Press release - Investor Signposts: Week Beginning November 9 2008
Upcoming economic and financial market events -
Australia
Nov 10 - Statement on Monetary Policy - The Reserve Bank will flesh out its views on the economy.
Nov 10 - Housing finance (September) - A 1pct fall is expected, but the outlook is more positive.
Nov 11 - NAB business survey (October) - Now seen more as ‘ancient history’.
Nov 12 - Wage price index (Sept quarter) - A 1.1pct increase is expected, taking annual growth to 4.4pct.
Nov 12 - Consumer sentiment (November) - A raft of positive influences – petrol, interest rates and the US election.
Overseas
Nov 14 - US Retail sales (October) - Non-auto sales probably fell 0.6pct.
Nov 14 - US Consumer sentiment (Nov) - Gasoline prices are down and the Obama victory buoys confidence.
The big picture
- The Reserve Bank isn’t going to die wondering – the interest rate stimulus applied to the economy over the past three Board meetings has been nothing short of amazing. Rates have been cut by two percentage points, matching similar declines over November 1991 – January 1992. But the stimulus this time around is far more aggressive because the starting point for cash was far lower than in 1991.. The current easing cycle is easily the most significant in 25 years – since the Australian dollar was floated in late 1983 when cash rates were halved.
- The 5.25 per cent cash rate is now the lowest since March 2005 - not December 2003 as reported in some quarters. A 5.25 per cent cash rate is slightly below both 10-year and 15-year averages, and now is close to a more ‘normal’ or neutral setting.
- Where is this fabled ‘neutral’ zone? Well, back in 2003, the Reserve Bank referred to the 5 per cent cash rate as ‘still below neutral’. And in the most recent statement the Reserve Bank made no reference to the need for ‘less restrictive’ monetary policy. So it is clear the current 5.25 per cent cash rate is close to ‘neutral’.
- However in the current environment the other consideration is that banks have lifted rates independently by around 50 basis points. That means that a ‘neutral’ cash rate is probably lower than it may have been in the past – that is, closer to the 4.75-5.00 per cent range.
- So why all this discussion about ‘neutral’ cash rates? Well, the neutral cash rate is important as it defines the rate that is neither serving to apply the accelerator to the economy, nor the brakes. And if we know where this level is, we get some sense of how many rate cuts lie ahead.
- We believe that the Reserve Bank will cut rates by at least 25 basis points, or a quarter of a percent, on December 2. It could very well by 50 basis points but, just like this month, it will depend on financial conditions, economic data and bank term funding conditions at the time of the December meeting
- While short-term interbank lending rates have come down substantially, term funding for financial institutions – the cost of raising funds for longer terms of 2-7 years – hasn’t markedly improved. That dichotomy between short and longer term rates I understandable. Many lenders are going through the most significant financial crisis they have seen. And human nature being what it is, it takes time for confidence to return.
- But there is reason for hope. Barack Obama’s victory in the US Presidential election has unleashed a new wave of confidence across global financial markets. There is a hope that the workout phase has well and truly begun and that there are no fresh skeletons to fall out of the closet. That is, most of the bad news is behind us.
- The environment has parallels with the beginning of the global bull market rally in March 2003. At that time it was hope of a short Gulf War that sparked optimism, dragging the US economy out of recession.
The week ahead
- The Reserve Bank again dominates the spotlight in the coming week, with the quarterly Statement on Monetary Policy to be released on Monday.
- The statement will be important for two reasons. The first is to flesh out the factors behind the dramatic rate cuts over recent months. Simply, a lot has happened in a short space of time, and the Reserve Bank must explain its actions. And secondly, investors will want to get some gauge on where rates are going. No doubt the Reserve Bank would also like to send some signals in order to reduce uncertainty.
- Apart from the Statement on Monetary Policy there is a fair slab of economic data to be delivered. Housing finance data is released on Monday with the NAB business survey, tourism data and the NSW mini Budget all slated for Tuesday. On Wednesday, consumer sentiment, lending finance and the wage cost index are all issued while the Treasury Secretary gives an address. And rounding out the week is data on average weekly earnings on Thursday and the State accounts on Friday.
- New home loans probably fell 1 per cent in September, but just like the business survey, the data is probably regarded as ‘ancient history’. The most positive economic reading is likely to be Wednesday’s consumer sentiment figures. Interest rates and petrol prices are down and the victory by Barack Obama will instil fresh confidence. If only share prices were also trending higher then the lift in consumer confidence could rival the record result set in January 1993.
- The September quarter reading on wage growth is released on Wednesday, but there won’t be the same focus now that inflation is off the radar. In fact stronger growth would be viewed as a positive – giving cash-strapped employees reason to spend. We expect that wages grew by 1.1 per cent in the quarter and 4.4 per cent over the year.
- In the US, economic data is thin on the ground in a holiday-shortened week. The key release is the October retail sales figures on Friday – a result that will be crucially watched by recession-obsessed investors. The car sales figures were dreadful so a large fall in sales is on the cards. And there will be particular attention on the retail components to see where consumers are cutting spending most. Overall, retail sales probably fell 1 per cent with non-auto sales down 0.6 per cent.
- Other US data on the radar screen includes monthly trade figures on Thursday and consumer sentiment on Friday. Confidence levels are likely to have rebounded – just how significantly will give us a sense of how close the economy is to the bottom of the cycle. There are also a number of Federal Reserve officials to give speeches. Gary Stern and Charles Plosser front the lectern on Thursday and Fed chairman Ben Bernanke participates in a central bank conference on Friday.
Sharemarket
- The Australian sharemarket has been a lot like a game of snakes and ladders over the past month. And while investors have gone up a few ladders, the problem is that we have slid down a number of snakes to leave us back where we started. The good news is that the sharemarket seems to be forming a base. The bad news is that it is still not clear whether the next move from here is higher or lower.
- Could the victory by Barack Obama be the spark to set off the next bull market? Unfortunately no bell goes off to announce the fact. But the last bull market rally began in March 2003 at the time of the second Gulf War. Investors embraced shares on the expectation of a brief and successful military campaign in Iraq. And that turned out to be the case. (The on-going occupation of allied troops is another story, however). Recovery wasn’t instantaneous and there were some big declines over the following month. But the recovery held, driven by greater confidence on the future. And the same confidence could spur the 2008/09 bull market.
Interest rates
- The latest pricing in the overnight indexed swap (OIS) market suggests that the cash rate is headed for 4 per cent over the next six months. Bank bill futures for June 2009 have an implied yield of 3.82 per cent. Has the Reserve Bank got a lot more work to do? We expect the cash rate to fall to the 4.75-5.00 per cent range, but for rates to fall even further will require significant weakness in the Chinese economy. It is Chinese economic indicators that we need to keep a watch on, less so the US data.
Currencies & commodities
- The decline in commodity prices since July has been nothing short of amazing. The CRB futures index has plunged over 43 per cent, with the decline over the past six weeks standing at 28 per cent. But those falls in prices are reasonably pale when compared with the measure of shipping costs – the Baltic Dry Freight index.. The Baltic Dry index has plummeted from 11,793 from mid May to the current level of 826, a decline of 93 per cent. Did China stop building new roads and railways almost overnight? The short answer is no. But the August Olympics did provide a complication, with the closure of factories contributing to the downward momentum in commodity demand and prices. And just as the run-up in prices was unsustainable, so is the recent slump.
Source Craig James, Chief Equities Economist, CommSec
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