Via Bill Evans at Westpac:
The Reserve Bank Board next meets on April 3. There is almost certain to be no rate move coming from that meeting.
Market Pricing and Analysts Forecasts
Market pricing for the RBA has moved significantly over the last six months.Last September markets were predicting nearly two rate hikes by end 2018. Now markets have pushed these “nearly two rate hikes” back to 2019 with only around a 40% chance of any move by the end of 2018. The first of these hikes is fully priced in by mid-year and the second in the second half of the year.
Economists’ forecasts have also been shifting.
Thirteen major banks/ investment banks contribute to the regular Bloomberg Survey. Back in September seven expected rate hikes by the third quarter of 2018 and six expected rates to be on hold.
Recall that throughout 2017 Westpac has had the “outrageous” call that the RBA would be on hold through 2017; 2018; and 2019.
The latest Bloomberg Survey sees considerable changes in the economists’ views. Only one of the thirteen continue to expect a hike by the third quarter of this year but eight others are anticipating a move by the first quarter of 2019. Only four, including Westpac, expect rates to be on hold through the first quarter. We cannot be sure when the other three are expecting the first move as the survey only extends to the first quarter.
A range of recent developments is easing concerns about the need for the RBA to raise rates.
Emerging Trends in the Labour Market
The labour market has always been seen as the “star performer” for the economy. But jobs growth is slowing. The pace of jobs growth over the last three months has slowed from 3.4% over the course of 2017 to 2.1% (three month annualised). Furthermore, the unemployment rate, which fell from 5.9% to 5.5% by September has stabilised, printing 5.6% in February.
Westpac concurs with around a 2.0% pace of employment growth over the course of the remainder of 2018. Associated with a modest further rise in the participation rate we expect the unemployment rate to remain around current levels. With the “full employment” rate assessed as being around 5%, considerable “slack” is expected to remain in the Australian economy over 2018.
Recently the modest fall in the underemployment rate has stalled with the rate actually rising from 8.3% to 8.4% over the last three months.
Developments in Housing Markets
Most housing markets have peaked. Over the last three months, house prices in Sydney have fallen by 4.2% (annualised) compared to an increase of 3.1% over the last year. For Melbourne and Brisbane house prices have stalled compared to increases over 2017 of 8.9% and 2.4% respectively. With the value proposition for investors in particular appearing to be discouraging (low rental yields; flat prices; increasing regulation and potential tax changes), prospects in the major Australian housing markets are clouded.
Financial Conditions are Tightening
Other asset markets have also been underwhelming. Since the beginning of the year, Australia’s share market has fallen by 4%, including a 7% fall for bank stocks and a 4.7% fall for resources.
Australian banks generally borrow in the short end of the market at BBSW – a rate that last year traded at around 20-25 basis points above the expected RBA overnight cash rate, reflecting “normal” credit risk. That margin has increased to around 50 basis points – effectively an increase in short term funding rates of around 25 basis points or one full RBA rate hike.
That increase in spreads is not due to an assessed widening in bank credit risks. There are other explanations for this development. One important explanation is the recent US tax changes which allow US corporates (in particular the cash rich technology companies) to direct funds (mainly US dollars) back to the US from foreign sources (total funds estimated at around $1.5 trillion without paying the onerous 35% tax rate). Foreign banks, including Australia, which had relied on this USD funding, have had to switch demand for funds to local markets, intensifying rate pressures.
The “shortage” of USD offshore funds has boosted USD funding costs – LIBOR by around 25 basis points.
Most business borrowers will be affected by this increase in BBSW. One small bank even slightly raised its variable mortgage rate to reflect this 25 basis point increase in short term funding costs. This is despite other banks cutting their rates on new lending for some forms of investment loans.
Australian banks have also recently suffered increases in their funding costs in longer maturities with bank 5 year paper lifting by around 15 basis points compared to the risk free rate.
Credit growth has slowed to 3.8% annualised over the three months to February compared with 4.9% growth for 2017. This includes a slowing in housing credit growth from 6.3% in 2017 to 6.0% annualised over the past three months. Business credit stalled over the past three months, with 0.4% annualised growth, in contrast to a 3.2% increase in 2017.
Global Growth may have Plateaued
The positive lift in global growth in 2017 may be fading.
Manufacturing PMI’s stood out in 2017 as signalling strong global growth. However recent developments have been less encouraging. The PMI’s are estimated to have bottomed out around September 2016. The Global manufacturing PMI has moved to 50.4 (September 2016) to 54 (December 2017) back to 53.2 (March). Respectively, Europe (52.6; 60.6; 56.6); US (51.5; 55.5; 55.7); Japan (50.4; 54; 53.2) and China (50.4; 51.6; 50.3).
Trade tensions must be impacting confidence although there remains considerable uncertainty over the extent and timing of President Trump’s trade policies. The 25% and 10% tariffs on steel and aluminium announced at the beginning of March were initially imposed on all countries, but subsequently rolled back to only a few nations, including China, although excluding Europe; Brazil; and Canada (among others). This exemption has been enough to hold the EU back from retaliating to date.
China has quickly become the sole focus of the trade debate. With tariffs to be imposed on around $50bn of imports from China. Just after this announcement, China retaliated with planned tariffs on $3bn of US imports across 128 products.
Our view is that it seems most likely that a compromise will be found between the US, Europe and China. But the animosity and uncertainty will continue to weigh on confidence
Exchange Rates are also Questioning the Global Outlook
Usually a slowing global environment will weigh on the Australian dollar and support the USD. The Trade Weighted Index for the AUD has fallen from 65.70 end January to 62.60 to date. The Australian dollar has fallen from a recent peak of USD 0.81 in late January to USD 0.773. Furthermore, the USD has stabilised. In 2017, a weaker USD (down around 14%) was associated with strengthening global growth. Since late January, the USD Index has held steady despite considerable market volatility.
Overall developments since the beginning of the year both domestically and globally have strengthened the case for a benign rate outlook in Australia.
We reckon 70 cents by year-end base upon a more bearish view of bulk commodity prices.
Lower again next year barring more Chinese stimulus.
FYI, MB has launched a new Australian dollar forecast index which will be updated regularly to keep you abreast of market outlooks. See it here.
