Australia | Aug 11 2011
By Greg Peel
“Citi economists are mindful that declining confidence could see activity weaken further and consider a cut in rates possible, though it isn't in their forecast, and they expect any easing would be fairly limited, given the economy's still strong medium-term outlook”.
So say the Citi equity strategists this morning. That said, the strategists have selected a list of stocks they feel would perform best were a rate cut to occur. They are JB Hi-Fi ((JBH)), Harvey Norman ((HVN)), APN News & Media ((APN)), Ten Network ((TEN)), Australian Securities Exchange ((ASX)) and Stockland ((SGP)). A resultant fall in the Aussie dollar would also be most beneficial for ResMed ((RMD)) and CSL ((CSL)).
But will the RBA cut? We know Westpac is convinced it will, by 100 points into 2012, and we also know the interest rate futures market is “predicting” such. Other economists are more inclined to believe the RBA will simply remain on hold, and we know that the board was very close to raising its cash rate at the August meeting.
I am wary of the constant suggestion that futures markets are “predicting” rate cuts. Contrary to popular belief, futures markets really don't predict anything. Institutions and corporations exposed to rate movements use interest rate futures as a hedging tool to “lock in” rates. Clearly global uncertainty has led to fear that rate cuts might be necessary, which is why hedging has become more urgent. Such activity has pushed rates down. But by the same token I could say that a rise in the cost of fire insurance premiums implies more people are predicting their houses will burn down.
Goldman Sachs has looked at the last three periods of monetary policy easing in Australia (the last being in 2008) and notes that current economic indicators are now consistent with those in place in two of those three periods. Consumer confidence, job ads, new orders, capacity utilisation and employment momentum are all consistent. (Goldmans made this suggestion prior to today's surprise rise in unemployment.)
What's more, most of these latest numbers were published either before or during the latest market turmoil, suggesting they have likely since deteriorated.
Household and non-resources spending is already weak and presumably will now be reined in further, Goldmans suggests. This will mitigate the inflation risk the RBA is concerned about, however “the RBA will have good reason to remain concerned that underlying inflation will remain comfortably high in the months ahead”.
The economists estimate that the recent spike in risk aversion is equivalent to about one third of the Lehman event, and given the RBA cut from 7.25% to 3.00% in 2008 the current expectation of a 1% cut is consistent with that one third comparison. But here's the clanger:
The last five times risk aversion spiked by the current amount, the RBA raised rates that month by 25 basis points, Goldmans notes. It did so in August '07, November '07, February '08, March '08 and May '10. Hence there are very few guarantees, Goldmans suggests, that the RBA will respond to the current volatility by delivering rate cuts.
Goldmans believes, nevertheless, that were the RBA to decide a monetary response was necessary, only up to 50bps of cuts would follow, not 100bps.
Yesterday the Macquarie equity strategists suggested that at least two things have to happen before the Australian sharemarket can actually bottom. One is that we have to get through the inevitable cycle of earnings forecast downgrades ahead, and the other is that the RBA has to cut rates, thus “normalising” the currently inverse yield curve.
