Rates still and even bet

Every single economist that has reviewed yesterday’s CPI print still believe there is scope to cut rates in May – none have altered their expectations meaning all 26 still believe we will have a cash rate of 2% from May 5.

Source: Bloomberg

I would agree the scope for a cut (even cuts) is still there and the fact the RBA has eluded to this fact coupled with the knowledge it is currently reviewing its estimates around growth, inflation and employment to the downside suggests clearly that another cut(s) is certainly going to happen. The question remains – when.

From what I see in the data, the May meeting could just as easily be another ‘wait and see’ month as the RBA doesn’t want to cut unless its arm is twisted.

The data has been uncannily resilient:

- Employment was incredibly strong.  In fact, I would say uncharacteristically strong considering other factors –  giving the RBA a reason to wait and see

- Yesterday’s trimmed mean year-on-year inflation read of 2.38% was well above expectations and well and truly inside the target range of 2% to 3%. This is the RBA’s key measure of inflation and is another reason to wait another month.

- Retail numbers were slightly stronger for March

- Credit is ‘cheap’ to say the least

- RBA is still watching the slow moving ship that is monetary policy filter into the real economy and wants further evidence that more assistance is needed.

- Finally the leftfield reasoning for holding the line on May 5 – the May budget.

I know the budget shouldn’t be considered an issue for monetary policy but it certainly is and the fact Stevens has been politely and diplomatically back handing the government around its current fiscal policy puts the May 12 budget in play as a risk to rates remaining on hold. It is a distraction and the fact the Treasurer is now talking about easing fiscal policy publically may mean the RBA waits to see the details from the fiscal side before moving on the monetary side.

The interbank market is obviously pondering these same dilemmas. The market reduced its expectations of a May rate cut to sub 50% in the wash out from the CPI print having started the day at 57%.

The risk to rates is now a month-to-month ‘data dependent’ issue as the RBA monitors the state of play domestically and internationally – it’s a risk the market will have come to terms with – but it clearly adds risk to the downside in equities and that was evident in trading yesterday.

The banks took a very solid hit post the CPI data, another signal that the ASX is under fundamental pressure. The value in the defensives has been stretched since the February rate cut, seeing the ASX rallying over 8% and up to six and a half year highs. With the RBA now keeping the market guessing as to when the much anticipated second cut will be, the yield trade is becoming overcrowded and extremely narrow.

It also explains the ASX’s underperformance compared to region peers – accommodation has meant stronger markets globally. The Nikkei made a new 15 year closing high crossing and closing above 20,000 points for the first time since February 9 2000 yesterday. The Nikkei has rallied 33% in the past six months and is down to the fact the Bank of Japan and the Abe government are working on the same page with mass fiscal and monetary policy stimulus. What looks like taking the Nikkei higher still (and the JPY lower still) is signs the BoJ is considering even more stimulus as it fails to reach its 2% inflation target inside the original allotted timeframe of two years.

China has a double equity positive – monetary and fiscal stimulus coupled with fundamentals in the likes of the H-Shares and the Hang Seng that are cheap compared to historical measures and regional peers. The mass inflows into equities look like continuing almost unabated even after the regulator tweaked the rules slightly last Friday. I expect Chinese indices to continue their outperformance in the coming few months.

Ahead of the Australian Open

We are currently calling the ASX up 13 points to 5850 after a solid finish to the US session. What needs to be pointed out is the moves in iron ore. The spot price added more than $3 to be US$54.04, iron ore futures yesterday rallied 2.7% and have been a strong indicator of the direction and strength in the spot price, I expect a solid bounce in materials today however watch the futures for an inside into how the spot price is likely to close.


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