The irrepressible lord of the bullhawks, Chris Joye, is out today with a well argued case for why interest rates are not going to be cut next week.
Chris uses the overnight speech by Phil Lowe to make four points:
First, Lowe noted that the extraordinary expansion of global central bank balance sheets, and near-zero interest rates, have no historical precedent. We are in unchartered policy territory, and there are almost certainly going to be long-term financial imbalances that ensue.
…Second, Lowe highlighted the striking decline in credit costs (or “spreads”) for Australian issuers, which are dominated by the big banks. On 19 October, I wrote here, “One of the most important, yet overlooked, stories in the Australian economy right now is the extraordinary compression in corporate credit spreads and bank funding costs.”
Third, the RBA is belatedly starting to acknowledge that interest rates, as opposed to its target cash rate, are getting quite stimulatory for rate-sensitive sectors. Two major banks have now cut the price of their fixed-rate home loan products to 20-plus-year lows. Unsurprisingly, auction clearance rates are reinvigorating. Last weekend saw the largest number of auctions go to market in Melbourne all year. Yet the clearance rate managed a reasonably high 65 per cent. Savings rates now barely cover the cost of inflation. And so riskier asset classes such as the sharemarket are roaring back to life.
Finally, Lowe makes the profound point, which I have regularly belaboured here, that low interest rates are not the good news many purport them to be. Low rates punish numerically superior savers over borrowers. And they can create substantial distortions in savings, borrowing and investment decisions.
Chris goes on to mention the bounce in iron ore as well. All very solid. But I still disagree.
First, although Australia most definitely already has an asset bubble, current growth rates for credit are subdued.
Second, banks may have better spreads but there is almost no evidence that they are passing on better margins to borrowers, In fact, it’s been the opposite.
Third, rates may stimulatory but see point one.
Fourth, low rates are bad news for sure. And what?
On iron ore, yes, we’ve seen a recovery and yes it will prevent the trade deficit from getting worse as spot prices offset delayed contract price falls. But coal has not bounced at all and more importantly, as BHP showed yesterday, the boom in mining investment is busted. By mid next year, at best, mining investment will be falling and GDP along with it. It doesn’t matter if mining investment levels are still very high. For GDP, it only matters what the change in the growth rate is.
I don’t like it, but the RBA is going to try to build more houses and although today’s building approvals print was ok, they are still very much in the dunny in historical terms.
On top of that, the RBA has entered the global currency war with increased rhetoric and passive intervention.
On inflation, see carbon tax!
In conclusion, in my view, the RBA will cut next week. I expect they will then sit on their hands until the new year and hope to not have to cut again, which I think will have to do.
Right now markets agree with me by a nose. Here is the CS1Y chart, still signaling three cuts in the year ahead:
And the Bloomberg probability paths which this morning showed a 52% of a cut in November:
And the probability paths favour 2.5% by next April, just in time for the the mining wind down:
Don’t fight the RBA.
