RBA holds; bring on Lowe-flation

Against my expectations, the RBA left their policy rate at 1.5% today. 

My main lesson from all this is that Gov Lowe doesn’t care much for his 2.5% inflation target. How else can we interpret leaving policy on hold with inflation below target and the unemployment rate going sideways above the NAIRU – at the same time as they acknowledge that a lower unemployment rate is needed to hit their inflation target?

The only other interpretation is that the politics of the situation got to them.

The decision was clearly a surprise to me – but the set of forecasts that accompany the decision are more-so.  They also happen to align with the budget forecasts delivered by the Australian Treasury in early April.  This is probably no coincidence; and is surely a lesson for me.

The prior weakness in housing and consumption has had most forecasters marking down their growth numbers — but I suppose that’s a problem for the RBA’s August meeting.  The RBA trimmed only 25bps from their Dec’19 GDP forecast (to 2.75%) and left their Dec’20 GDP forecast unchanged at 2.75%.  They’ll be lucky if growth is so strong. Today’s 10bps decline of real retail spending for Q1 (the third weak print in a row) suggests that the forces depressing H2’18 have carried over to H1’19.

With growth expected to hold around trend (and leaning heavily on the still-robust ABS Vacancy measure) the RBA expects the unemployment rate to remain ~5%.  It seems like they have pushed the dip below 5% back to 2021 (Q4’20 was 4.75% in the Feb SOMP), but you can’t be 100% sure from the words in the short statement.

They also appear to have downgraded the NAIRU, acknowledging that there remains slack in the economy and that a 5% unemployment rate isn’t going to get inflation back up to their 2.5% target.

With growth at trend and the unemployment rate going sideways above the NAIRU, I don’t see why inflation is forecast to pick up – but they reckon it will. The RBA expect core inflation to be ~1.75% in Q4’19 (down from 2%) and 2% in 2020 (down from 2.25% in the Feb SOMP table … but actually it was more like 2.125% in the fan-chart). We’re trapped in Lowe-flation: CPI is never going back to 2.5%

The final paragraph says that the board will be “paying close attention to developments in the labour market at its upcoming meetings”, which seems designed to make every meeting live. Still, non-SOMP moves are unusual, and the measurement errors on the household labour force survey are HUGE — so if I had these forecasts I’d really want to see the quarter-average unemployment rate trend up to be sure that something’s going on.

The tragedy of this is that if the RBA waits too long to cut the cash rate, the trouble in the housing market will make rate cuts totally ineffective. Missing the chance to cut with a positive message (we cut because we want faster growth, and low inflation means we can have it) increases the risk that the RBA will be (even further) behind the curve when they do get around to easing.

This increases the possibility of an ultra-low cash rate and quantitative easing down the track. In my view, that’s bad risk management.

Posted in AUD, CPI, economics, Labour Market, monetary policy, RBA | 3 Comments

Financial Stability and Mortgage dynamics

My argument for a May rate cut by the RBA basically boils down to the observation that inflation is very low and that there’s no financial stability reason not to cut — plus the judgement that the very low pace of inflation means that the prior test requiring the unemployment rate to rise is no longer needs to be met.

Looking at the ANZ H1’19 results pack suggests that there may even be a financial stability argument for lowering the RBA’s policy rate. The chart below shows the sharp increase in home loan delinquencies across the ANZ loan book over the past few months — and in particular over Q1’19. I think this is strong confirming evidence of a softer household / consumption sector.

Source: ANZ

This is no longer just a WA-story. The chart below shows the breakdown of late loans (90+ days past due) by state. Note the sharp increase in sour loans in NSW & ACT. Something’s going on Mr Jones.

Source: ANZ

Much of the trouble with repayments seems to be with the older loans. The 2yr seasoned 2017 vintage loans, for example, have lower delinquency rates than the 2015 and 2016 vintage did at the same time — though all are souring.

The pressure on loan quality from the expiry of interest only terms is likely to intensify — and this should keep up downward pressure on consumption. The ANZ forecasts about the same level of IO-to-PnI switching (for contract reasons) over the next two years. The issue with this is that about 30% of these households have LVRs greater than 80% — which means they’ll find it very hard to refinance into better / more suitable deals.

Source: ANZ

Given that house prices continue to decline, it follows that the proportion of loans with low equity will continue to increase (few people pay enough per month to keep up with the current pace of declines). At present, the share of the ANZ’s loan book that’s in negative equity has been stable at 5% for some time — but note that the orange bars for less than 80% LVRs are getting smaller, and that the 80%+ bars are getting larger. The mark-to-market from falling house prices is hurting.

Source: ANZ

This is a potential financial stability issue. The RBA can do something to limit these brewing risks. A lower cash rate would reduce monthly repayments and therefore mortgage delinquencies. It would also slow the decline of house prices, which increase the proportion of those trapped in mortgage arrangements they cannot afford to refi away. Selling into a weak market is bad for everyone.

Posted in AUD, Banks, Housing, monetary policy, RBA, Uncategorized | 6 Comments

Inflation and Monetary Policy — redux

My call that the RBA would cut rates in May was originally a little speculative — but following the Q1’19 inflation data, and weak credit data, I now think that it’s very solidly grounded in vanilla macro.

First of all, the very low inflation print cannot be dismissed as a once off. If you take the two-quarter average (as i have done in the above chart), trimmed mean CPI is at an all time low of 0.37%q/q. Given that growth is (at best) around trend, and that the unemployment rate has been stable at ~5% for two quarters, there is no reason to expect inflation to accelerate. Due to measurement issues, inflation is always overstated, so CPI at this level probably means that prices are flat — or perhaps falling a little.

So the question is, assuming current policy settings, can the RBA produce a compelling case that inflation will return to target in a policy relevant time period? I don’t think that they can do so — so the policy rate must fall.

Sure, inflation has been too low for some time, but for most of Gov Lowe’s term, there’s been a trade off between the inflation target and financial stability. This was laid out in Gov Lowe’s landmark speech, Inflation and Monetary Policy, on 18 October 2016. In that speech Gov Lowe emphasised the ‘third pillar’ of the RBA Act, ‘the economic prosperity and welfare of the people of Australia’. The point he made was that rushing the return to 2.5% inflation could have deleterious consequences for the state of household balance sheets.

Over recent times, we have considered the impact of our decisions not only on the future path of inflation, but also on the health of the balance sheets in the economy. Achieving the quickest return of inflation back to 2½ per cent would be unlikely to be in the public interest if it came at the cost of a weakening of balance sheets and an unsustainable build-up of leverage in response to historically low interest rates. 

Gov Lowe, Inflation and Monetary Policy, Oct 2016

Does anyone think that’s still a barrier to rate cuts? The chart below shows the total value of new finance agreements (to households and firms, 3mma). As you can see, this has fallen sharply of late, and is now at the lowest level in 5 years (since 2014). If you adjust for the larger population / size of the economy this looks even weaker.

ABS 5601, table 1

The RBA were already considering lower rates following a string of weak growth data — but were reluctant to cut until the famously noisy GDP data was confirmed by rising unemployment. Some argue that the RBA needs to see rising unemployment to cut — but i don’t think that test is relevant any longer.

The low CPI print totally changed the debate. Inflation is too low and the RBA needs above trend growth and a falling unemployment rate to make a case that inflation will accelerate. They don’t have a plausible story about a return to on-target inflation just now. On current policy settings, and assuming a healthy dose of optimism, I can’t see a plausible above trend GDP forecast until mid 2020 — which means inflation doesn’t get back above 2% until 2021.

When will it get back to 2.5%? Who knows. On current form you’d have to guess it’ll be after Gov Lowe’s term ends. Cutting the cash rate is the only way Lowe can have a chance of hitting his inflation target during his term. With a bit of bad luck he might even average something with a 1-handle.

A final point about politics: I don’t think the RBA will be constrained by the 18 May election. I doubt they will even discuss it. Therefore i find it curious that so many are calling a June or July cut. Such a move would look political itself. It would have to be very carefully managed.

Posted in AUD, economics, monetary policy, RBA | 10 Comments

Q1’19 CPI makes strong case for 7 May RBA cut

The slow pace of inflation in Q1 makes a very strong case for a 25 bps reduction of the RBA’s policy rate on 7 May, to 1.25%.

The key trimmed mean inflation measure increased 28bps to be 1.6% higher over the year. This is a 24bps deceleration from the Q4’18 print of 1.84% (it has since been revised down to 1.82%).  Nor is the weak inflation pulse some figment of the trim’s construction. The weighted median measure increased by just under 10bps to be 1.24%yoy.

This took the average of the RBA’s two Core measures of inflation up ~19bps on the quarter to by ~1.42%yoy.  This is being held up by the higher prior prints.  The 2qma is a good balance between signal and noise, and on this basis core inflation was ~1.2%yoy.  Both the two-core qoq and the 2qma are below the low inflation prints of early 2016 (of 20bps and 1.26%).  These low prints led RBA Gov Stevens to cut the cash rate, despite a falling unemployment rate.

So coming into the May meeting, the facts are that domestic growth disappointed, inflation disappointed, global growth slowed, and the labour market cooled a little. There is some disagreement between the different data sets, but the story is substantially completed by CPI.

We learn a lot about the balance between supply and demand from the CPI release, and the message from the details of today’s report is that the output gap is widening — in line with the slow GDP data. This makes sense: the origin of the weakness is housing, and falling house prices are slowing consumption — so we should expect CPI to be weak.

That is exactly what we see — sequential slowing of CPI over the prior year.

The fact is that the current data means the RBA cannot present a credible case for a return of inflation to their 2.5% target within Gov Lowe’s term — with current monetary policy settings. So monetary policy must be eased.

The only reason i can think of to leave monetary policy unchanged at 1.5% would be to avoid the federal election–but that is a political act in itself.

The lack of progress toward the inflation target justifies a rate cut, notwithstanding mixed signals on growth. The least political thing the RBA can do is to follow their forecasting/policy process and deliver one.

I think the economic case for a 25bps cut is a slam dunk — because the economy can run hotter, and should be allowed to do so.

Posted in AUD, CPI, economics, monetary policy, RBA, Uncategorized | 6 Comments

Q1’19 CPI, the RBA and May

The case for the RBA to cut their cash rate at their 7 May meeting has been beaten up by the RBA’s own views on the GDP data, but I still think that the data makes a decent case for an easing.

The rosiest possible assessment of the data is that growth has slowed to trend. Indeed, that’s the position i think Deputy Gov Debelle took in his speech, The State of the Economy.

Trend growth isn’t going to get the job done, as you need above trend growth to push down the unemployment rate and drive up wages and inflation over time.

So ultimately, the question is: does RBA Gov Lowe care about hitting his 2.5% inflation target? The chunky GDP downgrade that has to be put into the May SOMP means that the inflation forecast must come down a little over the projections (they linked the slower growth profile with a lower core CPI track in their Feb SOMP, so this part of their inflation model still works).

A weaker starting point would be inconvenient.

The last seven trimmed mean CPI prints have all rounded to 1.8%y/y. I think that’s very unlikely to remain true after today’s CPI print. The 0.6%q/q Q1’18 trimmed mean print will drop out of the base today, and I expect that it’ll be replaced with 0.4%q/q print (0.4%q/q is the average for H2’18). The RBA are expecting a high 0.4x%q/q print (rounding up to 0.5%q/q) which would take deliver ~1.75%

A 0.4%q/q result for trimmed mean CPI will take through-the-year core CPI down ~20bps, to ~1.67%y/y (from 1.84%y/y). That’s uncomfortable, but perhaps they’ll tough it out.

A 0.3%q/q trimmed mean CPI result would be a BIG problem for the RBA — as both inflation and growth will have clearly decelerated over the past year. Based on these starting points, I just don’t see how Gov Lowe could present his board with a credible case that inflation is going back to 2.5% in a relevant period with that starting point.

The RBA’s main job is to make headline inflation average 2.5% over time. The prior two RBA governors have hit their 2.5% target exactly. Given that today is likely to produce a 0 print for headline CPI (headline CPI will slow ~50bps to 1.3%y/y), Gov Lowe seems to have little hope of doing so in his current 7 year term.

Gov Lowe’s contribution to Australian Monetary policy has been the emphasis of financial stability — but with house prices continuing to fall, i don’t see how that’s a barrier to cutting the cash rate.

Posted in AUD, CPI, economics, monetary policy, RBA | Tagged | 4 Comments

IMF downgrades, RBA to follow

The IMF today downgraded global growth 20bps to 3.3%yoy (lowest since GFC), and said that the risks are skewed to the downside.

Among Australia’s key trading partners, Chinese growth was bumped up 10bps to 6.3%yoy; Japanese growth -10bps to 1%yyo; and Indian growth -20bps to 7.3%yoy.

All told, I expect that this global growth downgrade will increase the pressure on the RBA to cut rates — a pressure which I think they’ll respond to at their 7 May meeting. They responded to the IMF’s downgrade in Jan by ditching their tightening bias — so they have form in this area.

We’ll get the next clue about this in the Deputy Gov Debelle speech, The State of the Economy, at the American Chamber of Commerce in Australia (AmCham) with Adelaide Business School event, at 1.40pm on 10 April.

I still think a rate cut at their 7 May meeting is likely.

Posted in AUD, economics, monetary policy, RBA | 6 Comments

What’s the State of the Economy?

The RBA made a subtle change to their concluding paragraph of their April post-meeting statement last week. Given that they had used the same words for the prior thirteen statements, and that the change occurred alongside downgrades to domestic and global growth, I thought the change material — but reasonable people can disagree, so the RBA needs to do some explaining.

It seems like Deputy Gov Debelle will be doing that explaining in his 10 April Speech, The State of the Economy.

So what is the state of the economy?

Growth is slowing, inflation is stuck ~1.75% (below the 2.5% target and outside their control range), house prices are falling, and the fiscal impulse from the federal budget is a little smaller than most hoped (though we may see more during the campaign). Most forecasters are still downgrading the global growth outlook, and the IMF seems sure to do so again when they publish the updated WEO on 10 April.

According to the AFR, the IMF are also going to downgrade their Australian assessment. The AFR story also notes that the property downturn has been larger and earlier than expected, and that the case for a rate cut is developing. Dr
Thomas Helbling, the IMF’s lead economist for Australia, noted the slowdown would reduce inflation pressures and make the case for a cut.

“maybe the inflation trajectory, the projection, shifts down a bit; labour market conditions are a bit weaker, and then by the very logic of the flexible inflation targeting regime, I would expect they would ease … If there are material changes to inflation trajectory and, or – and typically it will be both, there will be an ‘and’, to the employment picture, I think they will.”

When Deputy Gov Debelle speaks on Wednesday 10 April, I would expect to hear much the same. The local and global economy have both slowed. Inflation pressures have declined a little, and there’s scope to ease without upsetting their financial stability mandate. In any case, the labour market seems far from delivering the 3.5% wage growth that’s consistent with hitting their inflation mandate.

As a side note, last week’s Federal Budget (see the notes to table 1 on page 2-5) assumes spot for AUDUSD (~71c) and uses market pricing for rates — so in a sense, the Australian Government has already assumed (and spent) the rate cuts.

The forecasts for the domestic economy are based on several technical assumptions. The exchange rate is assumed to remain around its recent average level — a trade-weighted index of around 61 and a US$ exchange rate of around 71 US cents. Interest rates are assumed to move broadly in line with market expectations.

The growth (and wages) numbers in the budget look too high to me, so it seems unlikely that recently higher Iron Ore prices will fund further tax cuts.

Posted in AUD, economics, monetary policy, RBA | 1 Comment

RBA sets up for May

The RBA today set up for a rate cut on 7 May.

After thirteen months in a row where they cut and paste the following words:

the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.

they changed to:

the Board judged that it was appropriate to hold the stance of policy unchanged at this meeting. The Board will continue to monitor developments and set monetary policy to support sustainable growth in the economy and achieve the inflation target over time.

See the difference?

For the last thirteen meetings, they have said that policy is sufficient to hit their targets. Now policy will be set to make sure their targets are hit.

That’s a meaningful change. It is relevant that it occurred at the same time as they cut their domestic and global growth forecasts.

It isn’t a lock just now — more weak data is required to complete the case — but the option will certainly be discussed at the May meeting.

Forget the unemployment rate test everyone is talking about — a 0.4% on trimmed mean CPI on 24 April will lock in a 25bps cut on 7 May.

Posted in AUD, economics, monetary policy, RBA | 4 Comments

The case for an April easing bias

The RBA board will discuss the disappointing Q4’18 GDP data for the first time at their 2 April board meeting. The size of the downgrade is so large, and the domestic and global data for Q1’19 has been so weak, that I think they’ll respond by making a further dovish step — potentially to an explicit easing bias.

The Q4’18 GDP data delivered a ~50bps miss on headline GDP, with particular weakness in dwelling investment, household consumption, and household income. These areas of weakness were partially offset by an unsustainable increase in public demand.

The weak H2’18, and poor start to Q1 (both locally and globally) should see the May SOMP growth forecast fall into the mid 1% region (helped by a negative base effect as the very strong Q1’18 drops out).

With growth so slow, it would be remarkable if the unemployment rate didn’t starting increasing. And a rising unemployment rate means there’s no reason to expect an accelerating rate of inflation.

The global picture has also soured. Since the RBA’s prior board meeting on 5 March, major forecasters have downgraded global growth. The OECD cut 2019 and 2020 on 6 March; and the IMF is widely understood to have already done so once again (they already downgraded in January). The RBA would have a clear idea about the IMF’s April WEO downgrade — though we have to wait until the IMF release when the release the analytical chapters of the WEO on 9 April.

Anyhow, these are just words: the facts call for some empirical judgement about the importance of the recent global growth downgrade. I don’t have time to build an Aussie / Global model, but I did notice a nice chart in the Norges Bank’s March MPR that i have included below. This chart shows the contribution of various factors to changes in the Norges Bank’s policy rate forecast: between the 4th MPR of 2018 (13 Dec) and their 1st of 2019 (21 March).

The global growth downgrade has shaved off ~20bps (10bps in the near term, and 20bps further out). That’s a meaningful step.

It might not seem like much, but it was enough for the RBNZ. Last week Gov Orr said that “the more likely direction of our next OCR move is down”, due to a weaker global growth outlook (partly a weaker Australia) and slower domestic growth in H2’18 (note that Q4 NZ GDP was a decent +0.6%q/q v. Australia’s weak Q4 GDP of +0.2%q/q).

Posted in AUD, monetary policy, RBA | Leave a comment

Underwater mortgages

The fact that Australian house prices are now back to 2016 levels (or below in some areas) means that there is a rising number of property transactions where the purchase price is now above the current valuation (or more importantly, the likely sale price).

This is feeding through into the RBMS sector, with a rising share of the mortgage pools that back recent issues now having very high LVRs.

The chart below is taken from some great work done by Coolabah Capital CIO Chris Joye. He and his team have re-valuated houses in RMBS pools and, after accounting for amortisation, find that the proportion of high LVR (> 90%) mortgages underlying recent RMBS issues has increased by 3x to 4x. Of the twenty RMBS they analyse, twelve of them now have a 90% LVR mortgage share in the teens — up from only one at the time of issue.

Of course, this is only a problem if folks stop repaying. However, that’s very likely for some. Regular (if tragic) life events such as loss of employment, sickness, or death, mean some people will always be unable to repay — and will have to sell to exit.

A high LVR and a soft property market, increases the probability of a loss being made at the point of exit.

So the equity protecting owners of RMBS is shrinking. Also, the softer housing market and economy means that pre-payment rates are slowing. So the RMBS are getting riskier.

If property prices keep falling ~1% per month, the share of mortgages with LVRs greater than 100% will continue rising. Sydney seems to be most at risk just now. The draw-down from the top is ~15% for Houses; Sydney Units are down ~11%, however looming supply (and problems with settlement valuations coming in below contract prices) make another 10% down seem entirely plausible.

Coming back to RBMS, Chris notes that there is already one (recent) issue where over 10% of the mortgages are underwater.

Unless something is done to ease credit conditions, all of these RBMS will have meaningful proportions of the mortgage pool with LVRs that exceed 100%. Given the way that ASIC’s Shipton is talking, I would think that the only easing that’s possible in the near term will have to come from the RBA.

Posted in AUD, economics, Housing | 5 Comments