There is non-trivial risk the RBA may turn neutral on Australia’s interest rate outlook as soon as tomorrow, meaning the September monetary policy meeting may not be the non-event many currently expect.
Focus will be on the statement, not decision
On the surface, Philip Lowe’s final rate decision seems one of the easiest of his seven-year tenure as RBA governor. Markets are near certain the cash rate will remain at 4.1%, echoing the economist community. It means the event may come and go without generating a ripple across financial markets.
While I too see the cash rate remaining steady, with expectations for anything meaningful already so low, even subtle tweaks to the RBA’s commentary could generate a reaction, especially if it involves the final paragraph of the statement. For me, that risk is underpriced.
RBA conditional tightening bias lacks credibility
When the RBA board met in August it retained a conditional tightening bias, signaling rates may need to increase further depending on how the economy evolved. I suspect the RBA’s conviction to follow through is akin to a wet lettuce leaf. All bark, no bite. While most economists believe the statement, markets aren’t buying the idea one iota. Collectively, they see the next move being a cut in late 2024.
It's not the first occasion markets and economists have diverged when it comes to the outlook. Just look at the start of the current rate hiking cycle where markets moved well before most economists. Now, as then, I think markets are on the money. Which brings me to what may be found in the final paragraph of the September policy statement.
Risk of adopting a neutral bias is growing
The most likely scenario is the RBA will retain a conditional tightening bias given most developed market central banks continue to run with one too. But the risk of the RBA breaking ranks and switching to a neutral bias – indicating rates are likely to remain steady for the foreseeable future – is growing by the month.
Domestically, the RBA has placed great emphasis on developments regarding the labour market and inflation. Over the past month, information on both fronts has softened, diminishing the risk of further tightening being required. Taken at face value, the Q2 private capital expenditure survey may also provide comfort Australia’s productivity doldrums may improve, reducing inflation risks.
Internationally, China’s slowdown has intensified with no meaningful stimulus rolled out yet. In the US, there is a growing belief the Fed has delivered its last hike for the cycle. Expectations for hawkishness from the ECB are also dissipating quickly.
Combined, it suggests there is no need for the RBA to do anything, begging the question whether it should just adopt a neutral bias? It would provide a clean slate for Lowe to handover to over to incoming Governor Michele Bullock who takes the reins later this month. It also fits nicely with the view offered in the RBA’s August SOMP that risks towards the inflation outlook were already “broadly balanced”.
Market playbook for the RBA turning neutral
While I still favour the RBA retaining a conditional hawkish bias on Tuesday, the risk of it being removed is not insignificant. If the RBA are to spring a surprise, this will be it.
Even though markets have already priced in a neutral-type outlook, such a move would generate volatility as economist forecasts are revised to reflect the shift in outlook. It would also bring the debate as to when the first cut will occur onto the radar.
ASX 200 upside looms
In the equity universe, a shift to neutral would normally support the ASX 200. Banks are likely to benefit from expectations for fasters credit growth and lower provisioning, offsetting potential headwinds from pressure on net interest margins. Discretionary retailers, real estate trusts and growthier tech names may also catch a bid. For the index, a test of the resistance zone between 7380 to 7400 would be likely. A topside break would open the door to a push to 7490, the high struck in July.
Source: Trading View
AUD/USD downside appears limited
In FX, AUD/USD is likely to come under pressure, potentially seeing the pair revisit the August lows below .6370. A clean break of that level would open the door for a push towards .6275 and then the 2022 lows below .6200. Given interest rate swaps and futures are already priced for the cash rate to remain at 4.1% until well into next year, for such downside pressure to manifest would likely require weakening in other currencies against the USD, especially the CNH.
Source: Trading View
For bond futures, a neutral bias should see a modest bid across the Australian curve, most likely for shorter durations.
Should the RBA retain the same or similar language to August, there is likely to be negligible market reaction given current pricing. While nothing is impossible, the risk of the RBA turning more hawkish or even hiking the cash rate is astronomically small, hence it’s not worthwhile detailing how markets will react to such an outcome.
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