Optimism on Rates Cuts May Be Overdone

Optimism on Rates Cuts May Be Overdone
Following the latest RBA rates decision, Mutual Limited’s CIO Scott Rundell looks at the latest sentiment and the outlook.

The last RBA meeting contained some slightly hawkish commentary, or remnants of hawkishness, which was in contrast to peer central banks globally that have flagged peak official rates, with the next move to be down. Specifically, after the February meeting the RBA said via its statement…”the path of interest rates that will best ensure that inflation returns to target in a reasonable timeframe will depend upon the data and the evolving assessment of risks, and a further increase in interest rates cannot be ruled out.”

Today, that line has changed to “the path of interest rates that will best ensure that inflation returns to target in a reasonable timeframe remains uncertain and the Board is not ruling anything in or out.”  So, is that more or less hawkish?

Instinctively it’s less hawkish as they have not explicitly said that an increase cannot be ruled out. Nevertheless, does the statement signal any greater or lesser clarity around the timing of rate cuts, and what path these rate cuts might take?  I’d say no.  Beyond the semantics of whether these two sentences are more or less hawkish or dovish than each other, the overall focus of the statement was broadly consistent with the prior meeting’s statement, with a slightly more neutral tone.  A neutral tone vs a mildly hawkish tone in February equates to a rally in yields.  Three-year ACGB yields dropped 6 bps on release of the statement, while ten-year yields were more measured, down 3 bps.

Inflation is moving in the right direction, with goods inflation moderating, while services inflation continues to drag its feet.  Elsewhere, “the data are consistent with continuing excess demand in the economy and strong domestic cost pressures, both for labour and non-labour inputs.”  Higher interest rates are doing their bit, supressing the buying power of the mortgage belt, which is working toward balancing out aggregate demand and supply.  Labour heat is cooling, gradually, but remains too hot to be consistent with full employment and inflation targets.  I guess you can’t have it all.  Wages growth remains a headwind, but the board feels it has peaked, and will moderate as we progress through the year.  Inflation is still not expected to hit the target band (2% – 3%) until 2025, and not reach the mid-point until a year later.

Also read: Why Reframing Fixed Income Is Key To Portfolio Stability

As for the outlook, the current statement used the word ‘uncertain’ seven times, which is up from the five times it was written in February, so I guess things are more uncertain now than they were then – insert sarcasm emoji.  Household spending and consumption, uncertain.  Productivity gains, uncertain.  Economic outlook, uncertain.  China growth and geopolitical risks such as Ukraine and the Middle East, yep, you guessed it, uncertain.

The $64 gazillion dollar question remains, when will the RBA cut rates?  Right here, right now, markets are pricing cash rates at around 4.12% by August, so that’s the D-Day for the first rate cut of the cycle according to market forces.  A further cut by the end of the year is also priced, with a cash rate down to 3.87% by the end of December.  Consensus (median) is around 3.85% by the end of the year, so broadly in line with markets.

I’ve been thinking a fair bit about the path ahead for rates, trying the pin the tail on the donkey’s behind, but am increasingly coming back to a point that is beyond the donkey in front of me, one that lives in the future, sometime in 2025. ANZ CEO Shayne Elliott recently said his personal view is markets are being too optimistic on interest rates, suggesting no cuts this year is a real possibility. I have a strong empathy for this view.