The Australian market is pricing in two rate hikes by the Reserve Bank of Australia over the next 12 months, despite the bank calling the top of the iron ore cycle, in a surprise to some market watchers.
The team at ANZ agree with the market’s prediction for two rate moves by this time next year. They point to a strong outlook for private business (non-mining) investment, strong public spending, lower unemployment and underlying inflation reaching 2 per cent.
“That’s meant we’ve revised our growth forecast, we’re much more optimistic,” says David Plank, head of Australian economics at ANZ.
“It’s a mild tightening cycle, partly because of where global interest rates are and highly indebted Australian households, but we expect the RBA to reach a conclusion that we don’t need such a low cash rate of 1.5 per cent.”
In contrast to many others developed economies, the RBA has not been forced to pull interest rates to zero or even negative territory, as the Australian economy remained relatively well insulated following the GFC.
Markets on Fed watch
Meantime, global markets sanguine preemption of a windback in the enormous US bond buying program indicates a faith the effects of quantitative easing will not be undone.
Ahead of the US Federal Reserve’s board meeting on Wednesday night, markets across the board were trading in relatively tight ranges.
The S&P 500 climbed only modestly in Tuesday night’s Wall Street session, the ASX is trading in a tight range and the US dollar slipped slightly against almost all G-10 currencies – extending its 2017 trend.
The muted market moves come despite investors widely expecting the US central bank is will on Thursday morning give the formal go-ahead to begin unwinding its $US4.5 trillion balance sheet. So far, investors expect the reduction to be so gradual that it won’t unnerve financial markets.
“This is the turning of a very, very large ship,” says Charles Jamieson, executive director at Jamieson Coote Bonds. “The US Fed has done 10 years of hard work, so they won’t want to upset the apple cart.”
The Fed is expected to slow their bond-buying program at around $US10 billion a month, ultimately rising to $US50 billion. But this number has been widely telegraphed and markets are prepared.
“It might sound like a lot, but in the context of the overall program, it’s a drop in the ocean,” says Mr Jamieson.
The ultra-loose monetary policy – which began as a calculated response to the shock of the global financial crisis in 2008 – has helped suppress bond yields and boost equity prices to record highs.
Bond markets have watched Aussie 10-year bond yields jump from 2.5 per cent on September 8 to 2.81 per cent by Wednesday morning, following their American counterparts as traders jostle ahead of Thursday morning’s Fed announcement, which will also include an update on the central bank’s “dot plot” chart of where members believe rates will be over the medium term. Yields on the 2-year are trading just shy of 2 per cent, up from 1.86 per cent on September 8.
But these rather dramatic moves in bond prices are not harbingers of a more rapid sell-off as the Fed unwinds its bloated balance sheet.
“It’s an asymmetric event really,” says Paul Dales, chief Australian economist at Capital Economics. “The boost to equities and other assets came from a shock and awe from the size of the policy, but you’re not going to get an ‘un-shock’ as the US Fed slowly takes itself off its medicine.”
Leader of the pack
The US Federal Reserve is the first central bank to indicate it believes its economy can withstand a tightening of monetary policy, given the US economy is seeing comfortable signs of recovery. But other central banks around the world are likely to take much longer in lifting their own interest rates and ceasing their unconventional monetary policy strategies.
Despite signs the European economy is picking up, the European Central Bank has indicated it will keep purchasing assets until September next year, although there has been increasing chatter of a slowing in the rate of bond buying. The Bank of Japan looks set to continue its QE program indefinitely.
Only the Bank of England has signalled it might begin to unwind its program, but only once it has raised interest rates to 2 per cent. The depressed pound, following Brexit, has meant the UK economy is experiencing more signs of inflation than many other developed economies.