Wednesday, 30 November 2011

Interest Rate Betting - An Update for December

The market reaction to the central bank liquidity and banking measures saw the money market scale back the chances for a December interest rate cut but a 25bp cut is still fully priced in after the disappointing retail sales and building approvals numbers this morning.

The betting markets, on the other hand, have not moved much in the last day or so with the betting favouring a 25bp rate cut next week. No change is the second favourite and the betting markets are pricing in the very real possibility of a 50bp rate cut. Rate hikes are triple digit odds.

The table below sets out the latest odds:








25 bp cut




50 bp cut




50bp cut or more




75 bp cut or more




These odds have changed a lot over recent weeks with a substantial shortening in the 25 and 50 bp rate cut scenarios and a blow out in no change. It took a while for the betting markets to reflect the reality of softer domestic growth, tight fiscal settings, global market ructions and a disinflation momentum that risks seeing inflation fall below the bottom of the RBA target band during 2012.

The 25 cut offers a potential 65% tax free return for a 5 day investment. Believers in the mining boom and residual inflation concerns being on the minds of the RBA can get a whopping 150% tax free return if they are correct and the RBA remains on hold.

All eyes will be on market conditions and global data over the next few days – and the TD-MI Monthly Inflation Gauge locally for final clues on what the RBA will do next Tuesday.

Please note, these views are my own and all comments are not investment advice.

Retail Trade & Building Approvals

Some important data today with the October readings for retail spending and building approvals.

The retail data showed a tepid 0.2% rise after a 0.4% rise in September – not strong by any means and fitting with the very weak credit data released yesterday. Consumers appears to be content to keep a tight reign on retail spending, which is no bad thing from a medium term perspective, but in the near term it means significant risks of weaker growth, lower inflation and an uptick in the unemployment rate. The retail data are consistent with further disinflation pressures.

Of great concern is the collapse in house building approvals – down 10.7% in October and almost 25% in the last two months. From anecdotal evidence, the weakness in new building approvals could be linked to a lack of finance for building projects. But whatever the reason, it is an issue requiring remedial (monetary policy) action.

The data, together with the extraordinary central banks action overnight means the RBA will almost certainly be cutting interest rates next week. The debate is likely to be do they go 25 or 50 bps.

The fiscal tightening, weak commodity prices and risk of a zero inflation reading for the December quarter CPI will also be part of the discussion as will the ongoing resilience in CAPEX. Overall, it’s a tough call.

The best guess remains on a 25 bp cut in December, with lots more scope for cuts in the early months of 2012 once low inflation and softer growth are confirmed. But if the RBA knows that the banks will not be passing on any move in full, it may want to go 50 to ensure borrowers get some meaningful benefit.

Desperate policy for desperate times

The efforts of the world’s major central banks overnight to free up borrowing and liquidity in the banking sector is clearly good policy. Something had to (and still has to) be done to drag the world from a particularly pernicious banking and economic situation.

But is this the silver bullet to once and for all lift the global economy back to health?

It seems very unlikely.

It’s another band aid that had to be applied and it will help which is good. But the very action itself shows how worried policy makers are about the current circumstances.

I am reminded of the shock interest rate cut in the US delivered by Federal Reserve Chairman Alan Greenspan on 3 January 2001. With the Nasdaq bubble starting to deflate, Greenspan rode to the rescue – it seemed - with an out of cycle interest rate cut that triggered a 10% jump in the Nasdaq on the day the cut was announced. Alas – the rate cut didn’t fix the core problem which was a speculative asset price bubble and when reality returned, the Nasdaq kept sliding to a point where its peak to trough fall hit around 80-% - and this despite yet more and more interest rate cuts from Greenspan. The US fell into recession.

Also recall the coordinated interest rate cuts in October 2008 from the same central banks at play last night. It helped support confidence for a while and was a necessary policy move, but again it reflected just how horrid the circumstances of the times were. Alas, 3 years on, that approach was no magic fix... nor are the near zero interest rate settings across the bulk off the industrialised world.

So to the policy change last night. It has sparked a sharp jump in stocks, the AUD has surged and the natural optimism of many people is such that they see it as a fix for the global banking and economic problems.

Sure, this time it might be different. Let’s hope so. This may fix the global ills but it seems more likely that the move, while a good one, is just another desperate attempt from desperate policy makers helping out desperate bankers in desperate times.

Tuesday, 29 November 2011

The Economy: What's hot and what's not

The data flow today sits nicely with the RBA moving to cut interest rates at its Board meeting next Tuesday. Most likely is a 25 basis point cut to 4.25%.

The private CAPEX data were nice and strong, confirming another 3 month increment of an unprecedented surge in mining and related investment. This strength has been well documented meaning the 12.3% rise in business investment in the September quarter is no real surprise to the market or indeed the RBA. It could be argued that these sorts of CAPEX results are why the interest rate cutting cycle is starting at 4.75% and not a whole lot lower. It’s also a reason why fiscal constraint is so important. The business investment climate remains hugely positive – the pipeline of investment is huge and will take many years to exhaust.

Which brings us to the other data today.

House price trends remain disconcerting. Capital city house prices fell a further 0.5% in October and are now down 4.0% since the start of 2011. While this remains miles away from the falls seen in countries such as the US, Ireland, Spain and the UK, the economic and banking fall out from collapsing house prices is something that no one wants to see.

If house prices fall much more in Australia, those with negative equity will rise, forcing banks to tighten credit, forcing consumers into distressed sales, forcing spending to retreat. Look to the US and UK for the effects on banks and consumers on falling house prices. It is extremely bad.

The RBA credit data – one of the top 3 or 4 variables in any monetary policy decision – shows a new fresh record low (34 years of data) in annual growth in housing credit. Personal credit also fell again while business credit remains weak. In simple terms, it seems that borrowers don’t want to borrow much and the lenders seem to be limiting their lending. This is a sure sign of softer growth and on-going disinflation. The credit data by themselves are screaming lower rates.

Let’s see how the retail trade and building approvals data go tomorrow for a bit more news on the economy into the December quarter which may at the margin influence the final recommendation of the RBA Board.

Monday, 28 November 2011

Fascinating Fiscal Facts - Who's addicted to spending and taxing?

The MYEFO presented some wonderful historical tables on various aspects of the Budget and fiscal policy. The highlights, to me at least are probably:

  • Total government receipts (tax, dividends, fees and the like) was 21.6% of GDP in 2010-11, the lowest level since 1973-74 when Frank Crean was Treasurer.
  • The tax to GDP ratio fell to 20.0% in 2010-11, the lowest since 1978-79 and is a whopping 4.2% of GDP below the record tax to GDP ratio raked in by the Howard government in 2004-05 and 2005-06. That's a lesser tax take of around $60 billion for one year that was taken from tax payers during the peak period of the Howard government. As mentioned elsewhere, it is easy to register a budget surplus when you tax the living daylights out of the population.
  • Real government payments (spending) will rise by an average of less than 0.1% per annum in the 3 years to 2012-13, the weakest 3 yearly spending growth since the mid to late 1980s under the Hawke/Keating Government. Never once did the Howard Government deliver a cut in real government spending - in fact real spending grew by a thumping 3.5% per annum for the last 5 years of the Howard government.
  • Payments (spending) will be 23.6% of GDP in 2012-13 - around 1.5% of GDP below the average of the last 30 years. In the 12 Howard Government Budgets, spending to GDP averaged 24.2% of GDP: and only in 3 years out of 12 of the Howard Government was the spending to GDP ratio lower than the Gillard Government is projecting for 2012-13. Which government is addicted to spending?
  • The 4.3% of GDP turnaround in the Budget balance in the 3 years to 2012-13 (from a deficit of 4.2% to a surplus of 0.1%) is the most rapid turn in the fiscal position on record.
There are more gems I'm sure, but that is for another day.

MYEFO - A quick post mortem

There were few shocks in the MYEFO statement, other than perhaps the size of the revision to the Budget numbers in 2011-12. Given that that year is five-twelths over, there is or was precious little the Government could do to influence that result to any significant extent, even if it wanted to.

There were no surprises in the economic forecasts - all on par with the general consensus at the moment, so here's hoping they are, at worst, correct or preferably, there is a bit of upside in the next 18 months.

Fiscal policy is now set in stone for the next six months. The boffins at the RBA and elsewhere can prepare their growth and inflation forecasts with firm knowledge of the influence of public demand on those forecasts.

The only policy game in town for the next 6 months is at the RBA. Any whiff of softer growth from current expectations and rates cuts can be delivered without fear or favour. We may even see an odd 50bp cut at one meeting if global conditions deteriorate further.

From a local data perspective, the extent and timing of the interest rate cutting cycle will be driven by inflation and employment results. This is where my baby, the TD-MI Monthly Inflation Gauge will be useful for the RBA in that it will give early signals on inflation pressures, ahead of the release of the official CPI. The Gauge for November is released on 5 December. The job vacancies and job advertisement series are pointing to further rises in unemployment. As this unfolds, wage pressures will be further contained, from an already low starting point.

I still reckon the RBA will be cutting the cash rate to around 3.5% in the middle of 2012, a point only reinforced by today's MYEFO. The data over the next 10 days will as always be useful in building the case or otherwise for that scenario to unfold.

MYEFO today

Not sure if there will be any rabbits out of the hat with the MYEFO today, but the Government's fiscal and economic management skills will be on display for all - including the RBA - to see.

The slower economy than envisaged at Budget time in May has delivered a $20 billion hit to revenue, or so it is reported, which spread evenly over the Budget estimates would trim $5 billion off the bottom line per year. If unchecked, there would be a deficit in 2012-13 and 2013-14, something unwelcome given the broad influences impacting the Australian economy now.

A conservative haircut rather than a back, crack and sack wax for Government spending is in order to make sure the surplus projections are maintained.

From MYEFO, expect to see a very low tax to GDP ratio for 2011-12 and beyond, driven by flat real growth in government spending - a feat never delivered by the Howard Government in 12 Budgets. Net government debt will likely be revised up by about 0.5% of GDP (but still peaking below 8% of GDP). The economic forecasts will be broadly the same as the RBA with GDP growth around 3.25% in 2011-12 and 2012-13, with the unemployment rate forecast to rise to 5.5%.

One interesting issue might be the Treasury forecast for inflation. The RBA remain of the view that the CPI risks remain tilted to the high side. Treasury may well forecast a 2% inflation rate for the year to June 2012 and be around 0.5% below the RBA forecast for the period beyond. I suppose this is fair enough - the latest RBA forecasts would not have factored in the fiscal action we will see today- Treasury numbers obviously would.

Sunday, 27 November 2011

The 2012-13 Budget Surplus

There's a bit more chatter about the need or otherwise for the Government to structurally alter fiscal policy in the MYEFO to ensure a Budget surplus in 2012-13.

I think it is very important to deliver that surplus as I have spelt out before – see

Of course the Government could let the Budget slip into deficit in 2012-13 but the economic consequences would be:

  • Interest rate settings higher than if the Budget was tight.
  • As a result, the Australian dollar would probably be higher (artificially in effect) than would otherwise be the case.
  • “Wasteful spending” would be left unchecked – this is undesirable in anyone’s language I would hope.
  • A slower path to lower public debt – which for Australia probably matters little given debt is so incredibly low, but one only has to look overseas to see the consequences of slack fiscal discipline. If the Government is to make a mistake on fiscal policy and the Budget, even Blind Freddie can see it would be better in Australia’s current circumstances to err on the side of fiscal tightness rather than being too loose. There's too much to lose.

And then there’s the very legitimate question of policy discipline. Let the Budget slip in 2012-13 – then why not the year after? Or the year after that? Or while a deficit of $3 billion is OK, what about $6 billion? What about $10 billion?


Barring an almighty global crap out, where of course all bets are off, the Government should stick to its guns, trim spending, tighten tax rules and juggle its priorities to ensure it has that surplus locked in for 2012-13. It's great economics and by the way, great politics.