RBA very unlikely to move today

7^th February 2017

RBA very unlikely to move today

The primary reason that the RBA will be less inclined to adjust the Cash Rate today is year-ended core Inflation (excluding volatile items) data for December 2016 amounted to 1.3%. This is well below the 2-3% RBA Inflation Targetover the Long Run. Outside of this, money markets have been consistently stable for months now and are providing yields well about the Cash Rate of 1.5%. This money market data suggests the RBA could actually raise the Cash Rate to bring more alignment to the CGS market. However, the bond markets only stabilised last year in November upon the Trump election result, as the markets moved to take more risk by moving moneys out of bonds and into equities. Click here to view current CGS yield data. Though it is uncertain how stable this trend will be as we move further into the Trump Administration, the buzz word in financial markets at the moment being ‘uncertainty’. Making it unwise for the RBA to increase the Cash Rate today.

October Cash Rate cut most unlikely with conditions stable in the money markets and negative real interest rates

30^th September 2016

October Cash Rate cut most unlikely with conditions stable in the money markets and negative real interest rates

It is no secret that the RBA look at a number of economic indicators when they go to board on the first Tuesday of each month (except January). What is a secret is the decision that they will make in the lead up to Tuesdays 2.30 announcement. The major factors that contribute to the RBA’s decision are clearly outlined on their website under the heading - What are the Objectives of Monetary Policy?. These objectives are:

-the stability of the currency of Australia;

-the maintenance of full employment in Australia; and

-the economic prosperity and welfare of the people of Australia.

Pivotal to these objectives is the RBAs use of the conventional method of targeting the annual inflation rate (through the CPI) within a range of 2-3%. While some economists are questioning the merit of this measure in the post GFC world, the newly appointed RBA Governor, Philip Lowe, has clearly stated his commitment to continuing the inflation target effort of 2-3%, saying In his Opening Statement to the House of Representatives Standing Committee on Economics on 22^nd September;

‘Our view is that a flexible medium-term inflation target remains the right monetary policy framework for Australia. This was reaffirmed in the new Statement on the Conduct of Monetary Policy, which has also been endorsed by the Reserve Bank Board. The goal remains for CPI inflation to average between 2 and 3 per cent over time.’

The evidence of effectiveness to the economy when changes to the Cash Rate occur can be seen more immediately in the money markets and foreign exchange market. However, effects to inflation, employment and GDP are more medium-long term based, where the evidence does not come available until months later upon the data being released.

The evidence suggests that the recent adjustment of the Cash Rate to 1.50% on the 3^rd August has stabilised the money markets, with the yield curve gaining a healthier shape and even 2 year CGS yields trading above the cash rate. Though, the AUD has remained high, the RBA failing in their quest to achieve a lower AUD to stimulate economic growth through rising exports and help to increase inflation to target levels through the rising cost of imports.

However, they have succeeded in achieving negative real interest rates; equal to the Cash Rate minus inflation. Core inflation (excluding volatile items) is the gauge that the RBA considers when making their decision on Monetary Policy, and this came in at a figure of 1.6% (Jun-15 to Jun-16) on the 27^th July one week prior to the RBA’s August board meeting. This equates the Real Cash Rate to be -0.1% meaning when investors borrow money at 1.5%, their borrowing costs are lower than the rate of inflation, making it easy achieve a return on investment. Of course, this is theory based because only Authorised Australian Financial Institution have access to borrow money at the Cash Rate, but the idea is that it will translate into more profitable opportunities throughout the banking system and stimulate monetary expansion.

Conclusively, it is highly unlikely that the RBA will cut the Cash Rate again soon, in light of the stabilised of money markets and negative real interest rates. Both, outcomes of the August rate cut. 

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.

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 29^th July, the ASX 30 Day Interbank Cash Rate Futures indicated an August interest rate decrease expectation of 64% 

CPI

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 4^th 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%.

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 16^th 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.’

Source: U.S. Federal Reserve

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 16^th December press release:

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

Source: U.S. Federal Reserve

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.

Australia needs more cash!

Blog Post 11| 28th October 2015

Australia needs more cash!

One of the major changes that has occurred over the past 20 to 30 years, since the days of financial deregulation, is the decline in the percentage of cash (liquid of currency) to bank assets (private debt). See graph 11.1 below:

Graph 11.1

This is significant because a ratio of this nature represents our nations ultimate ability to pay off the e debt. In other words, the private sector using a bigger credit card to finance the existing credit card debt. The credit card being an analogy as most of this debt is these actual loans that are collateralise with assets. Albeit, there is an argument for these loans being undercollateralised on the back of overvalued asset prices, but lets not go there for now.

Over time the common trend is that when interest rates are decreased (through the cash rate), currency volumes need to increase to reduce the value of money into the future. Similarly, when interest rates are increased, currency volumes need to decrease to increase the value of money into the future. In order to balance the ratio of cash to private debt, interest rates will need to come down further, in conjunction with some form of quantitative easing (increasing the currency supply and circulating this currency through buying government bonds from the banks). 

An argument for a sustainable rise to the cash rate in the near future has little merit given this long term trend.

Interest only mortgage loans under scrutiny by ASIC

 Blog Post 10| 27^th August 2015

Interest only mortgage loans under scrutiny by ASIC

The Australian Securities and Investment Commission (ASIC) are cracking down on interest only loans in the mortgage market suggesting a portion are at risk of default. This is an important initiative on the behalf of the regulator watchdog as in the mortgage market owner-occupiers mortgages interest only repayments equates to over 25% of the market and in the investor mortgage market this statistic is up around 60%. See chart 10.1 below from the March 2015 RBA Financial Stability Review:

Chart 10.1

Click here to reference chart on the RBA website.

The ABC News quoted ASIC last week saying:

'Interest-only loans offer a period, typically up to five years, where the borrower only has to pay the interest on the loan, rather than also paying down the principal.

This makes repayments lower in the short-term, but higher over the life of the loan.

'The ASIC review of 140 individual loans found that in more than 30 per cent of cases there was no evidence the lender had considered whether the applicant could afford their repayments over the long term.

ASIC said in 20 per cent of cases the lenders had not considered the actual living expenses of applicants and in 40 per cent of files they had incorrectly calculated the affordability of the loan.' Click here to reference the article.

However, as mentioned in an article from Banking Day yesterday - ASIC's call for better responsible lending compliance easier said than done. ASIC is questioning a large percentage of these loans they have reviewed to date suggesting lending practice regulation were not met. Gadens Lawyers said;

'"ASIC found that most lenders did not appear to be making sufficient inquiries in relation to requirements and objectives or, if they were, lenders were not recording their findings."'

King & Wood Mallesons law firm said;

'"ASIC comments that in the context of an interest-only loan recording the objective or requirement of a borrower is ‘to purchase property’ is insufficient because it does not address why an interest-only loan as opposed to a principal and interest loan would better meet the borrower's objectives... Without ASIC providing guidance on what is appropriate for each type of credit product it is hard to know what will satisfy the obligation."'

Just in time delivery

Blog Post 9 | 5^th May 2015

Just in time delivery

The decision by the RBA to cut the cash rate by 25 basis points in May has proven quiet effective in stabilising money markets since early May. 3 year CGS yields have normalised to above 2 year CGS yields, though this spread is again narrowing. 

Meanwhile the RBA is in between a rock and a hard place; a tiring economy that yearns for liquidity to improve the balance sheets of banks facilitating improvements to borrowing throughout the economy (enabled via reducing the Cash Rate) and a hungry housing market that is gobbling up cheap money, making housing less affordable and generating a potential asset bubble. 

For now, the stabilisation of money markets suggests that May rate cut decision was timely. The economic picture could have been quiet different now and into the future had they continued to hold off on cutting the cash rate.

Will they cut in May?

Blog Post 8 | 5^th May 2015

Will they cut in May?

The 30, 90 and 180 Bank Accepted Bills (BABs) rates dropped to 2.15, 2.17 and 2.25 per cent respectively yesterday (04/05/2015). An increasing amount of economists are siding with the argument for a rate cut. Will the RBA pull the trigger at 2.30pm today? Or, will they play devil advocate?

Even more signals for lower interest rates

Blog Post 7 | 21^st April 2015

Even more signals for lower interest rates

The spread on 3 year Commonwealth Government Securities (CGS) and 2 year CGS has widened to 5 basis points; 1.82 per cent and 1.87 percent respectively as at 20^th April 2015. This indicates that fund managers prefer 3 year bonds to 2 year bonds as they foresee the cash rate being lower for longer on the back of Australian economic conditions continuing to deteriorate.  

Should the cash rate have been cut on Tuesday?

Blog Post 6 | 9^th April 2015

Should the cash rate have been cut on Tuesday?

Callam Pickering from Business Spectator wrote a great follow up piece to the absence of a cash rate cut on Tuesday entitled Has monetary policy failed Australia’s economy? The article raised the question ‘What’s the counterfactual?’ … i.e. ‘Based on the historical relationship between interest rates and growth, there is a non-trivial possibility that if the cash rate was at, say, 3.5 or 4 per cent, then the Australian economy would either be in a recession or well on its way to one.’ Callam raises a very interesting point of the consequences of not cutting the cash rate in time before it causes adversity to economic growth and conditions, and having formerly worked for the Reserve Bank of Australia his opinion is one of validity. 

An April Cash rate cut is looking more likely

Blog Post 5 | 3^rd April 2015

An April Cash rate cut is looking more likely

The 30, 90 and 180 Bank Accepted Bills (BABs) have all dipped below the Cash rate in recent days. This will put pressure on the RBA to reduce the Cash rate this coming Tuesday when it goes to board for this month. Chart 5.1 shows the BABs rates against the Cash rate for 2015:

Chart 5.1 

 

Preliminary research indicates the annual inflation rate rose to 1.5 per cent last month, which is still below the RBAs 2 to 3 per cent target range. This also supports the case for a lower cash rate this month.

More signals for lower interest rates

Blog Post 4 | 23^rd March 2015

More signals for lower interest rates

The market for 3 year CGS did stabilise in mid-February to mid-March, with yields rising back to a normal level above 2 year CGS yields. However, this was short lived as demand for 3 year CGS has driven the yield again below 2 year CGS yields in recent days. See table 4.1 below:

Table 4.1

Who is paying the additional interest on the debt?

Blog 3 | 24^th February 2015

Who is paying the additional interest on the debt?

Much has changed in the world since the Financial Crisis of September 2008. Structural changes to financial markets have been a necessary evolution from this broadly unforeseen event. One of the major structural changes here in Australia has been the issuance of Commonwealth Government Securities (CGS) that has grown over 6 fold since September 2008; Australian Financial Intermediaries(AFIs) being are the largest domestic buyers of these instruments. The main reason for this is to ensure that in the event of a future financial crisis here in Australia the RBA would be able to inject liquidity into to AFIs quickly by printing currency and buying these holdings of bonds from the AFIs in a process known as Quantitative Easing (QE). This precautionary measure places the Australian banking system in much better position to weather a financial storm, but does come at a price. Chart 3.1 shows the change in the holdings of CGS and local and semi-government and other public authority securities by AFIs since January 2000.

Chart 3.1

The Australian Office of Financial Management (AOFM) is the body responsible for managing the market for issuing CGS. They regularly update the value of CGS on issue on their website www.aofm.gov.au. Graph 3.2 shows the growth in CGS on issue since January 2000.

Chart 3.2

As at January 2000 when the Cash Rate was 5% interest on CGS was an average of 6.88% pa (across the 2yr, 3yr, 5yr and 10yr terms), which on an account of AU$79.78 billion was AU$5.49 billion pa. As at September when the Cash Rate was 2.5% interest on CGS was an average of 3.01% pa (across the 2yr, 3yr, 5yr and 10yr terms), which on an account of AU$368.47 billion was AU$11.10 billion. Chart 3.3 shows the quarterly change in annual interest on CGS since March 2000.

Chart 3.3

 

The question is - who is paying the additional interest on the debt? And, who should be responsible to pay it?

Cut or Not To Cut…

Blog post 2 | 3^rd February 2015

Cut or Not To Cut…

As we get closer to the release of the RBA’s interest rate decision release today at 2.30pm AEDT, one of the key factors they will need to take into account is the Bank Accepted Bills (BAB) data which estimates end of day bank bill rates. See Chart 2.1 below:

Chart 2.1

Without an interest rate cut and an increase in the supply of liquidity, the cost of funding between the banks in the short-term will undoubtedly rise.