Is Australia the lucky country? Then, can one have faith in the Reserve Bank? These are the questions at the centre of a widening gulf between economists and traders over the future path for the cash rate.
Cash rate futures suggest traders expect interest to reach 2.9% by year end, a level not seen since early 2013. But economists at high street banks and investment houses are counting on about half that, around the 1.5% mark.
Futures markets, to be sure, could be wrong, but if they aren’t variable-rate borrowers and businesses could see interest bills surge double digits in eight months. Monthly payments on a million-dollar mortgage could top $6,000 in some cases.
David Plank, ANZ’s head of Australian economics, has respect for a market that’s pricing in more than one rate cut but says “it’s pretty normal for market expectations to overshoot where the cash rate actually gets to."
“We’ve seen the market get excited in prior cycles,” he said in an interview.
There are two reasons economists like Plank are more circumspect about the cash rate’s future trajectory. For one, wage growth in Australia remains stubbornly slower than among many of our global peers, and a thicket of enterprise bargaining agreements will likely keep it that way. That should help keep a lid on inflation. Second, with most of Australia’s $2 trillion in mortgage debt at variable rather than fixed rates, even small cash rate hikes should drive economic activity down to a level that lowers inflation.
Futures traders don’t buy into this lucky country narrative, according to Plank. They view Australia as only trailing the runaway inflation which has plagued the US, where interest rates are tipped to hit 3 per cent by December.
“It’s a bit of a Pavlov’s dog response, the US markets price in more and we price in more,” he says.
“A lot of offshore investors are hearing the RBA say things are different and they don’t believe it. Many Believe the RBA will ultimately surrender and tighten significantly more than it believes it will.”
Evidence of such a capitulation was on display (rather early) Tuesday when the Reserve Bank blindsided forecasters with an outsized 0.25% hike. Signalling that much more would be to come, the governor Philip Lowe conceded to "embarrassing" forecast errors and that "we should have done better". Raising the bank’s estimated figures, which were released on Friday, inflation is now projected to peak at 6% this year from the 3.25% it estimated in February. A lift was given to wages growth as well.
Economists budged up a bit in the wake of Tuesday’s mea culpa. Westpac is now forecasting 1.75% by year-end, versus 1.25%. Commonwealth Bank increased its December target from 1% to 1.35%. ANZ drew 1.6% easier at 1.5%.
Economists unsure about what lies ahead had allowed themselves to be influenced by the Panglossian Reserve Bank, says Andrew Lilley, a rates strategist at the investment bank Barrenjoey. As old forecasts are thrown out, they are loath to make the U-turn that will be necessary.
“If you don’t actually know what’s going on it’s very easy to listen to the bloke who has a monopoly on what the RBA is going to do,” says Lilley. “The problem is that people have a tendency to complacently assume that the next step will be what Phil Lowe said last, instead of taking into account anything that might have happened since then.”
“Bank economists are slow, the market is fast. The market doesn’t need to pay attention to a narrative, it just needs to have the right number.”
Futures markets have been well ahead of the cash rate’s trajectory for some time. A rate hike next year had been priced in as recently as nine months ago, when Governor Lowe was still insisting rates were likely to remain flat until early 2024.
Despite this track record, most of the ten fixed income traders, economists, and analysts think that the futures market’s forecasts are excessive.
There’s a massive amount of uncertainty out there, and market pricing can “turn on a dime” if the data changes, according to John Likos, a director at fixed-income researcher and manager at BondAdviser.
“Cash rate futures are historically awful at predicting interest rates,” he says, albeit better than economists.
