More slack than expected

The CAPEX report yesterday was a very strong reminder that the slack between mining and non-mining is not failing to be picked up - its actually failing altogether.


The long run outlook for private spending is now a major concern. Most world banks see FY16 and FY17 as a return to nominalised growth in Australia, the figures release yesterday counter those assumptions wholeheartedly.

The RBA had recently lowered its forecast for growth and inflation which were outlined in the Statement of Monetary Policy.  However, it too believes in a non-mining recovery although it will be moderate. 

That assumption looks to be completely incorrect now, as the CAPEX data for 2015-16 shows an outright fall in non-mining investment with an approximated 4.7% decline in the low range estimates. It is also likely that Q1 2015 capex in April will show the Q4 2014 figures predate the significant falls in oil price and non-residential building approvals.  Therefore, I would expect further weakness to be factored in. It also predates the major infrastructure cancelation of the East-West Link.

The CAPEX numbers will be a surprise to most, the fact non-mining on the long range forecast is expected to contract rather than expand will make the RBA sit up even further. The interbank market moved from a 38% chance of a 25 basis point rate cut at next Tuesday’s meeting to a 50.7% chance 20 minutes after the release - come the close of business it was 47.5%. Looking to the April and May expectations there is 75% chance by April of a cut and 98.2% chance come May.

Interestingly, of the 29 economists surveyed by Bloomberg, the medium estimates for rates at the end of Q1 2015 is 2% (the mean is 2.12%). That would imply most economists expect a further rate cut next Tuesday. The AUD fell 1.2% overnight to 0.7794, having crossed 0.7910 earlier in the night - the moves are related to US core CPI being well ahead of Fed’s expectations causing the USD to rocket back into buying territory. The euro was the hardest hit, however, the AUD wasn’t far off as low rate expectations coupled with the fact next week’s GDP could now disappoint considering the data, have yet to be factored into the currency.

Saving erosion and investment

From a strategy point of view, the data is certainly pointing to not only a further rate cut, but realistically the prospect of two or even three cuts to the cash rate. Media concentration on these expected cuts is focusing on the impacts this may have on the housing market - particularly the frothy Sydney market (which saw the medium house price rising another 1.4% in January compared to the national medium of 1%). What I see as a major concern is what is happening in cash savings.

Australia has never seen savings rates this low. The highest 90-day money market rate currently on offer is 2.75%. The average across the market is 2.25%. That is the same as the current central cash rate but is also the same as the year-on-year trimmed mean inflation rate. This means savings rates are negative, as cash rates are not enough to cover inflation and taxation.

The erosion of savings is forcing this cash pool into other asset classes and it’s very clear that it is the property and equity market. The seven year high on Wednesday saw yield plays that had seen dips over the past two weeks being snapped up and oversold material play (now offering 5% net yields in some cases) being heavily bid. The momentum in the market is suggesting it will go higher still, however, resistance is building at 5940. Yet if the RBA does move again (and it will) further hits to the cash rate will force more funds out of the cash market and into equities and property.

There’s an interesting situation here – with the banks beginning to see their retail funding pools being eroded, how will they respond? Margins are already thinning, do they go to the more expensive wholesale market to shore up capital? Do they curb lending (very unlikely)? Or do they compete and keep cash rates higher to keep the pool liquid thinning margins further?

What also happens when bad and doubtful debts begin to creep up considering they are currently very low and the sluggishness in the economy will filter through? Wage growth is not moving enough to keep pace with the rate of growth in house prices.

These are questions that will make Glenn Stevens and co sit bolt upright as they look to ‘assist the economy’.

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