sympathy for that view.

The offshore troubles with Europe and the United States are certainly driving the bids in gold and also interest rate markets which has helped to push down Australian yields. But as I write this morning the market has more than 50 basis points of easing already priced in and, absent some sort of equity market meltdown in Asia this morning, is at risk of being stretched in terms of valuation.

How and why can I say that when yesterday’s piece was in sympathy with lower rates? Because, I am talking about traders here and RBA minutes.

While the RBA’s statement earlier this month was quite dovish the question that needs to be asked and answered today is whether or not they will be as dovish as current market pricing. That’s not impossible given the magnitude of the RBA’s turn around since the May Statement on Monetary Policy but markets have deteriorated somewhat in Europe and the US as has the domestic data such as the NAB Business survey and Westpac Consumer confidence.

But the minutes are unlikely to reflect that and may indeed reinforce the reality that whatever the troubles of the domestic economy they are still clinging to their central tendency and worries about the mining boom.  Indeed writing in the Australian today Michael Stutchbury makes this point when he says of Bill’s note,

Yet Evans’s rate cut note hardly mentioned the two related forces that will encourage Stevens to maintain a firm grip on the economy: China’s rapid growth and the biggest mining development boom in Australia’s history.

Amid the gloom, China last week reported that its economy grew at a faster than expected 9.5per cent annual rates in the second quarter. Industrial production soared 15.1 per cent. While our foreign financial news is dominated by the US and Europe, our economy is fuelled more by China.

Australia’s resource exports are forecast to jump 18 per cent this financial year to $256 billion. The top 94 advanced minerals and energy projects plan to spend $173bn on expanding the economy’s resource export base, led by liquefied natural gas, iron ore and coal.

This investment mega-boom is largely baked in, whatever happens in the US or Europe, and is not scheduled to peak unil 2013-14.

That’s true and this theme is still likely to permeate the minutes today.

Stutchbury says that Mining Boom Mark II is remarkable insofar as,

The striking thing about mining boom mark II is that the Reserve Bank so far has not had to increase interest rates much at all. Instead, the floating dollar is doing more of the work to prevent the economy from overheating.

Our readers have known for some time and everyone else now knows that it is household pressure and retrenchment that has forestalled the RBA from having to pump up rates as far as they thought they would have had to. They have clearly been blindsided by the enduring nature of the savings boom and spending drought. We are on record here as saying that we think this trend is not transitory but structural and will be with us for a few years more. So as Bill points out even if rates fall they are unlikely to be overly stimulatory.

Traders have taken Bill’s call and run with it but on the current evidence rates are stretched and aggressively pricing cuts now and are consequently vulnerable to a reversal from a set of minutes that undermine current bullishness.

Market pricing for moves by the RBA prior to Westpac announcement Friday arvo 37 basis points of cuts, after 51. The low yesterday was 56 and it’s now 51. The 3 year swap rate prior 4.84, after 4.71. The low yesterday was 4.68 and it’s now 4.71%.

But in the grand scheme of things its just noise. Bill is pointing in the right direction and right to highlight the things we have been saying for many month’s now – households are stretched.

Having said that though, it might be a good trade to go into the release long AUD and short interest rates. We just might do that.

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Comments

  1. Speaking of pricing, what are the odds this whole episode has been a little forex play by WBC?

    The Shadow Governor, McCrann certainly isn’t in agreement with Evans and by my calcs he’s coming off a 17/18 record of correct calls. I know where my advice would be coming from.

    • McCrann’s rates record was based on RBA market softening. Ie leaks. Chris Joye sensibly killed that last year.

      Expect his record to decline accordingly.

  2. I was frankly amazed to see all the papers screaming “Interest rates to fall!” at my local newsagent on Saturday.

    Bill may well be right, but Boom Boom Battellino and the bullhawks are unlikely to change their view in a hurry. These guys are rusted-on believers in the multi-decade China boom.

    Regarding the investment mega-boom being “baked in”. Two points:

    1. The miners consistently over-promise on investment, and often don’t deliver, as Tim Colebatch points out.

    2. If there was a sudden loss of demand for resources (e.g. China blows up) the miners would halt investment in a heartbeat.

    • The papers simply took the opportunity to scream rate cuts!

      Evan’s call is based upon a European meltdown, not current conditions.

      Good on him for making a bold call before an accident happens rather than blaming everyone else for missing it afterwards. Right or wrong, he has given his clients the opportunity to position themselves. If it happens, the rest of economists will downgrade forecasts incrementally after the fact.

      Looking at European spreads today, Evans has every chance of being right. And if so, the following is likely:

      – there will be some form of interbank freeze when the default comes
      – there will be a subsequent fall in global trade
      – China’s export growth will diminish
      – commodities will fall
      – Australians will hunker down
      – Housing will weaken
      – Rate cuts will come

      All of this can happen without even a dent in mining capex, which, in my view, would also fall, just as it did after the floods earlier this year.

      • And if all of that happens China will surely open the credit floodgates again (and another huge fiscal stimulus) which will all flow into fixed-asset investment. Perhaps they could push it to 90% of GDP this time?

        The CCP are a bit like Bernanke, they don’t know what else to do. Faced with a crisis, Bernanke prints money, and the Chinese build stuff.

      • Am I reading this correctly – are you saying that if Eurozone (or US) issues induce an interbank freeze, decline in global trade and fall in commodity prices, then mining capex will be unaffected??

      • I pretty much agree with that view H&H.

        The light at the end of the tunnel remains the role of resources in recovery and I can’t really see the gas projects going anywhere soon, they’re here to stay.

        The real outlier for us is some sort of total China collapse and no one wants that (well, except for Lorax!).

    • …and what fraction of the money is actually going to be directly invested in Australia?

      …look, it could be > 70% or so, but I also know that much of the equipment, for example, will come from overseas…

      Just interested.

  3. I remember attending a breakfast meeeting in May 2009 hosted by Westpac with Bill givng predictions on the A$, interest rates, sharemarket, Aussie economy etc. One year on May 2010 most of the predictions were wrong!Why aren’t economist held accountable for past predictions?

  4. Carbon Bologny

    “it might be a good trade to go into the release long AUD and short interest rates.”

    Pardon my ignorance – How does one do that?

    • Deus Forex Machina

      Hi CB…

      It simply means you buy AUD/USD and sell Aussie 3 year futures or bank bills with a broker. But you have to be careful who you use and particulalry how much you risk.

      This sort of thing is something you’d only do if you had experience.

      I wouldn’t have made much money though – 24 pips on the Aud and 1 point on the futures. So hardly worth the risk to be frank.

      If you are interested in learning about trading feel free to drop me an email and I’ll recommend some starter books

      • Carbon Bologny

        Thanks DFM so much. I’m certainly not that advanced yet. My thinking was to buy 5.75-6% RBA bonds a few months ago and profit from a rush to those bonds if/when rates get cut. Even just the turnaround in thinking last week by Evans etc was enough to lift bond prices.

    • Deus Forex Machina

      Wow what a read…I hope I don’t write like that.

      Joye has in a long winded way summarise what we have been calling the “rerating” here since I started blogging at Macrobusiness. But i think the idea that its a non-linearity is a bit pretenious and misunderstands the drivers of the Aussie.

      I gave a talk yesterday where I discussed the possibility of the Aussie at 1.25 so I don’t disagree that this is a longer run possibility and the idea that the Aussie no-longer reacts with markets when they go of, our rerating, is yet to really be tested as I wrote last week because markets keep coming back from the precipice.

      For what its worth I think the Aussie has been rerated, I think that it will be more resilient through time falling into the high 80’s not 60’s under current global settings. While I think 1.10 is it for the moment on the top side I also think it will trade through here eventually. I have no idea when though.

      Cheers DFM