Goldman Sachs Says No US Rate Lift-off Until 2017 Ahead of RBA Meeting

Interest rates are back on the agenda ahead of today’s Reserve Bank meeting.

Yet as the RBA sits down to decide on its rate policy, it’s being urged to hold off on more cuts. Mark Crosby, an economics professor at Melbourne University, is leading calls for rates to remain at 2%.

No one, however, expected the RBA to lower rates today. Not least because of the spate of positive indicators coming out over the past week.

The number of advertised jobs rose by 3.9% in September, according to ANZ figures. While you shouldn’t read too much into this just yet, it’s a sign that business conditions are improving.

Meanwhile, the Australian Industry Group reported last month that the services sector was expanding. This suggests the economy is slowly readjusting away from its reliance on mining.

Elsewhere, inflation is on an upward curve. Inflation rose by 0.3% in September, following a 0.1% rise in August. The rate of inflation grew by 1.9% in the year to September. That’s the highest annual rate since November 2014.

In light of all this, it made the RBA’s decision an easy one.

Crosby made an interesting remark about the RBA’s rate policy going forward (emphasis mine):

Despite recent suggestions that the RBA should cut, it would appear unwise to do so in a world where the Fed is now very likely to raise at its next meeting.

Issues with excessive debt remain significant in many economies, and Australian ought not to exacerbate potential problems on that front through cutting rates.

The medium term question is still how rates become normalised’.

Instead of cuts, he advises the RBA should start lifting rates over the next six months. Will that happen? Not likely. And it all comes back to the future of US interest rates.

As present, markets remain convinced the US Federal Reserve is cutting rates this year. That’s happening even as expectations for a rate hike fall in the US. Yet here in Australia, the message isn’t clicking. The Aussie dollar even climbed to US$0.71 against the greenback today because of this false belief.

Why Aussie markets believe this is unclear.

During September the US economy added 60,000 fewer jobs than expected, at 142,000. The participation rate, showing the number of people looking for work, fell to 62.4%. And just a few days ago, the Atlanta Fed slashed its Q4 GDP forecast from 1.8% to 0.9%.

Over in the US, the discussion on interest rate policy has performed a U-turn. Many experts now see the Fed holding off until next year at the least.

Goldman Sachs says no US rate hike until 2017

The direction of US rates is likely to influence the RBA’s own policy. As you probably know by now, higher US rates would ease the pressure on the Aussie dollar. Which is a key pillar of the RBA’s strategy in boosting the Aussie economy over the long term.

Yet the RBA shouldn’t be expecting any US lift-off soon.

Have a look at what Goldman Sachs had to say on US interest rates a few weeks back (emphasis mine):

Our own answer to that question has long been 2016. In fact, our own view is similar to that of Chicago Fed President Charles Evans, who recently shifted his call from early 2016 to mid-2016. Although it is definitely possible to rationalize a December 2015 liftoff using various forms of the Taylor rule, there are two good reasons to delay the move longer.

First, the risk of hiking too early is bigger than the risk of hiking too late when inflation is so far below target and we have spent so much time stuck at the zero bound. Second, we have seen a sizeable tightening of financial conditions. At this point, our ”GSFCI Taylor rule” suggests that the FOMC should be trying to ease rather than tighten financial conditions. Our own view is terms of optimal policy is quite strongly in favour of waiting well into 2016.

Then, overnight, Goldman Sachs dropped this doozy on markets (emphasis mine):

Further bad news on output and employment could potentially result in quite a large shift in the monetary policy outlook. When the starting point for growth is far above trend, a given slowdown merely delays the point at which the labour market hits full employment, inflation pressure rises more significantly, and standard monetary policy rules call for lift off.

But when the starting point for growth is only modestly above trend, as it probably is right now, the same slowdown might halt the move towards full employment and greater inflation pressure entirely.

In that case, standard monetary policy rules might justify a continuation of the current zero-rate policy for much longer, well into 2016 or potentially even beyond. In this context, it is interest that the reduced market-implied probability of lift off in 2015 after Friday’s weak employment report mostly translated into a high probability of lift off not in 2016 but in 2017.

In the space of a couple of weeks, Goldman’s forecast has gone from mid-2016 to 2017! And yet we still have people like Mr Crosby who predict a November rate lift-off…

What it all means for the RBA and the Aussie economy

Quite simply, the longer the Fed delays hiking rates, the harder it’ll be for the RBA to hold off. Again, that’s because its plank for economic growth relies on a weak dollar. Without that, sectors like education and tourism aren’t likely to lead a rebound.

So the question for the RBA remains one of rate cuts, not rate hikes. Markets forecast a 30% chance of an Aussie rate cut by November. By December, the likelihood stretches out to 50%.

Yes, the past week has provided a bit of good news for the economy. But whether that persists over the long term is questionable. We’ll know much more when the Q3 GDP figures are out in November.

But if broader indicators are anything to go by, the jobs market and services growth is papering over the cracks.

Last month, you may have seen that both the balance of trade and terms of trade plunge. I wrote about this at the time:

The last quarter, between April and June, was the worst stretch we’ve seen in over three years [for the balance of trade]. Here are the figures for the last three months, starting from April: $4.15 billion; $2.677 billion; $2.99 billion. Prior to that, we only had one month, out of the last 18, where the deficit rose above $2 billion.

At the same time, Australia’s terms of trade (TOT) is getting worse. Unlike the BOT, it refers to the price of exports in terms of imports. In other words, you can look at this as the amount of imports we can buy for every unit of exported goods.

Worryingly, the TOT fell by 2.9% in the first quarter of 2015. In the last year, the figure has slumped by 11.4%.

As a nation, we’re importing far in excess of what we export. And, as the TOT suggests, our exports make us less than they used to. It means that we can’t rely on exports to keep the economy as stable as it was during the mining boom.

For every bit of good news, there’s a lot of bad news bubbling beneath the surface.

Of course, economists like Crosby are right about one thing. Rate cutting would achieve little at this point. All it really does is raise debt levels across the economy. But the RBA’s entire economic growth strategy revolves around a weak dollar. So it won’t be able to help itself.

Until the Fed starts hiking rates, which looks increasingly unlikely even in 2016, there’s only one direction Aussie rates are heading: down.

Mat Spasic

Contributor, Markets and Money

PS: The Reserve Bank is likely to hold interest rates at 2% when it meets today.

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