Bloxo: Rate hikes are coming (and so is Xmas)

Go the bullhawk:

Canada has started; the US has been on the path for some time; the ECB’s tone has shifted and so has that of Norway and Sweden. Australia? Soon, but not yet. In our view, the key two factors that forced the RBA to cut to a very low, 1.50%, cash rate setting are now both receding. First, was the massive resources cycle, with very low rates needed to rebalance growth to the non-mining sectors as mining investment and commodity prices fell. Second, extraordinarily low global interest rates meant that a low cash rate was needed to keep the AUD down, again, to rebalance growth. Now, with the mining downturn around its trough and global rates rising, Australia may not need a record low cash rate for much longer. But, unlike with the other central banks, don’t expect forward guidance from the RBA. You’ve got to watch the data. We expect a hike in Q1 2018.

The global economy is currently experiencing its most synchronised upswing in a number of years. The US, which has been leading the recovery, is continuing to show positive growth momentum. European activity indicators have had a run of upside surprises. Global trade has been lifting, supporting growth in Asia. Notwithstanding still benign inflation pressures in most countries, a number of central banks have turned less dovish recently, as a result of lifting economic activity and tightening labour markets. Some are lifting rates, others suggesting cuts are now unlikely and still others, hinting that they may slow asset purchase programmes.

For Australia, this episode has been a bit unusual. Australia’s central bank is often one of the first to start lifting rates in global upswings. But there are a few differences this time around.

First, commodity prices have not been lifting. This may reflect that the recent lift in global activity indicators has been most significant in the developed economies, with most of the upside surprises in Europe, so there has been less upward momentum in metals prices than if China’s investment was leading the way. Developed world growth tends to be less commodity-intensive than China’s growth. The lift in global trade has also allowed China scope to tighten local financial conditions, to help deal with some of its own imbalances, again, softening growth in housing and infrastructure investment.

Second, local wages growth and underlying inflation are low, although we expect that both are at or past their troughs. We see the slowdown in wages growth as partly the result of the long, drawn out, downturn in the mining industry, as high paid mining jobs were lost and replaced by lower paid services jobs. Wages growth has been showing some signs of stabilising and we expect growth to edged higher in H2 2017. As a result, underlying inflation is below the RBA’s 2-3% target band, although it looks to be past its trough. The RBA will need to be convinced that wages growth is past its trough to start hiking.

Third, there have been some measurement challenges recently, which have made it harder to get a clear view of the economic momentum. Q1 GDP growth, which ran at a below trend rate of 1.7% y-o-y, was held back by wet weather on the East Coast and the impact of Cyclone Debbie. Measures that are better at abstracting from the weather-related effects, such as surveyed business, which forms part of it conditions, are at around decade-highs, implying much stronger growth (Chart 1). Measurement issues in the labour force survey have also meant that momentum may have been understated. However, the official labour force numbers for the past three months have started to come back into line with other timely labour market surveys (Chart 2).

Our overall view is grounded in the idea that the biggest factor driving the RBA to cut all the way to 1.50% had been the massive cycle in the resources sector, and that this is now over. The boom and downturn was at least three times larger than anything Australia had previously seen. In addition, global interest rates have also been at historical lows, which has impacted local policy through the currency. With the mining downturn now stabilising and global rates lifting, we doubt the RBA will need its very accommodative setting for much longer. Besides, the low cash rate is also causing unwanted exuberance in the Sydney and Melbourne housing markets (auction clearance rates are still around 70% in both markets).

Nonetheless, the market seems reluctant to price in RBA hikes over the next 12 months. The market is currently pricing that the RBA is unlikely to lift its cash rate until mid-to-late2018, with OIS 50:50 priced for a 25bp hike by May 2018. This may partly reflect some of the issues with commodity prices and local measurement issues that we have raised above. It could also reflect that markets have become used to central banks, including the ones we discussed above, providing forward guidance before they take action. Keep in mind, the RBA does not do this.

Consider:

  • dwelling construction boom rolling over right now;
  • bulk commodity prices to fall again into year end;
  • mining and wider capex still falling all next year;
  • car industry closing;
  • income growth structurally stuffed by mass immigration being used to support the above,
  • Budget at imminent downgrade risk;
  • house prices set to slow as banks already hike rates, and
  • dollar to the moon.

Nothing would give me greater pleasure than seeing the RBA hike rates into the dumb bubble but it ain’t going to happen.

Comments

  1. BrentonMEMBER

    “First, was the massive resources cycle, with very low rates needed to rebalance growth to the non-mining sectors as mining investment and commodity prices fell”
    – AKA debt fueled construction binge; great re-balancing act…..

    “Second, extraordinarily low global interest rates meant that a low cash rate was needed to keep the AUD down, again, to rebalance growth”
    – True enough, and truer now more than ever.

  2. I would say that the market has already priced in (2) imminent rate hikes by the RBA. There is no other explanation for the Icarus-like rise of the banana-dollar relative to all othet currencies. FeO is back in the doldrums, growth is luckluster and the deficit expanding. The picture is worse than 12 months ago yet it soared. When traders realise there is no hike coming, will they hold on?

    • There are plenty of explanations for a stronger AUD.
      Jason, you didn’t take much notice of the US economic data over the weekend. Maybe you should.

      • BrentonMEMBER

        Problem with that Andrew is that we are still a piss ant currency down in the South Pacific. Even if US data was lacklustre, Australia’s is little better. As far as I can tell, the AUD is moving on some mythical belief in a 2nd coming of China. There is no other justification for why it should be viewed as a relative safe haven against the US.

      • @Freddy, but the AUD has been moving before the US data. It is based on risk sentiment and faith in commodities, which is bloody frustrating.

      • Sure I did Andrew. Problem is it went up against everything, including all its customers. AUD is not a reserve currency but it is a favourite amongst speculators.

      • $AUD is viewed as a safe haven in a world of stuffed economies. That’s why shorting it is proving so difficult.

      • I believe the hedge funds that have been annihilated on oil and short S&P now want to stick it to DXY. They don’t care about the other side – they don’t live there … grass is greener etc. So AUD is not strong … USD is just weak … on rising rates and failing Euro banks?
        Short AUD at 80: long DXY at 92 and change. Oh and the lower the AUD, the bigger the “For Sale” sign we just shingled at the RBA front door := higher domestic priced housing. No wonder we own nothing … and have the debt to prove it!
        … just my 2c worth.
        Thank you for yawning

      • Those are the reasons I argued for while why RBA can’t hike. But if they are forced to..
        Reality is FED will not be able to pass 2.5% at the max. At best I think the FED will get to 2% by mid next year and stop or risk to burst the all the bubbles everywhere.
        Is 2% rate in US enough to force RBA to hike? I don’t know. Hope someone can advise me..

  3. reusachtigeMEMBER

    LOLOLOLOL… Youse and your “lower teh interest rates, that will fix thing”…

    • I thought it was your mantra? Remember lower teh rates = even MOAR good times and relations.

  4. if you want to know the isolated effect of the AUD you need to consult two other currency pairings. For instance:
    AUD/USD v GBP/USD v GBP/AUD. By looking at the movements in the other two pairings you can then deduct the real movement in the AUD/USD
    This will tell you if an AUD appreciation v the USD is AUD strength or USD weakness or the magnitude of the trade off between the two

    • Good point Trav.

      GBP tumbles against AUD

      GBP up against USD on data

      AUD up against USD on data and mythical belief in AUD

      Conclusion, USD is weak, but AUD also strong on commodities/china sentiment.

  5. DominicMEMBER

    Aussie households have record levels of debt and the RBA knows all too well what will happen if they start raising rates.

    Hoist by their own petard, they sit tight until the dam wall starts to crack and then lower them one or two more times (for what it’ll be worth i.e. nothing)

    • Jumping jack flash

      Yep.

      They will keep them stagnant at best, and at worst, lower them again.
      Until such a time it becomes completely impossible to do so. We’re talking food riot territory for that, and that’s a long way off. Too many people have made out like bandits and still hold mountains of other people’s debt.

      So the rest of the world raises theirs, the teeniest tiniest amount possible, what’s the effect on Aus? 3/5ths of SFA.
      If it continues, then what? AUD lowers? That’s probably a good thing even if it does induce inflation on all our imported junk from China.

      But wait, won’t this inflation mean IR will rise?
      No, cleverly, the new RBA leader’s first change he made – that above target inflation for “a period” wouldn’t affect interest rates, will come into play.

      Problem solved!