Why Cyprus matters for the RBA

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After a period of calm, Eurogeddon is back. The current form is a Cyprus headache. While it is a surprise to close watchers it has rattled markets. The reason seems to be the risk of deposit flight from weak to strong banks caused those who imagine that a deposit tax might happen elsewhere.

Australia did without deposit insurance for many years, and the Kiwis have (wisely) dumped it again, but in the context of the strongly unbalanced EUR banking system making deposits ‘at risk’ is likely to be destabilising.

The sell side research writes itself at this point. Re-cycle the charts about target-2 imbalances, talk about the limits to this system and the risk of break up, and then add a few lines about capital flight and circle the bits on chart when this last occurred.

The conclusion is fairly straight-forward. Folks exit the EUR for ‘harder’ currency options. They buy bonds in the US, CAD, SEK, AUD etc. This flow (or the anticipation of it) has sent the EUR down and EURUSD vol (1m) back toward the highs reached right after the Italian election — though this remains below the peaks reached in Q2’12, when folks feared a deposit run and breakup.


So does this matter for the RBA? I think that it does. The reason is that it reverses the ‘market easing’ that has given the RBA the scope to sit on the sidelines this year.

I think that the RBA expected to cut rates a little further at the end of 2012, however they have not had to do so this year. In part, this has reflected slightly better demand side data — however easier financial conditions have probably played a more important role than the modest pickup in domestic data. Easier financial conditions predict a later improvement in demand — so if sustained, the RBA would have had confidence that demand growth would improve further.

The main cause of the ‘market easing’ was a re-rating of risk assets (that began following Draghi’s convertibility speech mid’12, and was extended by FOMC’s move to open ended QE). Through this channel, markets have delivered an unusually large boost to household wealth and confidence, as well as easier finance and a lower cost of capital for firms.

These changes work a lot like lower rates (in some cases they are lower rates: such as tighter credit spreads) — by boosting wealth and confidence it boosts household consumption and by lowering the cost of capital and boosting expected returns, it lifts planned investment spending.

Both higher consumption demand and larger non-mining investment are a key part of the transition from a high mining investment economy to a ‘more normal’ economy. I had thought that the RBA would need to cut rates at any case to boost demand when mining investment declined (probably in 2014, if you believe the latest ABS capex survey), but had rolled my call on a near term easing as a result of the rude health of financial markets.

If this Cyprus debacle means that the market easing delivered by higher equity prices and tighter credit spreads is reversed, and business and consumer confidence follows equity markets down, the RBA will need to ease in the near term soon to keep things on track.

This will be especially the case if fresh bond inflows prevent the AUD from falling, as it ought to, when risk markets tank.


    1. true, he had a good call on the recent jobs data. i don’t think it’s as good as the headline jobs number suggested — the stable unemployment rate seems more in keeping with reality to me — but there’s no doubt that a stable labour market is better than consensus has been expecting.

        1. yes i was — and then life got busy. the house was so dirty … :)

          do you think there’s still a story there — i thought there was a little. gross flows seem encouraging. but then i took so long.

    2. So he writes on 08 Mar 2013:

      “Watch the jobless rate. Economists and the RBA forecast it will drift towards 6 per cent. While I think there is scope for it to soften in the near term, I suspect it could start falling again this year. This would be a game-changer. An unambiguous decline in the jobless rate, propelled by an ageing population that shrinks the pool of productive labour, will force the RBA to remove its extreme stimulus.”


      **** I think there is scope for it to soften in the near term, I suspect it could start falling again this year. ****

      The first statement is wrong so far, and everybody has been wrong too. Re the second statement we’ll need to wait for the end of the year. I personally do not think UE will lower than 5.4% by end of year, but we will have to wait. We will also need to look at the participation rate and employment to population rate. UE may not go up, but persons in the workforce may decline (probably why he is thinking the UE will not go up). Full time vs part time is significant too and all have inflation ramifications.

      When you forecast something you need to state to clear numbers. General vagueness is not useful.

  1. Joye has not mentioned nominal GDP figures which are quite weak.

    I do see he has a number of people who support his spin though

  2. If the Fed keep buying 85 bn per month for the next two years (because that’s how long the UE rate could stay be higher than 6.5%), they will have bought an additional 2 trillions of assets. And that is not too risky ?????

        1. okay, that’s true. but i think this is — because it’s clear how the Fed could run out of capital and have a limited ability to sterilise. the exit is technically possible, but the risks of getting it wrong are large.

      1. I think they will not do 2 trillions… they must exit earlier, no matter where unemployment or inflation is. What if after 2 years unemployment is is still up there (likely) and inflation still low (likely too)? They keep buying and buying and buying until it all explodes again? They are playing poker and they are bluffing. But they will fold and the bluff will be called. We’ll see. Just like any other bank, central banks too do not say they have a problem until the very very last second (remember Lehman?). The exit announcement will be sudden.

      2. Why not do 2 trillion? The Fed is not like a regular bank. The BoJ’s balance sheet is much larger than the Fed’s as a % of GDP. Of course, they wouldn’t need to increase it by as much in the long run if they did more in the short run – the whole “Chuck Norris” effect that Lars Christensen has talked about. And a sudden exit would be stupid.

      3. IMO, USA not equal Japan.Culturally completely different. Economically too. Demographics. etc. Should they do 2 trillions, in addition to what they have already done, what % of the total market would that be. There’s a very high risk of creating a GFC II. There’s a risk that it does not work and they end up owning all of these assets, interest rates at zero, still high unemployment, and what if a recession comes up while they are already at the bottom of monetary policy? For instance the EU could break up in the medium term (it is clear it’s going to be very hard for Italy, Spain, even France to come out of a recession while still not being able to print money / depreciate currency), well in that case what would the Fed do? Buy the entire market incl shares? Basically there’s a risk to overdose the patient here, with the wrong medicine.

  3. On a different note: see what happens to our share market when the RBA easing bias is questioned and the prospects of a lower currency vanish? It’s pretty clear now that world share markets are a function of local currency depreciation.

  4. I find Joye annoyingly accurate. it’s frustrating b/c he’s so arrogant but he gets it right more than anyone i know

    1. That comment makes me laugh more than today’s Labor caucus ballot. Joye believes the cash rate has been too low since May and is now 125bp too low. On that basis, we should be seeing inflation start to surge towards 5%. There is probably no mainstream commentator in Australia today (other than Steve Keen perhaps but I don’t think he is mainstream despite his Business Spectator gig) who has been more wrong than Joye. Most functional people would reconsider their entire framework if reality had bitten them to the same extent, but he seems incapable of any intellectual self-reflection. Other commentators may be less exciting, but at least they are sane.

    2. OK, here is a challenge for you. Post some links to Joye predictions that have turned out to be “annoyingly” accurate in 2012/2013. But we already know you will not be able to.

  5. cyprus no longer in the eurozone


    We are witnessing the failure of Capitalism. After we have witnessed the failure of Communism not long ago. People in Cyprus, Greece and other countries may soon be as poor as people under the late Communism. There is no Democracy anymore in many parts of Europe, but rather now a Technocracy (nothing new really!), and it’s not even clear who / how / why decision are made. And who is benefiting. A big mess really. Big private gains supported by big public losses. Again.

    1. If you ask me, the biggest problem with capitalism is this idea that depositors or bond holders ought to be saved. Deposit insurance is a bad idea. Lending money in anticipation of a govt bailout ought not be rewarded.

      Markets cannot be made safe for retail. All the efforts to make them safe ultimately end in shifting losses to taxpayers — which is the opposite of what capitalism is about.

      1. Yes , that is exactly the failure. Tax payers have to rescue failed and bankrupt private organizations, the banks, which are the symbol of the free markets and capitalism. Because the alternative is worse. These are private organizations that became 8 times the size of the country economy?!?!? (Cyprus, but Greece, Ireland, Iceland the situation was/is similar too) History will laugh at us.

        For me, some points in random order:

        – Lack of oversight and regulation: too much debt before GFC which was the real / only driver of growth in many uncompetitive countries. Obviously markets where participants are egos and driven by self interest can’t self regulate properly in the name of common good.
        – Fast globalization without considering the impact that it can have on some societies (lack of competitiveness with was masked by escalating debt)
        – Banks simply do not work in the current form. Deposits taking banks, making huge bets on real estate, bonds, shares and when they fail, they are so huge we all pay the price, they even take down entire countries, even the biggest economy in the world. Even the idea of a PRIVATE bank taking deposits should be under discussion. We are all wondering now, where is my money I deposited at my bank. Do we think Australia is immune? What would happen if real estate collapses. What will happen when we have the first recession after 20 plus years. Govt would need to step in here too and support the private gains that bank are making now with public money? So, should we have private banks at all? In Australia bank assets to GDP are relatively low (I think around 2). But now RBA are wanting to push real estate prices up to support the economy in 2014???? So we are saying need more credit growth, inflated bank assets and bigger bank returns?

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