Commoweath Bank Market Insight Weekly 11-20-2011

8/3/2019 Commoweath Bank Market Insight Weekly 11-20-2011

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Economics: Market Insight Weekly

14 November 2011

ohn Peters Senior Economist T. +612 9117 0112 E. [email protected]

Important Disclosures and analyst certifications regarding subject companies are in the Disclosure and Disclaimer Appendix of this document and atww.research.commbank.com.au. This report is published, approved and distributed by Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945.

La dolce vit goes pear shaped as Italys bonds punted.

After the RBA cut the cash rate to 4% in early November, it clearly signalled in the subsequent November statementon monetary policy (SMP) that the door is still wide open for more policy easing down the line.

The key determinant of the depth of that easing will be if the European sovereign debt situation continues to fester anddeteriorate further with potential collateral damage for the global and local financial systems and economies.

In wake of the above events, financial markets are factoring in multiple (i.e. 4) RBA rate cuts by mid 2012. Markets fullyexpect a 0.25% rate cut in December, with a further three 0.25% cuts to 3% by mid 2012.

In our view such a scenario would need to see a significant slowdown in Asian and local economic growth pulses on theback of a potential Euroland sovereign debt and financial market implosion. On current economic readings, the localeconomy looks set to pick up momentum from here, and the Asian economies look to be holding up quite well.

We have lowered our cash and swaps rate forecasts but see only a shallow easing trajectory, unless the Eurozoneimplodes completely (the Armageddon scenario), with the RBA moving to cut the cash rate a further 0.25% to 4% inthe coming months and certainly by the end of QI 2012.

Wholesale market rates 6mth Trend Date Upcoming events

90 day bills Tuesday, 15 November Aus RBA Board Minutes, November

3 year fixed rate bill US Producer Price Index, October5 year fixed rate bill US Retail Sales, October

AUD/USD US Business Inventories, SeptemberAUD/EUR Wednesday, 16 November Aus Wage Cost Index, September QtrAUD/JPY US Consumer Price index, OctoberAUD/NZD US Industrial Production, OctoberASX 200 Thursday, 17 November Aus Average Weekly Earnings, September Qtr

Aus RBA Governor Stevens speaks.

Economic & Financial Markets Outlook:

Market action last week once again centred on the rollercoaster ride of unfolding events in the seemingly intractable Italianand Greek sovereign debt situations. EU-driven financial market volatility signals substantive potential negative risks forAsias and Australias business and consumer spending in coming year.

No doubt, unfolding financial and economic events in Greece and Italy and Europe generally will be dominant drivers ofglobal markets in the coming week, with any major ructions or volatility likely to eclipse local events and developments.

The recent RBA SMP was largely as expected and helped justify the 0.25% rate cut after the November RBA Boardmeeting. There were downward revisions to the central banks near term GDP and inflation forecasts (which include theplanned carbon tax impact). Previous RBA concerns in H1 2011 about upside risks to inflation have now morphedsubstantially into anxiety about possible downside risks to local GDP growth ahead.

The RBA in its recent commentary has warned that the significant risks to this central scenario continue to be tilted to thedownside, with a very disruptive outcome in Europe still possible. If such an outcome did occur, the Bank counselled thatthe world economy would be considerably weaker than the RBA central scenario (of 4% growth in the next couple of years)- notwithstanding the ability of policymakers in Asia to respond to a slowdown in their own economies. Our own view ofEuropes outlook is still very precarious with a Euroland collapse back into recession highly likely, so we think the RBA willcut rates again by 0.25% to 4% by QI 2012. This likely central banks action will be to further sandbag the localeconomy against collateral damage from likely negative economic outcomes in Europe, given the RBA now views the localinflation outlook as much more benign than six months ago. In the November SMP, the RBA substantially revised down its

underlying inflation forecasts.


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Global Markets Research


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Overall, while we expect further policy easing by the RBA, we see current market pricing for aggressive RBA easing overthe next 12 months or so as unduly pessimistic about local prospects. We envisage a much more shallow RBA easingtrajectory than markets do over the next 12 months and are factoring in a further 0.25% cut in the cash rate in the comingmonths. By delivering 50 bps pretty quickly (i.e. with another 0.25% cut by QII 2012 after the early November 0.25% cut inthe cash rate to 4%), such a move would buy RBA more insurance against downside shocks to growth as it further

assess growth prospects globally and at home as Euroland developments further unfold (or unravel). Meanwhile, marketssee another four 0.25% rate cuts by mid 2012, taking the cash rate to 3%.

Our medium term view of the growth outlook remains simpatico with the RBAs and we ultimately see the RBA lifting ratesagain at some stage as the economy picks up steam on the back of the mining investment boom, a resilient Asia andongoing historically high terms of trade. Under such a scenario we see labour market conditions tightening up again with anassociated fall in the unemployment rate and associated perils in terms of intensifying wage pressures and inflation. Underthese circumstances we would see the RBA lifting rates to ensure that inflation remains consistent with the 2 to 3%medium term target over the long haul.

Australian economic data this week.

The RBA Board minutes will not contradict the November SMP andare likely to highlight the Boards uncertaintyregarding the European situation and the risks this poses to the Australian and global economies.

QIII wage cost index (WCI) and QIII average weekly earnings will likely confirm that broad-based annual wages growthover 2011 has been rising modestly since the cyclical low in the second half of 2009. Recent central bank commentaryindicates that the RBA remains relaxed and comfortable about the future pace of wage growth, particularly in the non-mining sector. The RBAs November SMP noted that the RBAs inflation outlook was contingent on wage growthremaining around its current level. We are forecasting annual wage growth to remain under 4% at 3.8% in QIII.

Financial Markets & AUD

Nothing in recent RBA commentary validates the apparent market pricing for substantial rate cuts over the next year or sobut does leave the door open for some more modest easing in local rates - if Europes woes continue to snowball. Whilethe RBA is a little hazy about the near-domestic term outlook given recent economic and financial ructions in Europe andtheir potential knock-on impact on the Asian and local economies, the Bank still appears to be comfortable with its

medium-term views that centre on above-trend economic growth. The RBA is clearly going to be patient and wait to seehow current developments in Europe pan out. And how those developments may affect the domestic inflation and growthoutlooks. Thus we see current market pricing for aggressive RBA easing over the next 12 months or so as undulypessimistic about local prospects. We envisage a much more shallow RBA easing trajectory than markets over the next 12months and are factoring in a further 0.25% cut in the cash rate in the coming months

The AUD has been exceptionally volatile in the past couple of months , reflecting the Greece/Italy/Euroland financialcrisis and resultant wild gyrations in the major currencies, including the USD. At the time of writing (am Monday 14November), the AUD was trading near USD1.03 at USD1.0297 in wake of the announcement that Italian PM Berlusconi hadresigned and a new government under the econocrat Mario Monti will be sworn in shortly. These developments in Italyboosted market optimism over the weekend. Overall, we still expect the AUD to trade above parity with USD in 2012.Recent AUD volatility is likely to continue as markets grapple with the uncertainties surrounding the European and global

growth outlook. At the time of writing, the AUD fetched EUR 0.7481 and GBP 0.6413.

SWAP RATE FORECASTS end period 3, 5 & 10 Year Swap Rates, 2010 to now

RBA

cash

3m

bill

3yr

swap

5yr

swap

10yr

swap

14 Nov 11a 4.50 4.67 4.03 4.45 4.89

End qtr

Dec 11f 4.50 4.60 4.15 4.55 5.00

Mar 12f 4.25 4.20 4.10 4.50 4.95

Jun 12f 4.25 4.25 4.20 4.55 5.05

Sep 12 4.25 4.40 4.45 4.70 5.15

Dec 12f 4.25 4.40 4.80 5.05 5.40

Mar 13f 4.25 4.40 4.80 5.05 5.403.5

4.5

5.5

6.5

3.5

4.5

5.5

6.5

Jan 10 May 10 Sep 10 Jan 11 May 11 Sep 11

SWAP RATES - 2010 to 2011

3yr

RBA cash

5yr

10 yr

% %

3mth


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3

3.0

3.5

4.0

4.5

5.0

5.5

3.0

3.5

4.0

4.5

5.0

5.5

Jan 11 Mar 11 May 11 Jul 11 Sep 11 Nov 11

%

3 monthsahead

12 monthsahead

Source: Reuters

RBA CASH RATE PRICING%

Cashrate

1.24

1.32

1.40

1.48

0.95

1.00

1.05

1.10

11-May-11 6-Jul-11 31-Aug-11 26-Oct-11

AUD/USD & EUR/USD

AUD/USD(lhs)

EUR/USD(rhs)

0

2

4

0

2

4

Sep-98 Sep-01 Sep-04 Sep-07 Sep-10

CONSUMER PRICES(annual % change)% %

Headlineinflation

(exc GST)

Underlyinginflation

-60

-30

0

30

60

90

3.5

4.0

4.5

5.0

5.5

6.0

Jan-08 Nov-08 Sep-09 Jul-10 May-11

LABOUR MARKET

Employmentgrowth

(3mnth average, rhs)

Unemploymentrate

(lhs)

% '000

-3

0

3

6

9

-3

0

3

6

9

Dec-88 Dec-93 Dec-98 Dec-03 Dec-08

CONSUMER SPENDING(volumes, annual % change)% %

Retailsales

Householdconsumption

95

100

105

110

115

120

125

130

95

100

105

110

115

120

125

130

F eb-07 F eb-08 F eb-09 F eb-10 F eb-11

EMPLOYMENT(Index, Feb 07 = 100)Index Index

Mining,Utilities & part

of construction

Source: ABS

The rest

Total


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Commoweath Bank Market Insight Weekly 11-20-2011

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Transcript of Commoweath Bank Market Insight Weekly 11-20-2011