The technicals give me the signal but if anyone is interested in rate hikes and fundamentals, may be take a slice of advice from Bank of America.
© Oliver Levingston
Merrill Lynch (Australia)
oliverllewellyn.levingston@bofa.com
• The RBA will likely deliver a third consecutive 25bp hike next week. A cooler monthly inflation print has investors betting on a lower terminal rate in 2023
• The AU curve still looks too steep and we see inflation risks as increasingly skewed to the upside.
Slowing down, not a slowdown
We expect the Reserve Bank of Australia (RBA) to hike the cash rate by another 25bp to 3.1% at its 6 December meeting. Markets are pricing in a 76% chance of a 25bps hike (24% chance of a pause) as at the time of writing. The message will echo its determination to keep the economy on ‘an even keel’, balancing the challenge of suppressing rising inflation with the risk that rate hikes could tip the economy into recession.
The RBA has moved cautiously on rate hikes: not only was it slow to lift off, waiting until May 2022 to do so; it also surprised markets by downshifting to a 25bp hike in October, becoming the first major DM central bank to slowdown the pace of rate increases. It then stuck to its gradual hiking pace at its November meeting, despite a strong 3Q CPI print (see RBA review: Sticking to 25, 1 November 2022). The RBA has cited the high frequency of its meetings – the RBA meets 11 times, the FOMC and ECB each have 8 meetings scheduled per year – as a reason why it can afford to take a gradual approach.
Market pricing reflects increasingly dovish sentiment – markets are now pricing rates to rise to just 3.5% in mid-2023, down about 30bps in a month. Optimism on rates grew after the RBA’s monthly CPI for October, released on 30 November, showed both the headline inflation slowing to 6.9%YoY (vs. 7.3% in Sep) and the trimmed mean measure easing to 5.3%YoY (5.4% in Sep). However, we caution that for October, the new monthly series contains only 62% of the price data used in the Australian Bureau of Statistics’ (ABS) quarterly CPI – it omits, for example, new information on many administered prices such as utilities, which are not priced until the final month of the quarter.
For these reasons, the RBA has stated that “the quarterly CPI is likely to remain the principal measure of CPI inflation in Australia for the foreseeable future,”1 making it premature to call for a peaking in inflation based on the October monthly CPI print. Nor does it change the fact that inflation is likely to remain well above the RBA’s target band of 2-3%.
Yet the RBA will likely remain less hawkish than its counterparts overseas. Australia’s Wage Price Index (WPI) has only recently started to pick up above 3%. The RBA does not yet see signs of a wage-price spiral, though it has stressed the need to remain vigilant. It noted in its November Statement on Monetary Policy (SMP) that “reports of higher labour costs contributing to price increases have so far been largely contained to price increases have so far been largely contained to a few specific sectors.” A softer retail trade print (-0/2% MoM) and Governor Lowe’s apology before the Senate for the RBA’s (abandoned) promise to hold interest rates steady out to 2024 have added to growing expectations of a lower terminal RBA rate.
For these reasons, the risk of a recession in AU in 2023 remains a low probability and the risks to inflation remain skewed to the upside, in our view. The RBA’s restrained approach, sustained strength in the labour market and a continued boost from a record term of trade make an economic contraction less likely than peers. We do not have cuts in our profile.
Waiting for the wave
The main risk reflected in market pricing and the RBA’s published commentary is that households have not yet sustained the full impact of rate hikes. We have pencilled in hikes until May 2023 just before the mortgage rate reset wave accelerates in mid-2023. The maturity profile of fixed-rate mortgages taken out when lending rates were as low as 2% suggests the “cliff” may have traction. The line of questioning at Governor Lowe’s attendance before the Senate Economics Legislation Committee and public speeches from the RBA confirm that fixed-rate mortgage resets are at the front of their minds when they consider risks to the economy.
Yet Australia continues to enjoy meaningful protection from downside risks, in our view. A positive terms-of-trade shock that has reduced Australian Government funding requirements also means the challenges of housing headwinds should be easy for policymakers to counteract should we see signs of household distress in 2023. At the same time, a long period of low unemployment is likely to generate higher wages and partly offset the dampening effect of rising loan payments on consumer demand, reducing the risk of a housing-led downturn. On the upside, the prospects of a substantial shift away from COVID Zero policies in China continue to gather pace as a steady stream of announcements suggest the country is like to gradually reopen in 2023. The Chinese reopening could boost Australian GDP and increase the scope for the RBA to tighten rates further.
We see the RBA holding rates at 4.1% from May 2023. A rise in cash rates and signs of economic resilience should mean a flatter curve. We have also maintained a view that the AU 2s10s curve is too steep relative to other developed markets (a positive slope of 40bp for AU government bonds compared to -72 for the US). We continue to like a box flattener (AU steepener vs US flattener) and outright AU curve flatteners.
© Oliver Levingston
Merrill Lynch (Australia)
oliverllewellyn.levingston@bofa.com
• The RBA will likely deliver a third consecutive 25bp hike next week. A cooler monthly inflation print has investors betting on a lower terminal rate in 2023
• The AU curve still looks too steep and we see inflation risks as increasingly skewed to the upside.
Slowing down, not a slowdown
We expect the Reserve Bank of Australia (RBA) to hike the cash rate by another 25bp to 3.1% at its 6 December meeting. Markets are pricing in a 76% chance of a 25bps hike (24% chance of a pause) as at the time of writing. The message will echo its determination to keep the economy on ‘an even keel’, balancing the challenge of suppressing rising inflation with the risk that rate hikes could tip the economy into recession.
The RBA has moved cautiously on rate hikes: not only was it slow to lift off, waiting until May 2022 to do so; it also surprised markets by downshifting to a 25bp hike in October, becoming the first major DM central bank to slowdown the pace of rate increases. It then stuck to its gradual hiking pace at its November meeting, despite a strong 3Q CPI print (see RBA review: Sticking to 25, 1 November 2022). The RBA has cited the high frequency of its meetings – the RBA meets 11 times, the FOMC and ECB each have 8 meetings scheduled per year – as a reason why it can afford to take a gradual approach.
Market pricing reflects increasingly dovish sentiment – markets are now pricing rates to rise to just 3.5% in mid-2023, down about 30bps in a month. Optimism on rates grew after the RBA’s monthly CPI for October, released on 30 November, showed both the headline inflation slowing to 6.9%YoY (vs. 7.3% in Sep) and the trimmed mean measure easing to 5.3%YoY (5.4% in Sep). However, we caution that for October, the new monthly series contains only 62% of the price data used in the Australian Bureau of Statistics’ (ABS) quarterly CPI – it omits, for example, new information on many administered prices such as utilities, which are not priced until the final month of the quarter.
For these reasons, the RBA has stated that “the quarterly CPI is likely to remain the principal measure of CPI inflation in Australia for the foreseeable future,”1 making it premature to call for a peaking in inflation based on the October monthly CPI print. Nor does it change the fact that inflation is likely to remain well above the RBA’s target band of 2-3%.
Yet the RBA will likely remain less hawkish than its counterparts overseas. Australia’s Wage Price Index (WPI) has only recently started to pick up above 3%. The RBA does not yet see signs of a wage-price spiral, though it has stressed the need to remain vigilant. It noted in its November Statement on Monetary Policy (SMP) that “reports of higher labour costs contributing to price increases have so far been largely contained to price increases have so far been largely contained to a few specific sectors.” A softer retail trade print (-0/2% MoM) and Governor Lowe’s apology before the Senate for the RBA’s (abandoned) promise to hold interest rates steady out to 2024 have added to growing expectations of a lower terminal RBA rate.
For these reasons, the risk of a recession in AU in 2023 remains a low probability and the risks to inflation remain skewed to the upside, in our view. The RBA’s restrained approach, sustained strength in the labour market and a continued boost from a record term of trade make an economic contraction less likely than peers. We do not have cuts in our profile.
Waiting for the wave
The main risk reflected in market pricing and the RBA’s published commentary is that households have not yet sustained the full impact of rate hikes. We have pencilled in hikes until May 2023 just before the mortgage rate reset wave accelerates in mid-2023. The maturity profile of fixed-rate mortgages taken out when lending rates were as low as 2% suggests the “cliff” may have traction. The line of questioning at Governor Lowe’s attendance before the Senate Economics Legislation Committee and public speeches from the RBA confirm that fixed-rate mortgage resets are at the front of their minds when they consider risks to the economy.
Yet Australia continues to enjoy meaningful protection from downside risks, in our view. A positive terms-of-trade shock that has reduced Australian Government funding requirements also means the challenges of housing headwinds should be easy for policymakers to counteract should we see signs of household distress in 2023. At the same time, a long period of low unemployment is likely to generate higher wages and partly offset the dampening effect of rising loan payments on consumer demand, reducing the risk of a housing-led downturn. On the upside, the prospects of a substantial shift away from COVID Zero policies in China continue to gather pace as a steady stream of announcements suggest the country is like to gradually reopen in 2023. The Chinese reopening could boost Australian GDP and increase the scope for the RBA to tighten rates further.
We see the RBA holding rates at 4.1% from May 2023. A rise in cash rates and signs of economic resilience should mean a flatter curve. We have also maintained a view that the AU 2s10s curve is too steep relative to other developed markets (a positive slope of 40bp for AU government bonds compared to -72 for the US). We continue to like a box flattener (AU steepener vs US flattener) and outright AU curve flatteners.
Trade closed manually
