Lowe speech to Economic Society today following Tuesday RBA Board meeting. Pushing back against market pricing?   


Stephen Miller

RBA Governor Lowe spoke yesterday to the Australian Economic Society yesterday on The Labour Market and Monetary Policy.

Following in the wake of Tuesday’s RBA decision I expect the Governor to push back, albeit in a subtle manner, against market pricing of an increase in cash rate in 2022. Markets have priced a roughly 25bp tightening through 2022. That pricing appears to have been motivated by a slight tweak in the RBA Governor’s Statement on Tuesday that admits the possibility of a rate increase before 2024. That slight tweak was to say that the “central scenario” the condition for a policy rate increase “.will not be met before 2024”, whereas previously all of the forecast scenarios were pointing to “ unlikely to be [met] until 2024 at the earliest.”

My view is that the market has got a little ahead of itself.

The tweak in the language was a reflection of much better than expected rates of increase in employment and much greater than anticipated falls in unemployment. However, and perhaps frustratingly so for the RBA, that has not been accompanied by any significant and observable pick-up in wages growth which is pivotal to the condition that inflation be sustainably within the RBA’s 2-3% target band.

In addressing wage growth, it is important to establish cause and effect – i.e. wages cannot be levitated by fiat (indeed that would be self-defeating) but rather need to be caused by a tight labour market. In tweaking its language, the RBA too was keen to switch focus back to outcomes. In other words, wage and price inflation outcomes matter more than specific dates (or ‘calendar guidance’). The subtle shift in emphasis perhaps represents an attempt by the bank to shift the focus to outcomes.

It also is true that central banks are not always good forecasters of their own policy actions. However, markets too can be egregiously inaccurate in their forecasts of central bank actions. And the fact remains that there is a gulf between the RBA’s central expectation and that reflected in market pricing.

What can be said with some certainty is that the RBA is happy in the current circumstance to lag the global normalisation of policy rates. The Board appears to be in no hurry to follow the Bank of Canada, Norges Bank, or the Reserve Bank of New Zealand in flagging rate increases in 2022. That point of difference underscored by the RBA’s expectation that that the condition (or ‘outcome)’ for any increase in the policy rate will not be met before 2024.

The RBA would also like to get some clarity around the US Federal Reserve (The Fed) tapering process. While the Fed has commenced “talking about talking about” tapering any roadmap does not at this stage seem likely before the September meeting of the US Federal Open Market Committee (FOMC), any subsequent action may not commence before the end of the year. Hence, there was only a marginal reduction in the rate of bond purchases announced on Tuesday, and that doesn’t commence until September and is scheduled to last through to November.

As part of the quest to generate tight labour markets and attendant wage and price inflation, the RBA remains motivated to avoid an unwelcome upward movement in the Australian dollar (AUD). Any move up in the AUD could well frustrate the task of getting unemployment down and wage growth and inflation up. It seems clear that the RBA has achieved its stated objective in pursuing yield curve control and quantitative easing (QE) of “keeping the AUD lower than it otherwise would have been”. In my view, it doesn’t wish to risk the unwinding of those achievements by “prematurely” foreshadowing a more significant retreat from the currently historically high levels of monetary accommodation. That will likely remain the case until there is some clarity around the Fed roadmap to tapering.

In emphasising outcomes, Governor Lowe may argue (with some validity) that while inflationary pressures in the US are clear and there is (proper) debate about its persistence, those pressures are less visible in Australia.

While base effects will see June quarter annual ‘headline’ inflation likely get close to 4%, the RBA’s preferred trimmed-mean measure is forecast to be around 1.5%, still well south of the RBA’s 2-3% target. Indeed, the RBA forecasts only have that trimmed-mean inflation reaching the bottom of the 2-3% inflation target band in June 2023, and even then, wages are forecast to be running at a paltry 2 ¼ %.

The RBA also appears largely unconcerned by market expectations of inflation rebounding perhaps reflecting the fact that current market-based expectations of inflation are toward the bottom end of the RBA’s 2-3% target range.

While ever all of the aforementioned circumstances persist, we should expect the maintenance of the historically high accommodatory tack from the RBA.

FOMC minutes. No real surprises. US June CPI released Wednesday 13 July looms

The US Federal Open Market Committee (FOMC) minutes confirm that the Fed seems to inching, albeit cautiously, toward some retreat from the historically high levels of monetary stimulus applied during the pandemic.  However, in a similar vein to the RBA, the Fed seems to be adopting a cautious approach to the removal of historically high levels of monetary accommodation.

The minutes stated that “[t]he committee’s standard of ‘substantial further progress’ was generally seen as not having yet been met, though participants expected progress to continue.” On the process of tapering while the minutes stated that “[v]arious participants mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings”, no concrete timeline or indication of the split between tapering of MBS v Treasuries was given.

This is in line with Chairman Powell’s comments post the FOMC meeting on 28 June which he described as a “talking-about-talking-about meeting.”

It seems that a roadmap on tapering is probably decided at the September 21-22 meeting with any scaling back of bond purchases likely to occur after that.

Perhaps the most interesting feature of the minutes was the revelation of some embryonic concerns regarding inflation. While officials “generally expected inflation to ease” once transitory factors associated with the economy’s rapid reopening had abated, “a substantial majority of participants judged that the risks to their inflation projections were tilted to the upside.” And further that several officials commented that  “they anticipated that supply chain limitations and input shortages would put upward pressure on prices into next year,” and further that “during the early months of the reopening, uncertainty remained too high to accurately assess how long inflation pressures will be sustained.”

Those anxieties are not shared by the bond market with the US 10 year yield declining to 1.32% over night, well south of the peak above 1.70% back in late March.

The release of the June CPI next Wednesday looms as a critical challenge. Expectations for the ‘core’ CPI are at 0.4% month-on-month or 4.6% year-on-year– that puts current bond yields in stark relief. Both Fed and market inflation forecasts for the current year have been revised successively upwards this year. However, throughout that revision process, the Fed and markets have tenaciously stuck to the view that inflation surprises are transitory and that inflation returns to around the low 2% mark in subsequent years, although last night’s minutes suggest that the Fed is questioning just how quickly inflation might return to 2%. Whether the bond market’s tenacity survives another surprise next Wednesday and beyond and what another upside surprise means for the Fed remains to be seen. Certainly, I see it as a potentially big challenge for markets and policy makers going forward.

By Stephen Miller, GSFM investment strategist

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