Monthly Archives: April 2015

RBA coin toss heads for cut

It’s been a turbulent month of oscillating interest rate expectations. Early on, I argued that the case was swinging in favour of a hold, in contrast to market pricing and economists’ forecasts, with obviously implications for the currency.

The next few weeks lent support to this thesis, with chances of a cut diving as iron ore rallied wildly and a range of data releases pointed to a temporary patch of strength in the economy as the cyclical sectors fired following the February rate cut.

This pushed AUDUSD well up from its lows at the beginning of the month; last night it breached .8000 on the back of woeful US GDP figures.

Whilst musing on the possibility of a hold in May, I noted that a key concern was AUD strength forcing the RBA’s hand. Another (unmentioned) consideration was that APRA would move on macpru and thus the RBA would feel satisfied to ease again. If the RBA saw that sufficient regulatory breaks were being applied to the investor mortgage freight train, a cut could be on the cards.

If we go back to an even earlier post, there was an article I linked to by Fairfax journo Peter Martin in which he offered a strong indication that the RBA would hold in April. This irritated me enough to lambast the “extraordinary failure” of policymakers for permitting a cyclical property boom to supplant a real devaluation (which is more or less been exactly what’s happened). And as it turned out, his sources were solid. There was no cut in April.

Well tonight the clairvoyant offered another premonition: this time he sees a cut.

Below is perhaps the most important passage:

Although the Bank is concerned about the effect another of  cut on Sydney house prices, it is prepared to rely on its sister regulator, the Australian Prudential Regulation Authority to ensure banks do not cut their lending standards further in order to drum up more business after the cut.

Indeed, the equity market is getting jittery about the prospects of macpru:

Almost $20 billion has been wiped off the value of the big four banks by sharemarket investors this week, partly because of expectations the prudential regulator will take quicker-than-expected action to deal with the threat posed by rampant property speculation.

Yes, partly. But also because expectations of a rate cut tanked. If the RBA does cut expect a solid rebound. Whether a rally in financials lasts is all down to the sting in the macpru regime.

We’ll learn on Tuesday just how good Peter’s sources are, but currency markets are already all over it.

AUDUSD

Tough month. I have to confess after finding it “very hard to see the RBA cutting interest rates next month” a matter of days ago, it looks like the RBA is laying the groundwork for a cut.

APRA’s macpru house had better be in order.

Iron ore rebound rips the roof off

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It’s all over. Australia’s brief flirtation with economic ruin, as the price of our primary export commodity crumbled, is happily behind us.

Or so you would think listening to the more excitable segments of media commentary the past few days.

We are certainly in seeing a feverish short-covering scramble/steel mill restock, with spot now a good 23% above it’s low in early April (bull market!).

Iron ore

And it’s not over yet, with Dalian futures up a blistering 5.5% in the overnight session on Friday.

Although I was expecting a bounce, this has undoubtedly been a far more violent reaction than I’d anticipated. The proximate cause was BHP delaying expansion from 270mt of capacity to 290mt by six months or so. There’ll be a strong element of short-covering, however what’s really driving the rally is plain old FOMO (fear of missing out). These kinds of moves can only occur when steel mills are in a mad dash for cargoes. If you perceive your competitors starting to scramble for stocks, your only choice is to scramble yourself or face higher prices tomorrow. Naturally, this results in even higher prices tomorrow.

Enjoy it while it lasts. BHP’s delay has kept a number of juniors, FMG included, in the game longer than they otherwise would have been. Thus, unless there is a material pick-up in steel demand imminent in China, the medium-term supply-demand imbalance in the iron ore market has actually worsened as a result of BHP’s move.

It is still not outside the realms of possibility, but the iron ore rally makes it very hard to see the RBA cutting interest rates next month. As I highlighted a fortnight ago, assuming a dovish Fed this week, and an RBA hold next week, this points to considerable upside for the AUDUSD in the short-term.

Could RBA coin toss land on hold again?

Seems unlikely. All 26 economists surveyed by Bloomberg are calling a cut at the May meeting, taking the cash rate to 2%. Likewise, rates futures are pricing a 79% probability of cut.

Many found the RBA’s decision not to cut last month quite bemusing, what with the 25% collapse in iron ore prices since the March meeting, the rapidly approaching capex cliff, and the need for an ongoing real devaluation if we’re to see a meaningful revival in non-mining tradables. The reason for holding, however, was clear enough: the RBA is spooked by the investor mortgage Frankenstein it has unleashed, and would rather not cut unless it absolutely has to.

My hard-fought call last year that rates would fall before they rose was validated in February, but it bears remembering how heavily I stressed the bipolar nature of Australia’s economy. I believed rates would fall, but only because the structural weakness emanating from the slide in the terms of trade and the capex wind-down was going to overwhelm the cyclical boom in the property space.

Following the February cut, the cyclical factors have truly roared, so much so that I am now wondering if the balance is tipping in favour of further reticence on the part of the RBA.

Firstly, iron ore has bottomed for now and has put on a good 8% from the (admittedly very low) lows, with Chinese futures having been locked limit up (+4%) for the past two sessions.

Iron ore

I don’t anticipate this being much more than a moderate bear market rally, for the simple reason that the market is structurally buggered. A couple of charts from Citi this week illustrate the point.

New supply is still pouring in:

IronOre2

And I’ve discussed many times previously, we’re almost certainly past the peak in Chinese steel demand:

IronOre3

But if iron ore can hold it’s gains and perhaps add another 5-10%, the RBA may well side with cyclical argument for holding monetary settings steady.

Property markets in Sydney and Melbourne have piled it on since February, and I get the feeling the RBA is especially concerned by just how sensitive activity in this space has proven to the last cut.

House Price indices

Investor mortgage growth in the boom states, especially NSW, remains extraordinarily strong, as shown on this chart from Pete Wargent:

PWargentInvestors

And perhaps the most important real-time indicator, auction clearances, are also pointing to exceptionally tight markets.

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ScreenHunter_6970-Apr.-13-07.49

Viewed in isolation, this is not an environment a sane central banker could comfortably ease into. But of course it cannot be isolated from the external shock bearing down on the economy, and therein lies the RBA’s mighty quandary.

If Oz data remains benign over the next few weeks, and the iron ore price doesn’t crash through the lows before the next meeting, I suspect there’s a better chance of a hold than rates markets are pricing, and much better than economists are forecasting.

To the caveats: Firstly, the China national accounts data dump tomorrow morning could be a shocker. If it’s really nasty then the market will have to decide whether to buy on the promise of stimulus, or sell on reality. If nasty data snuffs out the metals rally, the chance of a cut obviously firms. Secondly, I expect the Fed to be dovish again at its meeting at the end of the month, and if this adds to unwanted AUD strength, the RBA’s hand may well be forced by FX markets.

RBA coin toss lands on hold

Which is more important, a 25% monthly collapse in the price of your main export or a raging housing bubble in your largest city?

It’s a tough call, however the RBA has a rigorous methodology for addressing the dilemma:

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Here’s the full statement.

It’s highly unlikely this decision will cool housing speculation over the next month in any noticeable manner. And it’s equally unlikely that iron ore will rebound materially in that time. (Despite being due for a bounce, Chinese steel futures are selling off again today.)

So stay tuned for next month’s coin toss.

Iron ore cracks the half-ton

10Wisden11

Paging Michael Pascoe, et al: Australia’s most important export commodity is rapidly siding with the doomsayers:

Iron ore

The iron ore crash that so few took seriously is now moving towards its endgame. Australia’s Dog Days have arrived.

But the tragedy-farce is not over yet; there’s still two big projects gearing up this year (h/t DLS):

Iron ore flood

RIO’s is due to commence production within the next couple months, while Gina’s ore will hit the market in September. And it’s all being dumped upon contracting demand.

We are in the grip of a very severe bust indeed.

For now, however, the impending collapse of Western Australia’s economy is a boon for NSW and Victoria, as it adds to expectations of further rate cuts. Further cuts, in the absence of tough regulatory disincentives, will toss more kerosene on the Sydney and Melbourne property frenzies.

The last cut ushered in a veritable swarm of buying in Sydney. As Domain Group’s chief economist recently put it:

“This is the hottest of hot auction markets ever.”

Sydney property prices

Obviously this cannot go on indefinitely. The WA export juggernaut is the foundation on which the hyper-financialized East Coast economies rest. Currently there’s a torrent of offshore capital flowing into these markets, so overall conditions are fairly robust. But eventually, without a sustainable, internationally-competitive productive base, bubble economies inevitably unravel. I have my own thoughts on when this might happen and what the triggers might be, but really it’s anyone’s guess.

Updated

Chinese iron ore futures have been crushed again today, currently a whisker away from limit down.

Further into the mire we sink…