Is the Reserve Bank’s glass about to become half-empty?
Half full or half empty? The RBA’s optimistic outlook and its plans to raise rates may be about to change. (ABC RN: Jeremy Story Carter)
In July last year, the Reserve Bank slipped an important phrase into its board meeting minutes, informing all and sundry “the next move in the cash rate would more likely be an increase than a decrease”.
This week in finance:
- Banking and financial services royal commission report tabled (Monday)
- RBA rates meeting (Tuesday) and Statement on Monetary Policy (Friday)
- Company results season starts with CBA (Wednesday) the main interest
That phrase has dominated interest rate discussions here ever since, affecting everything from the amount you pay for loans to the value of the Australian dollar.
The “next move is up” thesis reflected a sense of optimism; the economy would accelerate, a tightening labour market would drive up wages, consumers’ animal spirits would rise and inflation would rise back to where the RBA wanted it — the glass-half-full view of the economy.
Others argue it could have been achieved with another rate cut or two earlier, but the RBA believes the historic low of 1.5 per cent is just right to get things going without blowing a monetary head gasket.
The RBA shut up shop in December in a chipper mood, stout in its conviction the economy would resume motoring along at above 3 per cent growth and of course, “the next move in cash rate was more likely to be an increase than a decrease”.
Economy going flat
The past couple of months has not been kind to the glass-half-full outlook.
For a start, many of the RBA’s central banking peers overseas have been sounding increasingly dovish during the two months the RBA shut down communications (or “chilled out” as former governor Glenn Stevens would have it).
Locally, house prices have continued to fall, gnawing away at household wealth.
Inflation has remained stubbornly below the lower reaches of the RBA’s 2-to-3 per cent target. After three years below the target band, it is fair to say a trend has developed.
Credit is drying up, which is not a remedy for already weak household consumption.
Offshore, things are perhaps even more bleak. Parts of Europe are in recession. The bits that are not do not look too flash either.
China is struggling, with another batch of data last week showing manufacturing activity was still contracting despite renewed efforts at stimulus.
With US statisticians now back at work, their latest numbers to be dropped this week are expected to show GDP growth has slowed markedly in the fourth quarter to around 2.6 per cent from 3.4 per cent previously.
While the RBA has remained rooted to the spot — as it has for almost two-and-half years — the market has not.
Pricing on the RBA cash rate has swung from a 50 per cent chance of a hike by 2020 to 50 per cent chance of cut instead.
The market has shifted from betting the next rate move is up, to a 50pc chance of a cut by July next year. (Source: ASX)
Interest rate pivot
So will this week be a pivot point for the RBA’s thinking?
Many in the market think so, and there will be plenty of opportunities for the RBA to articulate a fresh approach as communications with the outside world are resumed.
The board will hold its first rate-setting meeting for the year on Tuesday.
Governor Philip Lowe addresses the national Press Club on Wednesday and perhaps more importantly, the RBA will release updates of its key forecasts in Friday’s quarterly Statement on Monetary Policy (SoMP). The board minutes will follow a couple of weeks later.
There is the slimmest of chances the RBA could announce a surprise cut, as it did in early 2015, but the weight of money is on the cash rate holding at 1.5 per cent for the 27th consecutive meeting.
Morgan Stanley’s Daniel Blake says while he doesn’t expect the RBA to move, he expects its forecasts to be downgraded.
“The recent data flow implies that the RBA’s 2018 GDP forecast of 3.5 per cent is unlikely to be achieved. We also think its 2019 forecast for 3.25 per cent looks optimistic,” Mr Blake said.
For the record, Morgan Stanley has 2.5 per cent GDP growth pencilled in for this year.
Mr Blake believes while the RBA may soften its language, it is not about to change its bias towards cutting rates — just yet.
RBC rates strategist Robert Thompson says the key thing to look for is whether the RBA trots out its well-worn “next move is up” phrase.
“Well aware of market pricing and speculation, the omission of this phrase would signal a shift to neutral and somewhat less confidence in the set of macro forecasts,” Mr Thompson said.
Mr Thompson said given the increasingly dovish tone creeping in to the language of the other big global central banks, it is likely the RBA will hit the delete on any mention of rates being raised.
However, don’t expect the dollar to crumble on the news.
The market is already well ahead of the RBA and started pricing in the possibility the “next move is down” some time ago.
Downbeat central banks fire up the market
The shift to more cautious central bank commentary has continued to push global equity markets higher.
Wall Street finished solidly, gaining 1.6 per cent over the week.
The ASX fell over the week, but futures trading points to a healthy opening on Monday.
Markets on Friday’s close:
- ASX SPI 200 futures +0.3pc at 5,821 ASX 200 (Friday’s close) flat at 5,863
- AUD: 72.5 US cents, 63.3 euro cents, 55.4 British pence, 79.4 Japanese yen, $NZ1.05
- US: Dow Jones +0.3pc at 25.064 S&P500 +0.1pc at 2,707 NASDAQ -0.3pc at 7,264
- Europe: FTSE +0.7pc at 7,020 DAX +0.1pc at 11,181 EuroStoxx50 +0.4 at 3,171
- Commodities: Brent oil +3.1pc at $US62.75/barrel, Gold -0.2pc at $US1,318/ounce, Iron ore $US87.30/tonne
However, the essential paradox of ploughing into the market on downbeat commentary remains in place.
Federal Reserve chair Jerome Powell’s more dovish stance has been taken as a nod and wink that he and his FOMC colleagues are done with raising rates for the time being.
Mr Powell’s view the Fed has “the luxury of patience” in deciding whether to raise rates again is very much hedging against an economic downturn later in the year.
“Both the stock and bond markets applauded the Fed for its more dovish tone,” Michael Arone, chief investment strategist at State Street Global Advisors told Reuters.
“If you take a step back and evaluate why they’re doing it, it’s because they’re concerned. So why shouldn’t investors be concerned?”
On planet Wall Street, it seemed every positive statement from the Fed and Mr Powell last year triggered a selling frenzy.
It will be interesting to see what a little negativity can do.
The cooling Australian economy has started showing up in earnings forecasts downgrades ahead of the February results season that kicks off this week.
There has also been a welter of profit warnings through “confession season” — fruit grower Costa, building products suppliers GUD and James Hardie, developer Lend Lease, cement maker Adelaide Brighton, Bluescope, Graincorp and Bega Cheese to name a few.
Citi strategist Tony Brennan says the reporting season could be a tough one for investors.
“While analysts have been downgrading their earnings forecasts across a number of sectors, so far their depth has not been that great,” Mr Brennan said.
“The declines in financial markets and commodity prices will be being factored into analysts’ forecasts, but the apparent further slowing in the housing market and weaker business conditions domestically seem less likely to be fully taken account of.”
It could be a tough results season according to equity strategists at Citi. (AAP: Paul Miller)
Earnings-per-share growth across the market had been pencilled in at 7 per cent after the August reporting season. It is now closer to 4 per cent and falling.
Mr Brennan forecast nasty surprises would outnumber the pleasant ones in coming weeks.
“Overall, Citi company analysts seem to give an impression of mixed conditions, challenging for sectors like banks, diversified financials, telecoms, and discretionary retailing, but more encouraging in insurance, engineering, and grocery retailing, while reasonable for resources, building materials, REITs [property trusts],” he said.
As usual it is not a frantic start to the season.
This week around 15 big companies are reporting, mainly half-year results including James Hardie (Tuesday), CBA and IAG (Wednesday), Mirvac and AGL (Thursday) and Newscorp and REA (Friday).
CBA’s challenging times
CBA is expected to unveil a flat underlying half-year profit of $4.9b this week (Reuters: Edgar Su)
CBA boss Matt Comyn could probably have done without fronting the bank’s interim results presentation two days after the banking royal commission’s final report is dropped, but then again that’s why they pay him the big bucks.
The question-and-answer sessions with both media and analysts is expected to be dominated by issues raised by the commission. CBA has more questions to answer than most.
UBS bank analyst Jon Mott compiled a list of topics to be dealt with even before the top and bottom line numbers are discussed.
“CBA is likely to face questions on responsible lending — including verifying customers’ financial positions — mortgage broker commissions, remuneration structures, further remediation costs, regulatory and compliance technology spending and the economic impact of the credit squeeze,” Mr Mott said.
Cash profit — the bank’s preferred measure that strips out one-off gains and losses — is expected to come in at around $4.9 billion for the first half, pretty much the same as last year.
However, as they say in the trade, it will be a pretty messy result given businesses being sold off, internal restructuring and restatements associated with costs arising out of its numerous legal and regulatory “issues”.
Most analysts expect CBA to announce another round of cost-cutting, but it is hard to see it fully bedded-down just a day and half after the royal commission’s recommendations hit.
Mr Mott remains “neutral” in his view on CBA as an investment proposition and cautious about the sector in general.
“The outlook for the banks is very challenging and is likely to deteriorate further as the housing market falls sharply,” Mr Mott said.
|Royal Commission final report||The report will be publicly aired after the market closes at 4:15pm (AEST)|
|Building approvals||Dec: Sharp drop in November due to apartment slow-down. Downward trend to remain in place|
|RBA rates meeting||Official cash rate to hold at 1.5pc|
|Trade balance||Dec: Surplus expected to expand further to $2.5b over the month on bulk commodity exports|
|Retail sales||Dec: Feedback from shops pre-Christmas wasn’t great. Expect weak growth, contraction possible|
|RBA speech||Governor Philip Lowes addresses the National Press Club in Sydney. Q&A bit will be interesting|
|Company results||CBA & IAG half year results|
|Business confidence||Q4: Should detail the the crumbling confidence appearing at the end of the year|
|Company results||AGL, Downer & Mirvac half year results|
|RBA Statement on Monetary policy||Downgrades to forecasts for GDP and inflation expected|
|Company results||News Corp & REA half year results, NAB Q1 update|
|US: Factory & durable good orders||Nov: Release of data held up by governmnet shut down. Likely to be a marginal uptick|
|CH: Lunar New Year Holiday||Markets closed|
|US: GDP||Q4: Likely to throttle back to 2.6pc from 3.4pc in in Q3|
|EU: Retail sales||Dec: Flat|
|US: Retail sales||Dec: Also flat|
|US: Trade balance||Nov: Data delayed by goverment shut down, deficit of around $US55b|
|UK: BoE rates meeting||Rates on hold at 0.75pc|
|US: Trade balance||Dec: Statisticians catch up after the shutdown. Deficit remains around $US55b over the month|