Wednesday 20 July 2016 by Opinion

RBA Minutes – Market pricing and how investors should react

Last Tuesday, the RBA released the Minutes from its Board meeting on 5 July 2016.  Most of what was contained in there was largely as expected 

Before talking about interest rates, there was a slightly more explicit acknowledgement about the property market. The RBA noted:

“Building approvals remained elevated at levels that would add to the considerable amount of dwelling construction work already in the pipeline.  Considerable supply of apartments was scheduled to come on stream over the next few years, particularly in the eastern capital cities.”

In my opinion, the RBA clearly emphasised where it sees the biggest areas of concern.

In terms of the future path of interest rates, the all important last paragraph had been elaborated on and certainly left the door ajar for a potential cut in August. The RBA stated (emphasis mine):

“Taking account of the available information, the Board judged that holding monetary policy steady would be the most prudent course of action at this meeting.  The Board noted that further information on inflationary pressures, the labour market and housing market activity would be available over the following month and that the staff would provide an update of their forecasts ahead of the August Statement on Monetary Policy.  This information would allow the Board to refine its assessment of the outlook for growth and inflation and to make any adjustment to the stance of policy that may be appropriate.”

This compared to the more succinct last paragraph in the Minutes from June:

“Given these developments, and following the reduction in the cash rate in May, the Board judged that leaving the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and inflation returning to target over time.”

In my opinion, the RBA is clearly stating that once new economic data is released – especially next week’s CPI – then revised RBA forecasts may allow it to adjust its cash rate lower.

Economists v market pricing

So with the August meeting very much a ‘live’ gathering what are the markets pricing in?

In a Bloomberg survey of economists, 24 out of 25 expect a 25bp cut to 1.5%; NAB cuts a lone figure expecting the RBA to hold at 1.75%.  Whereas according to the swaps market the decision to cut is much more finely balanced; there is a about a 57% probability of a cut, which is up from 48% a weeks ago and 42% a month ago.  Interesting two months ago that probability was at 52%.  Looking further out, the probability of at least one cut by the end of 2016 is 82%.

In my opinion, in this instance the swaps market is closer to the actual probabilities but if I was looking for some publicity hungry economist I would be joining NAB in predicting no change.

Whether or not you believe the RBA will cut in August or not, it is difficult to argue against the fact that RBA rates are heading lower.  Bloomberg has an interesting chart that highlights this message very clearly.  The chart below shows the most likely path is the dotted orange line and that is trending lower.

Source: Bloomberg

Investor action

Even though the market is pricing in lower RBA cash rates, I think that there are at least two more cuts left and the market is not willing to admit that prospect, just yet.  In 2012, Philip Lowe, the soon to be anointed new Governor of the RBA said that threshold for unconventional monetary policy was “around 1%, plus or minus a bit.”  So the next RBA Governor believed that the cash rate reductions still had an impact down to about 1%.

If you believe that the RBA cash rate is going lower, then now is still an attractive time to look at fixed income.  This is even more so given what many believe are the irrationally elevated levels of global equity markets.  On that point, the heading of my next set of presentations is “All bubbles burst”.  Enough said; you know what to do.