Friday, 30 September 2016

September Rate Cut is not Completely out of the Question

6th September 2016

September Rate Cut is not Completely out of the Question 

While it is highly unlikely, the RBA could further cut interest rates today when they meet for their decision on monetary policy for the month. In light of the 25 basic point cut last month, the AUD/USD actually increased by almost 1 cent when averaged over the month of August to July. This being counter logical to the outcome of a 20% reduction in the interest rate differential between Australian and the United States in a pre GFC world. Theoretically, lower AUD would increase import prices and decrease export prices, resulting in higher inflation, lower unemployment and higher economic growth. If the RBA are resolute to increase inflation to their targeted 2-3% range, and increase employment and economic growth, a .25% rate cut could be on the table at 2:30PM today. However, given the ASX 30 Day Interbank Cash Rate Futures is indicating only a 5% expectation of a decrease in the cash rate to 1.25%, this would be a black swan for market expectations.

Monday, 5 September 2016

August 2016 Cash Rate cut is more than likely

30th July 2016

August 2016 Cash Rate cut is more than likely

Key points:
-CPI inflation hits a 17 year low
-Money markets Overnight Indexed Swaps (OIS) are at new lows
-Government bond yields are moving into 1.50% territory
-24/25 economists surveyed believe there will be an August Rate cut
-As at Friday 29th July, the ASX 30 Day Interbank Cash Rate Futures indicated an August interest rate decrease expectation of 64% 

On Wednesday the Australian Bureau of Statistics (ABS) released their quarterly result of the Consumer Price Index (CPI) for inflation, which came in at 1.0% from June 2015 to June 2016. This sits well below the RBA’s targeted bandwidth of 2 to 3%. While the RBA do account for removing volatility when making the monthly decision on Cash Rate movements, the Core Inflation number (‘excluding volatile items’) still came in at 1.6% that is again below their targeted range. This is the lowest annualised reading since the quarter ending December 1999.

Money Markets
In the money markets, where Australian financial institutions manage their returns from borrowing and lending, the 1-month Overnight Indexed Swap (OIS) rates reached a new low of 1.623%. An overnight index swap is a swap contract for the overnight rate to be exchanged for a fixed interest rate. This indicates that Australian financial institutions are hedging to prepare their exposure to an August rate cut.

Government Bonds
The market for Commonwealth Government Securities (CGS) is yet again showing signs of a weakening economy, with negative spreads on yields between 2 year and 3 year bonds. This points to the reality that investment institutions have a preference of 3 year CGS over 2 year CGS because they expect interest rates to be lower for longer. 3 year CGS yields dipped to a new low of 1.47% below the anticipated 1.50% August Cash rate. 10 year CGS yield also hit a new low in July of 1.865%.

Predictions of Economist
In mid July, Bloomberg surveyed 25 economists to get their views on an August rate cut. These economists undoubtedly stay very tuned to the above data movements, and have based their expectations on the RBAs Cash Rate decision for August accordingly. 24 out of the 25 predict an August rate cut.

The ASX 30 Day Interbank Cash Rate Futures
On 4th July, the Melbourne Institute released their Monthly Inflation Gauge that came in at a 0.6% rise in prices for the month of June. This brought the annual Melbourne Institute inflation figure to 1.5%. The release is widely recognised as an accurate forecast for the ABSs CPI release. This low result shifted the ASX 30 Day Interbank Cash Rate Futures market to indicate an August Cash Rate cut expectation of above 50%, which later in the month reached a high of 70%.

Saturday, 30 July 2016

U.S. Federal Reserve Breaks Bad

Blog Post 12| 27th December 2015

U.S. Federal Reserve Breaks Bad

In the wind up of 2015 the Federal Reserve (FED, U.S. Central Bank) has made a counter logical (logical, in terms of their theoretical mandate) decision to increase interest rates, effectively reducing the amount of liquidity that will be available into 2016. On 17th December 2015 the FED made the decision to raise he Federal Funds Rate from a range of 0-0.25% to 0.25-0.5%, the first increase since 16th December 2008 in light of the Global Financial Crisis (GFC). In making this pivotal decision of U.S. monetary policy the FED have effectively broken their directive to target 2% inflation, which in their words:

‘…inflation at the rate of 2 percent (as measured by the annual change in the price index for personal consumption expenditures, or PCE) is most consistent over the longer run with the Federal Reserve's mandate for price stability and maximum employment.’

Although this is a relatively small increase to the rate at which U.S. private banks borrow from the FE, and future increases are forecast to be gradual; inflation only averaged 0.07% from January 2015 to November 2015. And, the FED did say in their 16th December press release:

‘…it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective.’

However, modern central banking theory and empirical evidence only support the use of, what is conventionally known as contractionary monetary policy (reducing the money supply through raising interest rates), to invoke a decrease to inflation. This is exactly the opposite outcome the U.S. FED is looking to achieve through its monetary policy efforts.

What is the issue with low inflation or deflation?

An economy naturally requires more real (inflation adjusted) spending in the current period relative to the previous period to achieve real growth. If prices are stagnant or decreasing, it removes the incentive for consumers and investors to purchase in this current period with the knowledge that they can pay the same amount or even less in the next period. This decreases spending and subsequently economic growth.

Japan has experienced these very economic phenomena since the 1990’s when they began on a course of low inflation/deflation on the back of asset bubbles bursting in both the share markets and the real estate markets. Resultantly, real GDP stagnated in Japan, though they were able to alleviate some of this downward pressure to growth through being a net exporter of goods and services. From January 2000 to March 2014 monthly inflation of consumer prices averaged -0.01%, and over this same period quarterly GDP growth averaged a mere 0.2%.

What is the probable outcome?

Through increasing interest rates the FED will impose lower inflation on the U.S. economy, reducing inflation to lower levels than before the interest rate rise that will likely bring about a situation of no inflation or deflation to U.S. prices. The overall effect of this is probable to be lower GDP growth and a greater risk of a recession in 2016.