The next move in rates

I fully expect the RBA to lower rates by a further 25 basis points today.

Source: Bloomberg

Since the release of the Statement of Monetary Policy (SoMP), Stevens has been in quite a rush to catch up to where the Australian economy actually is. His statement at last week’s parliamentary testimony perfectly sums up the path Stevens is on:  ‘If you feel the case has emerged and it is clear enough, it is usually best to get going on it.’ Code that they are going to cut rates.

There is plenty of debate now as to where rates will be come December and where rates will be 12 months from now, which I see being determined by the results of tomorrow’s GDP read.  Consensus expectations are for year-on-year growth to be 2.6% down from 2.7% in the previous quarter. That seems slight high considering yesterday’s inventory numbers were significantly lower than expected.

The fourth quarter also saw iron ore and crude bottoming while wage growth stalled. Do not be surprised to see GDP in negative territory on Wednesday and, considering the slowdown has continued into the first two months of Q1 2015, the RBA will need to get its skates on to catch up with the general growth of the economy – adding further fuel to the belief rate cuts are inevitable.

However, there is certainly a very prominent view coming from some market commentators and economists that the RBA should not move on rates today or indeed over the coming months due to the situation in the housing market.

I fully understand the concerns here – debt-to-income ratios are moving back towards 2007 levels and there is no doubt Sydney’s property market is frothy. However, the issues in Sydney are not just Australian-centric, many other mega cities around the world are experiencing the same frothiness -  London, Paris, New York, Shanghai et. al. are all currently experiencing similar ramp ups in property prices brought about by the global interest rate wars.

The counterargument to this is that Australia’s population is centred in in New South Wales and Victoria (approximately 60%), making it unsustainable. I would agree in the main but if the non-mining space is indeed the saviour of the Australian economy as stated by most – job and wealth creation are going to start in these regions due to the makeup of Sydney and Melbourne’s economies.

Looking at housing as the sole reason for not cutting rates is too myopic in my view. The RBA is charge with guarding the Australian economy with what is effectively a sledge hammer (interest rates) to do fine art (pinpointing the weakness while not driving up the strength in the economy, aka housing). Inflation is well and truly contained and the concern now is that we will have come close to disinflation after a large fall at the last update. Stripping out food and fuel, core inflation is teetering on the edge of the RBA’s range and likely to fall below it in this quarter – there is no obstacle for the RBA here either.

This bring the ASX into focus - money managers and institutional investors are finding they are underperforming the broader market as the bond market and cash markets see zero-to-negative real rates while the equity market returns over 9%. This is forcing cash that has been on the sidelines since the global financial crisis (GFC) back into equities.

Australia is becoming what the US was in 2013 and 2014 – bad news is good news, as the bad news will be championed by the market’s belief it will lead to further rate movements.

As in Japan, Europe and the US, will the RBA generate the wealth effect by driving up the share market to make its citizens fell wealthier? It certainly feels that way. So what does that mean for the ASX’s trajectory?

The 6000 point is now a real possibility in the next week and closing above this level would signal another leg higher in the bull market that began in 2012. The question is at what point will it slow? The general rule is to never fight momentum so it’s unlikely to slow in the next few weeks – the ASX clearly wants to go higher and there is currently nothing to stop it.

However, value will catch up to it and I think the first value squeeze to catch the market will be yields below 4% and P/E ratios above 18. That puts the ASX well over one standard deviation from the historical mean and may lead investors to pause and reflect on the profits they’ve made.

This is still a little way off and today is all about Martin Place and its 2:30pm AEDT announcement. Currently we are calling the ASX up 14 points to 5973. Happy rates day.

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