AUD executes the pop and drop

Posted on September 22nd, 2017

The AUD executed a pop and drop around the FOMC as the market moved from focusing on over-blown expectations of looming rate hikes in Australia to weaker commodity prices.  Signs that the slowdown in the Chinese property market is accelerating add to weaker fixed asset investment growth to suggest that steel prices will fall further.  The housing market in Australia may be on the brink, and Amazon is about to crash the retail party.  Australian equities are underperforming global markets.  RBA governor Lowe told the rates market to cool its heels, again.  The rise in medium and long-term yields in Australia relative to the USA looks misplaced considering how highly leveraged are Australian households.


Chinese property market slow-down accelerated in August

In our report earlier this week, we noted that the weaker Chinese steel-making commodity prices appeared to reflect weaker fixed asset investment growth and rising steel inventory (albeit from low levels). (AUD facing growing headwinds –

The latest housing market data in China also show an acceleration in its slowing trend this year, and may further weigh on sentiment in the steel market.

Price growth of newly built residences in first-tier cities slowed to 4.8%y/y in August (from 25% at the beginning of the year and a peak in April 2016 of 31.5%y/y).  Third tier cities have seen increasing price growth this year, but this has flattened out in recent months, easing a bit in August to 8.2%y/y.

Monthly prices fell in first-tier cities in August by 0.3%m/m, the weakest result since 2014. Third-tier prices rose 0.4%m/m, the smallest increase since January.

A diffusion index of monthly price increases less decreases in 70 major cities fell for new and ex-subsidized homes in August from 47 to 28.  For existing homes, the DI was steady at 43 in August, from July, but is down from a peak of 62 in March.

Chinese steel price falls accelerated on Thursday, after the FOMC meeting.  Iron ore prices have reversed about two-thirds of the rise from the low for the year in June, to the recent high in August.


AUD yield support may have peaked

The AUD had been strong ahead of the FOMC as Australian rates were rising even faster than recovering US rates.

There have been solid domestic growth indicators through much of this year in Australia; notably in employment growth and private and public sector investment in the non-mining sector that might help justify a rising rates outlook.  However much of this more buoyant outlook for rates appeared to arise from global trends in monetary policy rather than a holistic view of conditions in Australia.

There were some in the market looking for more hawkish language from RBA Governor Lowe in his speech on Thursday.  When he stuck to the more ‘steady-she-goes’ rhetoric that has featured through the year, rates in Australia gave up some recent improvement relative to US rates.  The AUD fall that began after the FOMC accelerated, forcing recently bullish traders to cover, and shifting investor focus from rates back to weak commodity indicators.

The Australian rates outlook is probably about right now, but we see little scope for rates to rise much further for the time being at least.  And if they do, they are more likely to lag developments abroad.

As we mentioned in our report earlier this week, “compared to improving trends in many major and emerging economies, less leveraged to fixed asset investment in China, the Australian outlook is not so special.”

There remains significant slack in the labour market, wages growth remains subdued, the housing market now appears to be slowing more clearly, and Chinese commodity demand appears to be weakening.

The market is now pricing in a full hike by around Q3 next year, accelerating to price-in two hikes by around end-2018.  Considering that Australia may be much more sensitive to interest rate rises than other countries (owing to high household debt and high house prices), the recent resurgence in medium to long-term rates in Australia (rising more than in the USA) seems less sensible.



House price slowdown a risk for Australian economy and rates outlook

The data is showing resilience in the housing market, although there are some tentative signs that demand has slowed.  CoreLogic weekly data on capital city house prices remains buoyant, with monthly house price gains at 0.7% over the last year; but there has been more volatility this year.  Auction clearance rates are at around 70%; still solid, but down from high levels in the first half of this year and late 2016.

The RBA policy minutes from its 2-August meeting noted weakening in the Sydney housing market.  It said, “In the established housing market, a number of indicators suggested that conditions had eased in Sydney, but to a lesser extent in Melbourne.”  It referred to weaker prices, auction clearance rates and auction volumes in Sydney (although not yet in Melbourne).  And it said, “Rent increases had remained low in most cities and rents had continued to decline in Perth.”

It also continued to note that, “In the eastern capital cities, a considerable number of new apartments was scheduled to be completed in the period ahead.”


Australian equities under-performing

Australian equities are significantly underperforming other major and emerging market equities.  Until recently the strongest sector has been its resources/materials sector.  However, this sector has turned down recently with weaker commodity prices.

Australia’s largest sector (financials) has underperformed global banking stocks.  Australian banks are finding themselves under more regulatory scrutiny recently after a series of scandals, and under increased pressure to improve mortgage lending standards.  While considered highly profitable safe investments, banks earnings will be in the firing line if the housing market does turn down.

Australia’s retail sector is under pressure from the Amazon that is reported to be expanding its on-line retail business in Australia.  There has been speculation that Amazon will open a dedicated Australian online website in the next month or two.

The RBA noted in its minutes that retailers were already engaging in a price war in Q2.  It said, “retailers had discounted prices to achieve sales, which meant that growth in nominal retail sales had been more modest.”

Amazon to crash Christmas, says Citi – The



RBA Governor Lowe holds the line

RBA Governor Lowe provided subtle reassurance that rates policy is currently on a stable path, notwithstanding a global trend towards less monetary accommodation.  This let a bit of wind out of the sails of some looking for signs he might be gearing up for a hike.

A steady hand

He concluded, “Over recent times, the Reserve Bank Board has not sought to overly fine-tune things. We have provided support and allowed time for the economy to adjust to the new circumstances. In its decisions, the Board has been careful to balance the benefit of providing this support with the risks that can come from rising household debt. As things currently stand, we look to be on course to make further progress in reducing unemployment and moving towards the midpoint of the medium-term inflation target.”

Not following global policy tightening

On global monetary policy trends, He said, “A rise in global interest rates has no automatic implications for us here in Australia. Notwithstanding this, an increase in global interest rates would, over time, be expected to flow through to us, just as the lower interest rates have. Our flexible exchange rate though gives us considerable independence regarding the timing as to when this might happen.”

Households more interest rate sensitive

One theme he spoke of was the dampening impact high household debt is likely to have on the Australian economy.  He said, “It is likely that higher levels of household debt change household spending patterns. Having increased their borrowing, households are less inclined to let consumption growth run ahead of growth in incomes for too long. Higher levels of debt also mean that household spending could be quite sensitive to increases in interest rates, something the Reserve Bank will be paying close attention to.”

China adjustment risk

While speaking confidently about the longer term prospects of Australia’s linkages to China and Asia in general, “the fastest growing part of the global economy”, Lowe noted near-term risks related to China’s adjustment. He said, “There are risks on the horizon, with the Chinese economy going through some difficult adjustments. One of these is the switch from a growth model based on industrial expansion to one based more on services. Another is managing an increasingly large and complex financial system. Australia has a strong interest in China successfully managing these challenges.”

Domestic economy on the right track

On the domestic economic front, there are signs that the recovery has sustainable above trend momentum with stronger non-mining sectors and bottoming out in the mining investment downturn. He said, “Business conditions, as reported in surveys, are at the highest level in almost 10 years. There are also growing signs that private investment outside the resources sector is picking up. …. . According to the June quarter national accounts, private non-mining business investment increased strongly over the first half 2017, to be around 10 per cent above the level at the start of 2016. Non-residential building approvals have increased to be above the levels of recent years and there is a large pipeline of public infrastructure investment to be completed. The decline in mining investment has also largely run its course.”

What RBA is watching

Lowe noted the things the RBA are watching for confirmation that policy is on the right track.  He said, “We would like to see the improvement in business investment consolidate and a continuation of job growth at a rate at least sufficient to absorb the increase in Australia’s workforce. Some pick-up in wage growth in response to the tighter labour market would also be a welcome development. So these are some areas to watch. But as things stand, the economy does look to be improving.”

Rates more likely to go up, but not for some time

WSJ journo James Glynn reported that in Q&A, Lowe said he noted that markets are pricing that interest rates will go up rather than down. “I’d agree with that. The second is that it’s some time before an interest rate rise will occur and I’d also agree with that. “The market pricing moves around from day to day but those two points are right. More likely it will go up but it’s not for some time.”

RBA’s Philip Lowe says borrowers should prepare for cash rates to move higher – The

The Next Chapter; Philip Lowe; 21-Sep –