Global Markets Reckon RBA Will Cut Rates This Year

Few topics dominate Markets & Money as much as central banking policy.

No one is expecting a rate cut from the Reserve Bank of Australia (RBA) this afternoon. Market analysts believe the RBA will keep rates on hold at 1.5%. Then, over the next few days, analysts will dissect the language used in the RBA’s media statement.

Whatever comes out of the meeting today won’t really tell you much about the market. That’s because the RBA is missing a key piece of data.

Of course, last week, there was the well-publicised ‘house price slow down’ data. Information from CoreLogic showed property prices in both Melbourne and Sydney declining 1.7% and 1.3% respectively in May.

Other data that rolled in for May wasn’t all that hot either. Retail sales grew 0.1%. Wage growth was up 0.5%, keeping the year-on-year figure at 1.9%. And the total value of construction fell 0.7%, to $46.4 billion.

The problem is, first-quarter gross domestic product (GDP) won’t be released until tomorrow. After the surprise December quarter increase of 1.1%, we don’t know exactly how much falling commodity prices have affected Q1 GDP just yet.

I wouldn’t get too comfortable. Knowing the iron ore price has fallen over 50% since December last year, that retail sales are a whiff above nothing, and that construction declined in May, I’d say the economy is in a little more trouble than we realise.

However, because of the timing of the GDP figures, the July meeting is likely to give us a better indication of what the RBA’s next move is.

Although, if we look to Bloomberg’s recent data, global markets are forecasting a rate cut from the RBA this year, writing:

Since the Reserve Bank of Australia’s last policy decision on May 2, market bets on an interest-rate cut by the end of this year have doubled. While that chance is still only about 20 percent, swaps traders see Australia as one of just two developed economies where cuts are possible in the coming year after data during May pointed to anemic growth in the first quarter.

While reports since the RBA’s last meeting show strong employment gains and a surprise rebound in retail sales, construction has been soft and wage growth stagnant. Signs of a cooling housing market could also give the central bank leeway to ease down the track, after prices dropped in May for the first time in 18 months.

Bloomberg suggests that Australia and Switzerland are the only advanced economies where markets are betting a rate cut is coming…

Advanced economies

Source: Bloomberg
[Click to enlarge]

Australia’s chances are far higher than Switzerland’s by the look of it. Going on the chart above, we may be looking at a 0.5% rate cut coming our way.

Quite frankly, a 0.5% rate cut in the next six months would be fairly drastic. That means our cash rate would drop to 1%. Giving us a new record low, from the current record low of 1.5%.

Our yield advantage gone

Even if the RBA had all the GDP data in front of them, it may not matter anyway.

A rate cut from the RBA will potentially weaken the Aussie dollar and lead to us importing inflation. But that’s not the inflation they want.

The RBA is after economic-expansion based inflation, not imported inflation.

A lower Aussie dollar will be good for our commodity sector and other export-reliant businesses. But a weaker Aussie dollar will drive up prices for consumers. Because we import so many goods, a lower currency means that you’ll pay more for general items.

On the other hand, a rate increase could start to reveal some of the ugly hidden problems in the housing market, stifle inflation, cripple wage growth, and increase unemployment…and of course slow construction and consumer spending further.

But the RBA has a bigger problem: It is now going up against the US Federal Reserve. The RBA has two choices. It can cut rates this year or sit back and hope the Fed does the dirty work for them.

The general market consensus is that the Fed will raise rates at the June meeting next week. As readers of Strategic Intelligence know, Jim Rickards predicts at least three rate increases by the Fed this year (including the one from March).

Given the Fed funds rate currently sits at 1%, two rate increases of 0.25% will give the US the same interest rate as Australia — 1.5%. Meaning we would have rate parity. Through this, we would lose our yield advantage.

One of the reasons people trade the Aussie dollar is because we tend to have a higher interest rate than other developed countries. The higher interest rate encourages capital into Australia. If the US has the same interest rate as Australia, that will attract more capital into their market, potentially taking it from ours.

If we lose our yield advantage, it would weaken the Aussie dollar, perhaps dropping well below 70 US cents.

It could be that it doesn’t matter what the RBA does next. It just has to ride out what the Fed does.


Shae Russell,
For Markets & Money

Shae Russell started out in financial markets more than a decade ago. Working with a derivative brokering firm, she helped clients understand derivative markets, as well as teaching them the basics of technical analysis. Since joining Port Phillip Publishing eight years ago, Shae has worked across a number of publications. She holds the record for the highest-returning stock recommendation, in which a microcap stock returned over 1,200% in six months. Ask her about it, and she won’t stop yapping on. For the past two years, Shae has worked alongside Jim Rickards as his Australian analyst, translating global macro trends for Aussie investors, and how they can take advantage of these trends. Drawing on her extensive experience, Shae is the lead editor of Markets & Money. Each day, Shae looks at broad macro trends developing around the world, combining them with her distaste for central banks and irrational love of all things bullion.

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