Morning comment: RBA back in neutral?

Chris Scicluna
Emily Nicol
Mantas Vanagas

Despite slightly weaker readings from the service sector surveys – perhaps not surprising in light of the recent partial government shutdown – Wall Street continued its advance on Tuesday with technology and consumer discretionary stocks driving the S&P500 to an eventual 0.5% gain. Even so, the post- payrolls sell-off in the Treasury market came to an end with yields moving down 2-3bps. The US dollar continued higher, however, as investors awaited President Trump’s State of the Union speech to Congress.

Trump’s speech covered familiar ground, beginning with a call for bipartisanship to support his well-known policy goals, including his much-promised border wall. So, with no obvious market reaction to the speech, the few equity markets that were open in Asia today have mostly nudged higher in line with Wall Street’s earlier lead, although Japan’s TOPIX was little changed as were JGBs. Most excitement occurred in Australia, where the ASX200 rose just 0.3% but bond yields moved sharply lower in response to remarks by RBA Governor Philip Lowe, which opened the door to a possible rate cut should the labour market reverse its present course and undermine progress towards achieving the Bank’s inflation target (more on this below). Markets were again closed in mainland China, Hong Kong, Taiwan Singapore and South Korea, with New Zealand also closed for a national holiday.

We have already seen the most notable data release out of Europe today, with Germany’s latest factory orders figures disappointing once again, but perhaps not quite as bad as the headline number suggests. New orders fell 1.6%M/M in December 2018, following a drop of 0.2%M/M the previous month, which was smaller than previously thought. Domestic orders fell 0.6%M/M and foreign orders fell 2.3%M/M, although new orders from the euro area rose 3.2%M/M. Excluding major items, however, orders rose 3.5%M/M following a drop of 0.9%M/M previously. And, while the drop in total orders left them down a hefty 7.0%Y/Y in December, over the fourth quarter as a whole they were still up 0.3%Q/Q (and up 0.7%Q/Q excluding major items) following drops of 1%Q/Q or more in each of the previous three quarters.

Germany’s manufacturing turnover figures for December, meanwhile, provided some optimism about what to expect from tomorrow’s IP data. Following a drop of 2.0%M/M in November, turnover in December rose a vigorous 2.5%M/M, the most since November 2011, strongly suggesting that manufacturing output also posted a solid rebound following the decline of 1.8%M/M the previous month. That increase, however, seems unlikely to be sufficiently strong to prevent a further drop in manufacturing output over Q4 as a whole. Moreover, while these data might provide some comfort, surveys point to renewed weakness in German manufacturing in early 2019, with the output PMI back down in January to November’s level of 50.3 and the new orders PMI having plunged to a particularly weak 44.9 – both respectively their lowest readings in more than six years.

Following yesterday’s Board meeting, today RBA Governor Philip Lowe addressed the National Press Club on the topic of the economic outlook over the year ahead. The elaboration provided by the Governor was more dovish than had seemed likely based on yesterday’s post-meeting policy statement. For investors the key paragraph of the speech was as follows: “Looking forward, there are scenarios where the next move in the cash rate is up and other scenarios where it is down. Over the past year, the next-move-is-up scenarios were more likely than the next-move-is-down scenarios. Today, the probabilities appear to be more evenly balanced”. In judging the future path of policy Lowe added that the Bank would be monitoring developments in the labour market closely. On the one hand, continued job growth and a more rapid rise in wages would probably justify tighter policy at some point. On the other hand, Lowe acknowledged that income and consumption growth could disappoint. This could lead to as sustained rise in the unemployment rate and a lack of progress towards the inflation target, so that a lower cash rate could be appropriate at some point.

Importantly, Lowe concluded by noting that the Board will continue to assess the outlook carefully and that at present it still does not see a strong case for a near-term change in the cash rate. It is also worth recalling that yesterday’s post-meeting statement indicated that the Board forecasts a further decline in the unemployment rate to 4¾% and gradual pickup in underlying inflation to 2¼%, albeit the latter occurring at a slower pace than forecast earlier.

So while today’s comments acknowledge the potential of a rate cut under certain scenarios, the RBA’s central forecast remains that the most likely outcome is a continued period of policy stability, followed by an eventual rate hike (it is worth emphasising that Lowe described the risks to the outlook as “more evenly balanced”, and not “evenly balanced”). And with Lowe adding that “It has long been the Board's approach to avoid reacting to the high-frequency ebb and flow of news”, this also suggests the RBA will not be quick to shift its policy bias in the face of incoming data. Be that as it may, given the market’s current inclination to look for signs of the policy stance evolving towards a potential rate cut, Lowe’s comments caused front-end Australian government bonds to rally as much as 11bps (the 10Y fell 6bps) and a near 1 cent decline in the Australian dollar. Attention will now turn to Friday’s Statement on Monetary Policy which will formally set out the Bank’s updated forecasts and policy outlook.

In the US, today will bring November’s trade report, with a narrowing in the trade deficit to about $54bn expected on account of softer imports following two consecutive strong prior months. In the bond market, the Treasury will sell 10Y Notes. Ahead of tomorrow’s BoE announcements, no notable economic data are due from the UK, where Theresa May continues consultations on Brexit in Northern Ireland ahead of her visit tomorrow to Brussels for yet another discussion with Commission President Juncker.


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