RBA holding still waiting for big waves to hit

Posted on August 17th, 2017

I will keep it brief; this is a quick comment from the road, as I am on a marketing trip this week and next in New York/Boston/London spreading the word about AmpGFX.  Let me know if I have neglected to reach out to you, and you want to see me,  I may be able to squeeze you into my schedule.

You may have noticed that I have been following the AUD/NZD a little more earnestly recently.  Let me dig deeper into that rich albeit now well-mined vein and draw out some thoughts from the RBA policy minutes.


Subdued inflation outlook, RBA talking down AUD

The RBA discussed inflation and commented specifically on market services CPI and the influence of low labour costs.  The market services ex-vol items is the lowest underlying measure at the moment at 0.8%y/y in Q2, up from 0.7%y/y in Q1.

They mentioned a number of factors that tended to downplay the recent rise in inflation, pointing to tobacco excise and utility price rises that could be considered temporary.  And low rent trends in major cities.

They forced the exchange rate into the discussion on their inflation forecasts saying that “the forecasts were conditioned on the assumption of no change in the Australian dollar exchange rate during the forecast period, which extends to the end of 2019, and that this assumption was one source of uncertainty.”

This is just obvious and does not need to be said, but by saying it, raises the exchange rate as a significant policy issue.  They planted it there to continue to discourage the market from pushing up the AUD.

The sub-target outlook for inflation suggests no rush to raise rates even if the RBA is surprised by strength in the economy.

The RBA is trying quite hard by its standards to discourage further gains in the exchange rate, but there is no sign they would consider intervention any time soon, and it is still quite a ways from considering a rate cut to offset further currency gains.  At best it seems a higher exchange rate might delay hikes, but these are considered unlikely over the year ahead anyway.

Their flat outlook for rates probably prevents a big rise in the AUD/USD.

The RBA currency statements are little different than the RBNZ and should have limited bearing on the cross.


Upside risk to investment outlook

However, the RBA minutes commentary on private and public business investment sounded quite upbeat and appears to allude to upside risks to the RBA forecasts that are for a “pick up later in the forecast period”.  But to remain subdued for now.

They cite evidence pointing to a faster pickup sooner: strong business confidence, commercial vehicle sales up, non-res building approvals up, public infrastructure flowing to private order books.

The RBA minutes noted that business investment had picked up internationally, they said, “In particular, growth in business investment had picked up in several advanced and emerging economies, including the United States, Canada, Japan and a number of economies in east Asia.”

It is interesting that the RBA is using the international experience to support their forecast of subdued wage growth, but do not appear to be applying the same thought process to business investment.  If business investment is happening more globally, and conditions and indicators are pointing to the same in Australia, its further reason to expect a stronger recovery in Australia, sooner.


Low bar for labour market improvement

The minutes also talk about the strong labour market this year.  But forecast little further improvement in the unemployment rate.

This is a point of risk for AUD bears.  The RBA has set a very low bar for the labour market to improve faster than its forecasts.  At the end of their forecast period (2+years) they see unemployment only a bit below 5.5%.  Unemployment (5.6%) could improve a lot faster if the recent pace of job growth keeps up.  Especially if business investment rises faster than forecast.


China risks now almost the central case

It does appear that while the RBA has acknowledged stronger growth in China and commodity prices this year, the risk of weaker growth driven by financial sector stress has moved from a tail risk for the RBA to almost its central case.

The minutes and the RBA SoMP released on 3 August spent considerable attention on the subject and, without spelling it out, the RBA appears to have incorporated a significant risk of an economic downturn and financial upheaval in China coming within its current 2 to three year forecast period; even next year, say no long after the 5-yearly leadership reshuffle later this year.

The RBA is more concerned by China risks than most investors in the street; although certainly, it is a fairly mainstream concern.

This does make it hard to get comfortably long AUD.  But on the other hand, the China cloud is causing the market and the RBA to pay little attention to more current evidence of a pick up in economic growth momentum in Australia, and abroad.

There is a risk that the AUD rises suddenly because of a switch in focus from China clouds to domestic economic strength.

The RBA minutes said, “Growth in China was expected to ease in 2018 and 2019 because of structural factors such as a declining working-age population, as well as policies to address financial risks. Members noted that the outlook for the Chinese economy remained a significant source of uncertainty. In particular, it was unclear how the authorities would negotiate the difficult trade-off between growth and the build-up of leverage in the Chinese economy. To address risks in the shadow banking sector, the authorities had recently sought to improve coordination among financial regulators and had announced tighter regulatory measures. Members noted that such measures could be difficult to calibrate and that, as a result, financial conditions might tighten by more than expected.”


Keeping still to avoid rocking the boat

In the final discussion on monetary policy, the RBA board did say that “faster growth in business investment was expected”, somewhat at odds with other areas of commentary, but it also said the overall growth outlook was little changed.

It appears that the outlook for growth and inflation was little changed, in part because the stronger exchange rate since May had offset the improvement in business conditions and the labour market.

But the RBA was discouraging further strength in the currency, implying that it was on the cusp of dampening forecasts.  It said that, “a further appreciation of the exchange rate would be expected to result in a slower pick-up in inflation and economic activity than currently forecast.”  Repeating the wording used in the policy statement and SoMP.

Housing and household debt remain key areas of policy concern, given higher attention and weight in all RBA statements, more so since RBA Governor Lowe took the helm about a year ago.

Like China, this is colouring the RBA’s forecast for growth more darkly than the current trends in the economic data.  It remains a factor that is both restraining the RBA from raising and cutting rates.  The RBA is pleased that macroprudential measures have been added since last year and continues to monitor their impacts.

At this stage, overall credit growth is relatively stable and there is some evidence of moderation in the big city housing markets. The RBA is arguably sitting calmly trying not to rock the household debt boat.