Maxim Monthly Market Insights - May 2015


  • The RBA cut rates again this month citing concerns over business investment intentions even though the domestic economy is improving.
  • That cut, delivered on the implied promise from the February move, which Westpac chief economist now believes completes this cycle.
  • But, the RBA has left the door ajar for further cuts should the economy need it and in particularly if the Aussie dollar stays too high


What did the RBA see that you didn’t – business investment

National Australia Bank chief economist Alan Oster called the Reserve Bank’s decision to cut rates to a new modern day low of 2% at this month’s Board meeting ‘line-ball’. He noted that consumers are still cautious and that the RBA had moved because “recent signs of improvement in the economic partials are encouraging but the non mining sector needs to lift more to offset the impact on domestic demand of sharply lower mining investment and the hit to income from commodity prices.”


image003_0.jpgThat’s a notion that was borne out in the RBA’s quarterly statement on monetary policy last Friday according to Westpac chief economist Bill Evans who said,
“Most of the sentiment expressed in the Statement on Monetary Policy comes as no surprise. In fact our support for a
likely rate cut in May was predicated on the Bank’s downward revision to growth specifically because of a weaker outlook for business investment and exports.”


The key here is that even though we know the mining investment boom has ended and the economy needs to transition the RBA has clearly been spooked by the drop off in investment. That is, investment intentions dropped off a ‘capex cliff’.
Indeed in its quarterly SoMP the RBA highlighted that, “the pace of the decline in mining investment could be greater than had previously been anticipated if declines in commodity prices place further pressure on mining sector profitability, particularly in the oil and gas sectors.”
But, they went one step further noting that, “The latest Capex survey implies that any recovery in nominal non-mining investment in 2014/15 will be reversed in 2015/16.”

This is why they cut rates.


But with record Australian employment, record low interest rates, a currency that’s not that strong and is providing a boost to domestic growth the RBA “continues to expect household consumption to gradually pick up to an above trend pace (from mid-2016)” according to the ANZ.
So in the end the RBA has taken out insurance on the economy – and it should work.


Even at 80 cents the Aussie is helping growth accelerate


The Aussie dollar has fell from a high of 1.1080 in July 2011 to a low earlier this year of 0.7530. That’s a 32% depreciation and even though the Aussie traded up above 80 cents in the wake of the RBA’s decision to cut rates and drop an explicit easing bias last week the fall is helping domestic growth by altering the relative prices of domestic-and foreign-produced goods and services.


RBA on hold for at least 6 months


Westpac chief economist Bill Evans deserves props for being the first Major forecaster to call the start of the RBA’s easing cycle. He’s clearly got a good feel for the RBA at the moment.
Evans believes the RBA has given guidance it will act and that the RBA has a soft easing bias. But, he does not:

“think that the Bank will be quick to act on that bias, notwithstanding the elevated level of the AUD. For now we are comfortable with our call that rates will remain on hold for the remainder of 2015 and throughout 2016. There is time to assess the progress of the household sector and continually test whether above average growth in 2016 is a likely prospect.”


The RBA is doing a good job – they’ll cut again
only if needed


But, that doesn’t mean RBA Governor Stevens is happy about the Aussie dollar. In his statement accompanying the interest rate cut he said:

“The Australian dollar has declined noticeably against a rising US dollar over the past year, though less so against a basket of currencies. Further depreciation seems both likely and necessary, particularly given the significant declines in key commodity prices.”
The key here is that the RBA believes that once the Fed begins to tighten later in 2015, most likely September the market believes, this will support the US dollar and put downward pressure on the Aussie dollar – making it fall toward 75 cents again.

If it doesn’t the RBA has retained an easing bias and will act on it.


Getting ready for the change in US interest rates


You can’t get a clearer message from a central banker that bonds and stocks are overvalued than the one the Fed Chair Janet Yellen gave earlier this month after talking to the IMF about the arcane topic of risk and financial institutions. Yellen said:

“I would highlight that equity-market valuations at this point generally are quite high. Now, they’re not so high when you compare the returns on equities to the returns on safe assets like bonds, which are also very low, but there are potential dangers there.”

The reason this is important is that as the Fed prepares to move raise interest rates for the first since the GFC there is a real risk of market disruption. Even a mini-market crash. The reason for this is that increasingly investors and traders are all on one side of the central bank ‘liquidity trade’ which has driven stocks to all-time highs, bonds to all-time lows, in some cases negative, and which under the guise of unrestricted liquidity have actually lead to a global market which could devolve into one with no liquidity.

Here’s a link to more analysis in an article at Business Insider.

Tying it all together: The RBA is trying to ensure the economic transition takes place in a steady manner and is making room for a further improvement in domestic demand and business investment with the recent rate cut. They will hold for some time now to reassess.

Prepared by Greg McKenna on behalf of Maxim Accounting - May 2015

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