Anticipation continued to build for a global policy pivot Tuesday, when the RBA opted for a smaller-than-expected rate hike at its October meeting.
Just one in four economists predicted the 25bps move. Philip Lowe was careful to preserve the hawkish language around inflation throughout the new statement, but noted that “the cash rate has been increased substantially in a short period of time.” He described the path to a soft landing (in this case a balance between returning inflation to a range of between 2% and 3% while “keeping the economy on an even keel”) as “narrow” and “clouded in uncertainty.”
When taken in conjunction with the smaller hike increment, the decision felt like a relent, even as Lowe emphasized that “inflation in Australia is too high,” in part because domestic demand continues to outstrip supply.
The 25bps increase came on the heels of four consecutive 50bps hikes (figure below). For now, that makes Australia an outlier in a world of upsized hike increments. But, as Morgan Stanley’s Mike Wilson wrote of the Bank of England’s intervention in the UK bond market last week, “this is how it starts.”
“While inflation has yet to peak in Australia, the RBA’s more cautious hiking pace indicates that it’s prepared to wait for the effects of monetary policy tightening already enacted to emerge more fully,” SPI Asset Management’s Stephen Innes said Tuesday.
Lowe referenced the threat of a global economic downturn, and alluded to the housing market. “One source of uncertainty is the outlook for the global economy, which has deteriorated recently,” the statement read. “Another is how household spending in Australia responds to the tighter financial conditions [as] higher inflation and higher interest rates are putting pressure on household budgets, with the full effects of higher interest rates yet to be felt in mortgage payments.”
Data out Monday showed Sydney home prices fell an eighth consecutive month in September. A broader gauge of prices fell 1.4%. “It’s possible we’ve seen the initial shock of a rapid rise in interest rates pass through the market and most borrowers and prospective home buyers have now ‘priced in’ further rate hikes,” Tim Lawless, research director at CoreLogic, remarked. “However, if interest rates continue to rise as rapidly as they have since May, we could see the rate of decline in housing values accelerate once again.”
Lawless needn’t worry. Rates will apparently not continue to rise as rapidly as they have over the past four months, or at least not if Tuesday’s downshift is any indication.
Three-year Aussie yields tumbled more than 30bps (figure below), the most since the 100bps rate cuts delivered in and around the financial crisis.
There are Australia-specific (i.e., idiosyncratic) factors at play, and the housing market is paramount. More than half of mortgages are variable-rate, and fixed terms are very short by US standards (i.e., two or three years). So, the RBA is constrained in its capacity to keep ratcheting rates higher in large increments.
But stepping back and looking at Tuesday’s decision from a macro perspective, it’s the latest sign of tentative capitulation from central banks. A “soft pivot,” so to speak. The currency paid the price. The Aussie tumbled.
“Although the RBA doesn’t explicitly refer to global markets but rather an ‘[uncertain] outlook for the global economy,’ recent weeks’ cross-asset volatility was likely a concern for the RBA as faulty market plumbing impairs the transmission mechanism of monetary policy,” Innes went on to say. “Depending on an individual economy’s growth-inflation trade-off, investors will take a dim view of central banks tightening ferociously into more extreme cross-asset volatility.”
“Is the RBA leading the way toward a downshift in dovishness?” BMO’s Ian Lyngen and Ben Jeffery asked. “This appears to be the narrative at the moment [but] we’re less convinced the Fed is ready to follow suit with a smaller hike in November.”
“Is the Fed going to follow the RBA and pivot to a slower pace of policy tightening, shifting the dollar smile down in the process and triggering a deeper wave of short covering for other currencies?” SocGen’s Kit Juckes wondered. “I don’t think their move was a sign of things to come from other central banks, as much as another reminder that they have a less hawkish bias than I’d like,” he went on to write. “They’ll eventually shift to a balance of tighter monetary and easier fiscal policy, but they’ll do it slowly and reluctantly enough to infuriate me.”
The RBA’s rapid-fire rate hikes this year were the culmination of an about-face months in the making. The bank was forced to abandon its yield-curve control regime late last year when yields on the target note rose to eight times the cap (here, here and, for the coup de grâce, here). But Lowe steadfastly refused to countenance the idea of aggressive rate hikes to combat inflation. In fact, he was reluctant to entertain any hikes at all in the near-term, repeatedly insisting rates would likely remain at record lows until 2024. The market never believed him.
Now that I think about it, maybe Lowe can still be right! If the global economy falls into the coordinated recession many think is now inevitable, and markets crash as a result, Aussie rates may well be at record lows in 2024. (I love it when a plan comes together.)
Good central banking is iterative and should be flexible. It is pretty obvious we have reached an inflexion point. The fomc has until early November to get the joke.
“The Hannibal Report”
It does not seem possible that rates can ultimately be controlled by the central banks. Will they not eventually destroy their own money/credibility by purchasing what a normal person with good sense would refuse to buy? Why would any sane man or entity buy a 4% bond if inflation is at 5-10%? Inflation should/will dictate interest rate. I do not have the answer to how this is negotiated or resolved, but I doubt it will not be by central banks buying what the market will not. It defies reason.
I was down visiting the Federal Reserve in New Orleans a few years ago after the 2008 crisis. They were trying to improve their image and were hosting what they thought were prominent people for tours. That was a mistake in and of itself. There was an open session for questions at the end. I am a simple real estate guy by background and no market analyst. I was dabbling in an overseas trade right then and had been thinking on international trade. I made the statement that it seemed to me that the greatest export that the United States had was dollars; that we “shipped” dollars overseas and got hard goods in return. I followed that up with “Do I see this correctly?” The quick response I got was “Yes, what is wrong with that?” It kind of stunned me and I said “Nothing I suppose, as long as the dollars all stay over seas and do not come back here, that would be inflationary.” And we moved on.
Are the dollars beginning to come home to roost? It appears to me that the demand overseas for dollars is falling on the margin. This run up in the dollar feels like a exhaustion to me. That is my sense.
On top of that (if that is true – we shall soon see) we are going to start selling natural gas to Europe and dollars are going to flow the other way. Plus, we are talking about being a manufacturing nation again. I like that, but can we afford to do it? We will have to export those goods and dollars will come home. If these things are true, they further undercut our central banks ability to expand its balance sheet. We seem very bloated with obligations to be making more obligations. But we are going to buy more debt because we have to when too few show up at auction.
It feels like a time to batten down the hatches if one can while the world fights this out; hopefully with money and diplomacy and not guns.
Walt, I hope things are good. I enjoy your posts. I do not know how anyone can write as much as you do. I particularly I have appreciated your introducing me to Zoltan Pozar. I have listened to his Odd Lots podcasts carefully. I can better understand him talking than writing. I think he is on to something with his Bretton Woods III. I like his view of the dollar as a “project”. This whole economic system is dynamic and changing constantly. It looks very volatile right now.
“Why would any sane man or entity buy a 4% bond if inflation is at 5-10%?” Because, as my old grad finance prof used to say, “Something is always better than nothing.” And my TIPs are throwing off 8.5% … an even better something.
or if you anticipate inflation to fall over a 5, 10, 20, 30 year period you lock in a higher rate now…
Where the dollars are isn’t inflationary in itself. The ratio of overall currency in circulation to things you can buy is the driver of inflation.
Increasing production is the best way to reduce inflation: the home currency gains value (other things become cheaper) because it can be exchanged for more goods and services. Increasing exports is a sign that the country is producing more than it needs, so it serves to reduce inflation.