Despite the RBA's massive rate "U-turn" and their insistence that we are in the final stage of the hiking cycle, has it come too late to stop a recession? Chris Rands and Darren Langer examine the factors influencing the market and reveal their expectations of the economy and the Australian credit market in episode 37 of The Rate Debate.
Despite the RBA's massive rate "U-turn" and their insistence that we are in the final stage of the hiking cycle, has it come too late to stop a recession? Chris Rands and Darren Langer examine the factors influencing the market and reveal their expectations of the economy and the Australian credit market in episode 37 of The Rate Debate.
Hello and welcome to the Rate Debate. I'm Darren Langer, co-head of Fixed Income at Yara Capital, and joining me as always is my co-portfolio manager, Chris Rans.
Speaker 2:Hello everyone.
Speaker 1:Well, first Tuesday of April and the RBA has just met. Uh, so after three and a half percent of rate timings, the RBA has decided to have a break. Chris, apparently monetary policy works with lags. They tell us who would've thought, right? I don't know whether we've been talking about that much for the last year, but I, I, I think, um, to me today's statement was pretty bland. You know, it seemed to be more like commentary than any forward-looking statement. I mean, what did you get out of it that, uh, I missed
Speaker 2:<laugh>? Dunno if it's missed anything, but I think the biggest change apart from them pausing, is in, in the final kind of paragraph where they talk about what's coming this month, what they've said is the board expects that some further tightening of monetary policy may well be needed. So that's a bit of a departure from what they've been saying in the past. They've been saying monetary policy will be needed to be tightened. So you're getting a bit of, I think, optionality into the statement now, you know, this comes after a bit of flipping and flopping, I think from December through to February and now, but I think we're now at the point where you're not looking at automatically higher rates
Speaker 1:Anymore. You bring up a good point. The R V eight does seem to have chopped and changed its mind a few times since Christmas. We thought they should have paused in February. They came out, they're all revved up. They're worried about wage price spirals and you know, a few other things. But pretty much they've been backtracking ever since. You know, I, I think the last two rate hikes are likely to end up being a policy mistake. But as you said, you know, it sounds to me very much like they've added some, at least optionality in that they only will go if they absolutely feel they have to go. And that's gonna ultimately be what the next sort of inflation print show. And so far this year, you know, inflation's are nothing but weaken rather than get stronger.
Speaker 2:Yeah, I I think that kind of really goes to what has caused them to move around. If you think back to December when, when we were kind of speaking about what we thought the R B A would be doing, that's when we were starting to see our indicators show that they should be on pause. At that point in time, the RBA actually said that they were thinking about leaving cash on change for a period of head. We then kind of went on holidays, we came back and there was a, a very high inflation print, and that got them into the mode where they're saying more rate increases will be needed. And now if you kind of roll forward, there's a bit of commentary starting to come through the last minutes that says they're, they're a little bit concerned about employment, GDP wages and those types of things. So because of that, they're getting ready to, I guess, slow down and step back. It is a little bit neurotic, but it, it kind of looks like they've just been, you know, taking the data as it comes and changing their opinion month to month.
Speaker 1:They keep talking about being data dependent. What that doesn't mean, you know, you react to every single uh, number that comes out. You know, you gotta think that they should be at least trying to forecast some things. But given their, um, attempts at forecasting over the last two years, haven't been overly, uh, good. Um, perhaps maybe even they've given up<laugh> on the ability of forecasting it and are just taking it step by step. I think overall, you know, an assessment of the economy, what's happening overseas, the fact that we are starting to see some of the, the worst part of inflation moderate, uh, you know, it, it really was pointing to the need to slow down. You know, we, we can argue whether it had, should have been February or or whatever, but I think they finally got there. Um, the big question is he really gonna be, you know, is this it and are we now probably heading into an easing cycle or will we see, you know, further hikes, you know, three, six months down the track?
Speaker 2:Yeah. When you think about kind of what the RBAs done in the past, typically once they pause, you're probably very close to the end of the hiking cycle. If not, you're there. Usually what you'll see is that the cash rate will stay stable for about anywhere from six to 18 months and then, you know, if the economy picks up, maybe they can go higher, but the, it's probably more likely after that period the rates need to drop a little bit. I think when you look at what the R B A has kind of done here as well, there were some signposts in the minutes last month that this was coming. So in the middle of the minutes, they actually said that members agreed to reconsider the case for pause and that would allow them to have some additional time to reassess the outlook for the economy. So they were starting to see some signs of weakening data. You know, as you said, the, the monthly C P I figures starting to come off GDP was worse than expected. Household consumption has been lower. The only reason kind of retail and things like that arising is because of population growth, not because people are are spending more. And on top of that, now you've got those credit problems with bank defaults occurring offshore. So you did have a lot of kind of things occur over the past month that set them up for this, but on top of that, that statement where they said they're getting ready to consider it was already setting this up, I think four weeks ago.
Speaker 1:Yeah, I mean, it, it's a good point. You know, the instability that's come about from credits who's failing and problems within the US banking system suddenly seems to have led not just the rba, but the Fed and a few other central banks talking about tightening of credit and credit availability. I mean, all our numbers again, have shown that's been happening for some time. That's ultimately the purpose of tightening interest rates. What do you think, you know, the global instability in banking has has caused inside the central bank thinking and why is it now suddenly much worse than perhaps, you know, what they were thinking two months ago?
Speaker 2:I think it's, it's tough to kind of really think about that question from the Australian perspective because we certainly don't think the Australian banks are in the same position as offshore. We think that, you know, our regulatory regime is stronger, you know, the Australian banks are are looking very strong, so we don't really see the same problems that you would in the us But having said that, monetary policy has been moving in the same direction globally. So if you look at, you know, federal Reserve interest rates, or sorry, US interest rates in the front end, the two year bond yield rallied, you know, a hundred points when those banks started to fall over. So I think it does point to globally, we're entering this period now where rates have hit a level that is, is starting to cause some kind of problems. It's important though, I think to remember that when you tighten conditions, this is essentially partly what you're trying to do. You know, you've said conditions have been too easy for too long, there's been too much investment, there's too much inflation. Well, we need to start tightening the strings and certainly there's going to be companies that fall over because of
Speaker 1:That. Yeah, that was kind of my point. I mean, you know, you tighten interest rates to reduce the amount of credit available in the economy and slow the economy down, but it seems to have come as a shock to central banks that that's one of the outcomes,<laugh>, maybe it's becoming more exacerbated by what's happened, but again, that comes down to more of a regulatory failure than maybe something that we're trying to engender. But it does seem a bit surprising that central banks are using that as a reason to, to pull back rather than just the fact that they've already put so much, um, tightening in the system and that they're starting to break things. It just seemed a bit of a surprise to me that that suddenly become an issue for them where it should have been prior
Speaker 2:<laugh>. Yeah, it seems like they certainly need something to snap to get the picture that they've gone a little bit too far. If we kind of step back though, and, you know, you try and answer the question, well, why were we saying they should be pausing? You know, at the back end of last year, we kind of use three indicators and all of them are pointing to monetary policy should have been on pause. So the first of those is an economic indicator. It takes kind of a wide array of different, uh, Australian series and it, it just tries to check how they're performing versus their history. That has gone from being into a very strong expansion area into what is now neutral. So, you know, whether you look at building approvals, G D P, labor market yield curve, commodities, a lot of those things have come off that's, that's really kind of slowed that indicator down. Certainly the first thing for us was the data was slowing. The second is a calculation that we do on a household ability to repay their mortgage that's gone from essentially the easiest conditions in 40 years to now the tightest conditions in 40 years. We've never really seen a change occur that quickly or of that magnitude. So I certainly think that that's now clearly in restrictive territory and probably gonna start to cause some pain. And then the third thing to just kind of put all this together is their language has really softened, the RBA has started to use the word slow and slowed a lot more and they've kind of taken out a lot of the, the positive language in their minutes. So, you know, when you put all of that together, it's saying we're in restrictive territory now and you guys should be slowing down.
Speaker 1:Yeah, and I think too, we're, we're starting to see that with several offshore central banks too. Probably the Bank of Canada we've mentioned before was one of the first to start identifying some of these problems. But even with the Fed now, you can see their language is starting to change. It's talking about the possibility of where problems might lie. The banging systems obviously spook them as well. What are your feelings that the next fed meeting, are they gonna continue to tie in your or do you think they're gonna go and pause as well?
Speaker 2:Yeah, if you, if you kind of take that same analysis that we just did did for the RBA and run it over the Fed, it, it gives you the same answer that they should be getting ready to slow down and stop. You know, if you look at the US their pmmi are contracting typically that leads industrial production. So you probably start to see that contracting soon. You know, the curve is hugely inverted, which tells you the market doesn't believe them. And if you take that kind of similar economic indicator that I described to Australia in the us it's fallen from hugely expansionary to now be slightly contractionary. So, you know, you've got this same set of economic indicators saying the US economy is slowing, you've got some credit problems, and all of that says they should stop. But if you listen to the Fed Governors, that's not what they're saying. You know, if you, if you take some of the more hawkish members like Bullard, he's still saying rates should go to five and a half percent, if not six, and some of the other members are, are not far behind. So, you know, I certainly think of the Fed here as the data and the kind of market indicators like the yield curve are saying they should stop. But the messaging that we're getting from the Fed is that they're not listening.
Speaker 1:Yeah, it, it's interesting that the Fed keeps talking about the fact that they can't see signs of inflation having turned yet pretty much every inflation indicator. Yep. They're still high, but they're lower than they were. So it's a bit hard to sort of say that there's no signs of inflation moderating. But yeah, I I think the next fed meeting will be interesting if they keep going. Um, it's certainly gonna make it, um, um, very interesting bond market because, you know, regardless of what the R B A does, you know, rates are gonna follow what happens in the US to some extent, but we've already seen a, a pretty big rally in the US then a big selloff again, to come back to more normal, it's hard to know what the bond market's gonna make of the next, uh, fed meeting. So something I don't mention a lot on this, um, podcast is the price of oil. I guess one of the things that we've been talking about a fair amount recently is that the, the cost of energy has been coming off and that's been helping inflation drop. OPEC came out the other day and basically made the comment they're gonna start, uh, dropping production by a half a million barrels a day, or price shut up five bucks instantaneously. Do we see this is a problem going forward or is it just, you know, another, I guess, blip on the, the data road to lower inflation? If
Speaker 2:The oil price goes from$80 where it is at the moment up to say a hundred dollars, which is, you know, it was there not too long ago, then I think that'll have some inflationary impacts, you know, in three to six months time where it, it looks like inflation's kind of starting to pick up again. The hard part that I kind of find with judging with where we are at the moment is that, yes, the cuts in production should push the price higher, but equally the falling pmmi, the drop in industrial production, typically that's associated with a, with a lower oil price. So, you know, if demand for goods and, and those types of things is softening, maybe that can offset some of the inflation impact. But it's just very hard to tell at the moment because you've got this kind of softening demand story from, you know, a potential US recession against, you know, artificially driving the, the oil price higher from production
Speaker 1:Cuts. Yeah, I would've thought demand probably in the end wins if demand comes off. You know, it doesn't matter what Saudis do or OPAC does, you know, I think all prices will maybe not come off dramatically, but at least level off and that should take some of that pressure
Speaker 2:Out. Yeah, and, and I think the trouble will be if they do kind of drive the price higher to a hundred dollars and then we get this kind of second wind of inflation that picks up, then everybody in the market will be thinking about that 1970 story where you get high inflation, it drops down for six months and then it reac accelerates and we need to go higher. Clearly, we, we don't kind of believe, I think completely that that's what's going to occur, but I think that will be the narrative if the oil price really picks up.
Speaker 1:So given the fact that we, we've said that rates are likely now to be on hold for at least three, maybe six months, possibly longer, depending on the data flow, probably a pretty good environment for fixed income investors. You know, having relatively stable yields, earning decent sort of income probably means that, you know, returns will be reasonably good for the next couple of months. Still a bit of choppiness, but I think, you know, we haven't seen that kind of stability for, for probably a year or more and we've had, you know, pretty big selloff then we've had a pretty big rally. Probably would be nice just to see yields go sideways for a little while. But I think if we are in that environment where people really believe rates are stabilized and unlikely to go up, but may not be cut soon, it's probably a pretty good environment to, to own some bonds. Certainly. Uh, yeah, definitely think the outlook is, is probably better than it's been for some time.
Speaker 2:Yeah, I think it actually sets up to be, you know, pretty positive here. While yields aren't as high as they were kind of, you know, two months ago, they're still high versus the past seven years. So there's still pretty good yield sitting in there. And if the central banks do start pausing, it creates an environment where that weepiness where, you know, every second day where we're guessing how high might rates might go, we'll come outta the market and you'll get a little bit more stability. So you trade off that by having slightly lower yields than where they were a couple of months ago. But there, there should be a little bit more certainty with, with where rates end up as we kind of get this language from the R B A that they take out the will be tightening to maybe we'll see in the future.
Speaker 1:Well that's it for the month. Uh, if you ever wanna suggest topics to, uh, Chris or I, uh, we can be contacted for the rate debate@yaracm.com. So tune in next month when we deliver our latest thoughts on the RBAs may rate decision and provide an update on what's happening in markets. Until then, stay safe.
Speaker 3:The rate debate podcast content may contain general advice. Before acting on anything in this podcast, you should consider your own objectives, financial situation, or needs, and seek the advice of an appropriately qualified financial advisor.