Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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When's the next Aussie rate cut?
Eleanor Creagh
Australian Market Strategist
Summary: The increasingly poor state of the Australian economy and the Reserve Bank's failure to meet its objectives, combine to make another rate cut inevitable. But the market is split on whether this will happen in July or August.
The minutes of the Reserve Bank of Australia's June 4 policy meeting, where the official cash rate was lowered to a new record low of 1.25%, were released today and clearly outline that further easing is on the cards.
Despite more cuts being widely expected, the Aussie dollar sank to a five-month low , closing in on levels last seen in the January flash crash, and yields on the Australian Government three-year note and 10-year bond slid. With the terminal cash rate likely to land a lot lower than current levels, yields will still have further to fall.
Most of the information conveyed in the minutes has already been covered in the speech by Governor Lowe that followed the June 4 move to lower the cash rate and in other communications from the central bank following the June 4 decision. The key focus now is on how aggressively the RBA will move on further policy easing. The minutes clearly state the expectation that further easing is incoming, saying “more likely than not that a further easing in monetary policy would be appropriate in the period ahead”. But what is less clear is the timing of further rate cuts as a certain amount of ambiguity remains in the statement “period ahead”.
Despite more cuts being widely expected, the Aussie dollar sank to a five-month low , closing in on levels last seen in the January flash crash, and yields on the Australian Government three-year note and 10-year bond slid. With the terminal cash rate likely to land a lot lower than current levels, yields will still have further to fall.
Most of the information conveyed in the minutes has already been covered in the speech by Governor Lowe that followed the June 4 move to lower the cash rate and in other communications from the central bank following the June 4 decision. The key focus now is on how aggressively the RBA will move on further policy easing. The minutes clearly state the expectation that further easing is incoming, saying “more likely than not that a further easing in monetary policy would be appropriate in the period ahead”. But what is less clear is the timing of further rate cuts as a certain amount of ambiguity remains in the statement “period ahead”.
As we've previously outlined, this outcome is inescapable as further stimulus will need to be injected into the Australian economy for the RBA to even come close to meeting its objectives, and unemployment needs to fall by a significant amount before generating inflationary pressures.
And as we highlighted last week, communication from the RBA represented a crucial shift in the its assessment of the labour market which will have a material impact in lowering the bar for further rate cuts. The RBA now estimates the “non-accelerating inflation rate of unemployment” (NAIRU), which refers to a theoretical level of unemployment below which inflation would be expected to pick up, is now around 4.5% and could be lower.
This highlighted that the RBA is woefully behind the curve and a long way off meeting its mandate of maintaining full employment given that unemployment is currently at 5.2%, so it will have to move to aggressively cut policy rates. Especially once you factor in the limited ability for the banks to pass on further rate cuts as the official cash rate creeps towards the lower bound.
And as we highlighted last week, communication from the RBA represented a crucial shift in the its assessment of the labour market which will have a material impact in lowering the bar for further rate cuts. The RBA now estimates the “non-accelerating inflation rate of unemployment” (NAIRU), which refers to a theoretical level of unemployment below which inflation would be expected to pick up, is now around 4.5% and could be lower.
This highlighted that the RBA is woefully behind the curve and a long way off meeting its mandate of maintaining full employment given that unemployment is currently at 5.2%, so it will have to move to aggressively cut policy rates. Especially once you factor in the limited ability for the banks to pass on further rate cuts as the official cash rate creeps towards the lower bound.
May labour force data released last week saw unemployment remain at 5.2%, well above the 4.5% needed for the RBA to satisfy its objective of full employment. Another significant hurdle for the RBA is the substantial spare capacity within the labour market, preventing material upward pressure on wages. Underutilisation will need to fall substantially from the current level of 13.7% before seeing a material uptick in wages.
So, we know the RBA will be ramping up rate cuts, but the timing of a follow up 25 basis points rate cut is still up for debate. The market is currently split on when the RBA will follow up with a second rate cut with the futures market pricing a 50% probability of a cut in July.
Given the glacial pace with which the RBA has woken up to the marked deterioration in economic growth August could be more likely, giving the RBA more time to assess the impact of easing, the economic outlook and the prospect of fiscal stimulus, but July is certainly still an option.
The RBA has materially shifted its assessment of the labour market and level of spare capacity that remains so there may be little to gain from holding off until August. Given that the RBA’s communication strategy appears to be shifting with the outlook for policy being much more clearly articulated to market participants in speeches as opposed to post-meeting statements, Governor Lowe’s speech on Thursday on The Labour Market and Spare Capacity should be a key indicator of whether the RBA will follow up with a second rate cut in July or August and how aggressively the central bank will move to meet its targets.
Given the glacial pace with which the RBA has woken up to the marked deterioration in economic growth August could be more likely, giving the RBA more time to assess the impact of easing, the economic outlook and the prospect of fiscal stimulus, but July is certainly still an option.
The RBA has materially shifted its assessment of the labour market and level of spare capacity that remains so there may be little to gain from holding off until August. Given that the RBA’s communication strategy appears to be shifting with the outlook for policy being much more clearly articulated to market participants in speeches as opposed to post-meeting statements, Governor Lowe’s speech on Thursday on The Labour Market and Spare Capacity should be a key indicator of whether the RBA will follow up with a second rate cut in July or August and how aggressively the central bank will move to meet its targets.
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