It was only a couple of days ago that the RBA told us they had expressly discussed the prospect of tightening rates at this month’s Board meeting yet this morning as I write the market has 80 basis points, that’s three RBA cuts, of easing over the course of the next year.
This is an amazing situation when you take into account how hawkish the Governor’s statement was on Tuesday. Further out the interest rate curve the 3 year swap rate traded down below 4.50% yesterday morning and sits around 4.53% this morning. Even 10 year swap rates are only 5.37%.
Even though we worry about consumers and the economic backdrop, these rates imply an economy no one should covet. Just have a look at that 3 year swap chart above. We are now lower than we got last year in the so-called global soft patch when we saw markets pricing cuts in Australia and before the RBA reiterated its concerns about inflation and unemployment before the last rate hike. The important thing, in terms of current market pricing, is that 3 year swaps are around 0.25% below the current cash rate, the last time that were at rates around here, they were still at or above the cash rate.
That means the market is either over-reacting or really is concerned about the economy. Perhaps a little bit of both. So it is worth discussing what is driving this sharp fall in market interest rates.
Firstly it is, leaving aside the CPI, it is the deterioration and indeed acceleration in the deterioration, of the non-mining sector of the Australian economy which has contributed to this fall. Data yesterday showed that retail sales fell 0.1% last month against the market’s expectation of a rise of 0.4%. While we certainly don’t revel in it this economic weakness it won’t be a surprise to our readers given the outlook we have been talking about here at MacroBusiness for the domestic economy for sometime now. Coming on top of the credit aggregates and housing data, not to mention the crash in the AIG’s performance of manufacturing index last month, retail sales really do show how weak the economy is becoming outside of mining.
But what is really driving this rally in rates and sell off in equities, is that markets are waking to the fact that the global economy is weakening materially, which, on top of all the debt problems in the US and Europe, is undermining confidence and increasing uncertainty. We have written before that we didn’t think Greece would take markets down but that the weakness we saw in the global economy would, and so it is at the moment. Some may say that this is just a rerun of last year’s soft patch – unfortunately I’d argue that this is something deeper this time as consumers and business the world over recognise that the economy is not coming back in a hurry and stop spending and investing. Even just at the margin it’s enough for another developed world recession.
Indeed I received a piece from Westpac on this topic from my old colleague Richard Franulovich. Richard said,
In many respects the current slowing is now deeper than the 2010 soft patch. Yet, the adjustment in various markets so far has been comparatively more muted than was the case in 2010. That is all the more unusual given that the tail-risk of a deeper slump is arguably greater now than in 2010. The US is now growing below stall speed whereas it wasn’t in 2010. And, there are constraints on the ability of additional monetary and fiscal support to provide a backstop that did not exist in 2010.
My bolding but this is an excellent point – how have markets held in so well relative to the parlous economic outcomes. I don’t have an answer for this but what I do know is that the S&P 500 has broken, decisively, the uptrend from the lows in 2009.
So if this gets a wriggle on over coming weeks, Australian markets are going to pay more attention to the RBA’s worries about offshore events than they are about its concerns for inflation and the mining boom. There is a big risk tomorrow with the release of the Quarterly Statement on Monetary Policy that we’ll see a re-run of what happened in May, with dialled up RBA rhetoric compared to market expectations – I’d probably be going into that release short interest rates and long AUD/USD for a quick trade.
Overall, though, I just can’t see the RBA getting an excuse to tighten. I hold that what the RBA has tried to do is buy time before the next hike in rates but the underlying weakness in the domestic and global economy will forestall the need for any rate hikes anytime soon. Equally, however, given their rhetoric, it seems only a catastrophe globally is going to get them to cut rates any time soon.
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