A bigger wedge between commodities and the AUD needed to move the RBA

Posted on November 25th, 2015

The chilled-out RBA suggests that there needs to be a significantly bigger wedge driven between the AUD and commodity prices to bring rate cuts back onto the table.  With a considerable amount of domestic data, Chinese data and global policy developments, the outlook for the AUD is uncertain, but near term risk is leaning toward a rise towards 0.75.  The GBP has come under pressure as the BoE continues to down-play the outlook for policy tightening.  The BoE also appears likely to deploy countercyclical macroprudential measures enabling low-for-longer rates.  US economic reports in the last week have pointed to somewhat softer activity and may encourage thoughts of a slower pace of rate hikes beyond December. A speech by Yellen next week will be watched closely, as should the PCE deflator due tonight.  In contrast, recent Eurozone data has been resilient, suggesting the ECB does not need to pull out all stops with policy easing next week (even though it may still do so).  With some uncertainty over US data and the path of policy tightening, we see a case for selling GBP against the JPY.


RBA Stevens gets even more laid-back

RBA Governor Stevens has taken his chill pills and offered no assessment of the exchange rate in his speech on Tuesday.  The AUD has exhibited a more positive technical picture over recent weeks, and indeed has established a series of higher lows since September.

While this has been counter to the recent broader decline in commodity prices, it is consistent with evidence that the Australian economy has picked up momentum supported by stronger services sector growth.  Rate cut expectations have also been whittled down.  The RBA and more commentators can see the light at the end of the mining investment down-turn tunnel, even though the tunnel might seem longer and darker if you were to consider the trends in Chinese demand and commodity prices.

RBA Governor Stevens’ relaxed style appears to be getting more laid-back as he starts to hand the mantle over to the next group of leaders at the RBA with his retirement expected in September next year.

His Q&A session after the speech, a time when most central bankers are careful to stay on message, revealed more about the Governor’s frame of mind than usual.

The tone suggested it is going to take clearer evidence of downside risks for growth and inflation for the RBA to move policy.  December was always unlikely, but it is ice-cold now.  The next opportunity is the board meeting at the beginning of February.  A lot can happen in a little over two months, but recent positive momentum in non-resource sectors will fuel the possibility that the low for rates is in, sufficient to drive a bigger wedge between the AUD and commodity prices.  In fact it appears that wedge needs to grow quite a bit further to make the case for a rate cut in Australia.  Considering the technical picture for the currency, I wouldn’t feel comfortable re-selling the AUD until it was close to 0.75.

Domestic Australian data in focus

Stevens felt no compunction to reiterate the global risks to growth (most obviously weaker commodity demand from China) and continued to express more confidence in the domestic economy. The spotlight now turns to the economic data including the capital investment survey due tomorrow, credit growth and business indicators that feed into the GDP report on Monday next week, the current account, net exports, building approvals, house prices, and manufacturing PMI on Tuesday, the Q3 GDP report on Wednesday, services PMI and trade balance on Thursday and retail sales on Friday.  And the week after includes business and consumer confidence and the employment report.  On recent trends the data seem more likely to support the AUD than not.

Chinese data and global policy developments

The more negative risks for the AUD over coming weeks come from abroad with Chinese industrial profits data due on Friday, manufacturing and service sector PMIs due on Tuesday next week.  The following weekend on 8 Dec, Chinese trade data are released, followed by Chinese activity and credit data including industrial production, fixed asset investment and retail sales, and total social financing in the week of 10 to 15 Dec.

Interspersed with these reports are two very important central bank meetings.  At one end the ECB is expected to deploy further significant monetary easing on Thursday next week (3 Dec) albeit after it sees an advanced estimate of CPI inflation the day before.  This might be viewed as supportive of the AUD, helping support growth in Europe and global risk appetite.  On the other hand, it may be viewed as negative as the ECB escalates the currency war, dragging growth away from Asian exporters and weakening currencies in the region.

USA Federal Reserve policy tightening appears likely on 16 December.  Next week on Tuesday, Fed Chair Yellen speaks to the Economic Club of Washington.  This may be crucial for setting up market sentiment into the Fed meeting.  If Yellen emphasizes a forecast for gradual policy tightening and risks from a stronger USD and weaker emerging market economies, then this may blunt positive the impact of rate hike expectations on the USD.

Commodity price trends and OPEC meeting

The weaker trends seen in commodity prices recently may have further implications for global market conditions, raising the risk of financial stress in these sectors spreading to broader asset markets and investor confidence.  Alternatively, Saudi Arabia’s suggestion that it may work with other producers to stabilize the oil price may help lift commodity prices for a while and reverse some recent damage to investor confidence in this sector.  OPEC ministers are due to meet on Friday next week (5 Dec).

Australian budget Update may be less supportive

Less supportive for the AUD may be the Australian Government’s Mid-Year Economic and Fiscal Outlook (MYEFO) due in mid-December.  The Deputy Secretary of the Australian Treasury, the government department responsible for the nation’s budget forecasts, Nigel Ray, said that it had lowered its projection for the growth potential of Australia from 3.0% to 2.75%.

This reflects both a lower rate of population growth and a lower estimate of average hours worked.  He said that this would lower the Treasury’s forecast of the budget balance.

Not mentioned by Ray, but a factor nonetheless, is that lower commodity prices are also likely to weigh on the government’ budget outcomes, and one might expect this to also dampen the budget estimates.

The MYEFO is due for release in mid-December.  Ray said that the estimates for the report will be finalized next week after the latest GDP report is releases.  Lower budget estimates may dampen confidence somewhat.

The lower potential growth rate for Australia has also been mentioned by the RBA in its recent reports as a factor that may have prevented a larger rise in the unemployment rate.  Less employment growth is now required to sustain the same rate of unemployment.  From a monetary policy perspective the lower potential growth rate might result in less rate cuts in the current cycle, but also suggests that interest rate may not rise as much as previously thought in the longer term.

This cuts both ways for the AUD, but most immediately it is part of the narrative why the RBA is not rushing to cut rates further and is providing a measure of support for the AUD.


What they said

  • RBA Governor Stevens Q&A: Asked why he not cut rates…. Was it because the Bank believed the economy was picking up, or was it because a further cut from already low levels would hurt the incomes of retirees who lived off interest. RBA Governor Steven’s replied, “You are making the case for us to sit still.” … “It is an idea I happen to agree with.”…. “The question I ask is: how do you make growth better?”…..”It may be you can make it better by lowering rates, it may be that you can make it better most effectively by articulating a case for stability, playing to the positive things that are happening, not smashing the savers over the head further, if the relative effect of that stimulating is not as great as it used to be.” ….. “I am more than content to lower rates if that actually helps” ….. “But is that the best thing to do at any particular time, that’s the question that I frame.”….”As for February, you know that’s three months away,” …. “We’ve got Christmas, we should just chill out, come back and see what the data says.”  (RBA governor Glenn Stevens indicates interest rates to stay on hold in December – SMH.com.au).
  • RBA Governor Stevens’ speech: “A number of data points over recent months suggest that prospects for firmer conditions in the non-mining economy are improving. Business surveys indicate that firms report conditions to be, if anything, above their long-term average in some key sectors. Firms seem to have stepped up their hiring. Job vacancies have been increasing, hours worked have been increasing and employment growth, even before the most recent month’s data, had strengthened noticeably over the past year. Labour force participation has risen, and the unemployment rate has been stable. This is supporting income growth as the terms of trade decline works its way through the economy.”
  • Reflecting the lower Q3 inflation data and low wage growth trends, “The Board concluded that inflation would not be a barrier to further easing of monetary policy, should that be useful to support demand.
  • “The growth transition [in China] towards services will have implications not just for the value of resource shipments from Australia, but for the Asian regional manufacturing chain.”
  • “China’s demographics are not favourable. To be sure, the continuing process of urbanisation means that the labour available for manufacturing or services production may grow for a while. But, overall, China’s total working-age population will be shrinking over the years ahead. Contrast this with India, another large country, but with vastly different demographics. India’s population of working age will exceed China’s within a decade and continue to grow. So India should become much more prominent in our conversation about the global economy and our own. Are we intellectually prepared for that?” (The Long Run, Address to the Australian Business Economists (ABE) Annual Dinner, Glenn Stevens – RBA.gov.au)
  • Nigel Ray, Deputy Secretary, Australian Treasury: “Taken together, the latest data on the population and labour force trends suggest that potential output will be lower than estimated at Budget. We now think potential GDP will grow by around 2¾ per cent over the next few years, lower than the 3 per cent estimated at Budget.” … “It is reasonable to conclude that the changes to population and hours worked that I have outlined would, everything else equal, lower the path of the projected underlying cash balance.” (The Macroeconomic context, Address to the Australian Business Economists Conference, Nigel Ray – Treasury.gov.au)


Economic news

  • Australian skilled vacancy trend data slowed from 1.1%m/m in Sep (revised down from 1.8%m/m) to 0.6%m/m in Oct. The seasonally adjusted data fell 1.6%m/m in Oct after rising 4.3%m/m in Sep; the 3mth moving average was +0.6%. The data take some steam out of the recent run of strong vacancy data.
  • Australia: Construction Work Done fell 3.6%q/q in Q3, after rising 2.1%q/q in Q2 (revised up from +1.6%). The data were lower than an expected fall of 2.0% in Q3.  Over the last year, CWD is down 2.6%, declining for around two years after forming a peak around 2012/2013.  The data reflect the mining investment downturn.  Engineering construction fell 7.3%q/q in Q3 after rising 4.5% in Q2; down 11.7%y/y.  Residential building rose 2.0%q/q in Q3 after falling 1.5% in Q2; up 12.4%y/y.
  • New Zealand: foreign tourist spending rose 38% in year ended September.
  • USA: GDP revised up from 1.5% to 2.1% in Q3 q/q saar, as expected. Personal consumption revised down from 3.2% to 3.0%, weaker than unchanged expected.
  • USA: Case Shiller house price index rose 5/5%y/y in Sep, up from 5.1%y’y in Aug, higher than 5.2% expected.
  • USA Conference Board consumer confidence fell to 90.4 in Nov, the lowest reading in over a year, significantly weaker than 99.5 expected, down from 99.1 in Oct, revised up from 97.6. The Jobs plentiful sub-component in the survey fell for a second month from 22.7 to 19.8 reversing gains in Aug/Sep.  The data is at odds with the recent recovery in the Michigan consumer confidence, but is more consistent with ebbing in the weekly Bloomberg Consumer index.  Overall confidence appears down from cyclical peak levels around the end of 2014, but still at reasonably healthy levels; around the best since 2007.
  • USA: Richmond Fed manufacturing index fell from -1 to -3 in Nov, weaker than +1 expected. The three month average of -3 is the lowest since 2012, suggesting manufacturing is proving to be a more significant drag on the nation’s economy.
  • USA: Trade deficit narrowed from $59.15bn (revised wider from 58.63bn) to 58.41bn in Oct, narrower than 60.90bn expected. Exports fell 2.6%m/m, Imports fell 2.3%m/m.
  • German IFO survey of the business climate firmed from 108.2 to 109.0 in Nov, above 108.2 expected, a high since Jun-2014, consistent with the improvement in the PMI’s reported yesterday.
  • UK CBI Retail Sales monitor index of reported sales fell from 19 to 7 in Nov, a low since Feb, much below 25 expected. Sales for this time of year fell from 24 to 4.  However retailers were optimistic that there would be a recovery with expected sales in Dec rising to 31 from 24 in Nov.


In the News

  • BoE Governor Mark Carney told a parliamentary committee that the BoE’s Financial Policy committee could raise capital requirements of banks as a “countercyclical buffer” to dampen the credit cycle. A policy that would allow interest rates to be held lower for longer. A decision may be announced when the Financial Policy Committee reports on 1 Dec. ( Carney hints at temporary rise in capital requirements for banks – FT.com)


On the Radar

  • USA: Wednesday: PCE deflator, Personal income and spending, durable goods orders, Markit services PMI first estimate, new home sales, University of Michigan consumer confidence final estimate for November.
  • Australia: Thursday: Private Capital Expenditure
  • New Zealand: Thursday: Trade balance
  • Japan: Friday: CPI, labour data, Household spending
  • Eurozone: Thursday: Money and credit growth
  • Eurozone: Friday: EC business surveys
  • UK: Wednesday: BBA loans for house purchase
  • UK: Friday: consumer confidence, GDP Q3 revision and components


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