BFC (BABY FINANCIAL CRISIS)

A colleague of my brother's at the CBA has just coined the phrase Baby Financial Crisis - BFC. It's a little tongue in cheek but it's worth seriously considering the notion. There has been much talk of the potential for a 'W' shaped recession. The world has gone through a period of significant upheaval and there has been a great deal of wall paper 'printed' to paste over the cracks. The fact remains however that a great deal of debt - much of it toxic remains to be unwound. The problems in Dubai have clearly illustrated this fact. It remains to be seen whether the issues there cause others around the world to surface.

I still believe the RBA will go ahead with another lift in rates tomorrow of 25 points. Futures this morning are unwinding a bit of their Friday afternoon rally so it seems they are still expecting the tightening too. The situation in Dubai will likely bolster the argument for a pause however at 3.75% until growth in Australia and the world is clearly sustainable.

Yields

Yesterday there was an upward jump in BBSW as the market started to pre-empt next week's rate hike. Part of that has been unwound today as worries about Dubai and their ability to pay back debt plays on expectations about how far our rates can rise while the global economy is still quite delicate.

Private Capital Expenditure
There was a 3.90% drop in private capital expenditure for the third qtr but a big upward revision in spending plans for all of 2009/2010 countered any pessimism.

Yield movements around RBA rates hikes

As we approach a likely 25 point rate hike next week I thought I'd provide some information on rate movements immediately before and after the RBA moves the cash rate. You'll note from the attached table (click here to view) that the move is generally priced in. In the November case there was a chance of a 50 point rise so some rates actually dropped after the rate rise. What you'll find in the longer end of the yield curve ( 5 to 10 years) is that the rate rises will reach a point where further rate hikes will cause these rates to drop. This is because the market is making an assumption that the rate rises will stunt growth and have a dampening effect on inflation. I suspect we will be getting close to this point when the cash rate reaches 4.50%. If China growth takes off, or inflation starts to spike in Australia due to rates staying low for too long, longer rates won't perform as described above however and the yield curve will steepen.

RBA - Guy Debell

Assistant Governor Guy Debelle spoke yesterday about a number of issues. Key for me was his assertion that lending to businesses was likely to pick up. One of the big impediments to growth has been a reluctance buy banks, while access to funds has been difficult, to lend to businesses. During the early days of the GFC lines of credit were cut left right and centre - particularly buy foreign banks who faced particularly severe demands in their home countries. Now that it's clear that many of the dangers have passed it's hoped that tight credit conditions may be relaxed providing favourable conditions for continued growth.

"As confidence returns, one would expect to see business credit growth pick up again."

RBA Minutes

The RBA released minutes to it's last board meeting yesterday. They discussed a number of factors such as the improving global economy (GDP rose in all major economies apart from the UK in the Sept qtr), the strength in China (GDP growth was estimated at 2.25% in the Sept qtr after 4% in the previous qtr), and inflation and unemployment forecasts that are already well known from the recent Statement On Monetary Policy.

The conclusion was that spare capacity in the economy is continuing to be whittled down and that "further gradual adjustment" in the cash rate is appropriate. We continue to expect therefore that there will be another 25 point lift in December.

I've pasted below the final three paragraphs of the minutes as they give a good indication of their thinking:

Overall, members considered that the recent information was consistent with the conclusions reached by the Board a month earlier: namely, conditions in the global and Australian economies were significantly better than had been expected earlier in the year when the Board had lowered the cash rate to 3 per cent; the Australian economy was operating with less spare capacity than earlier thought likely; and the growth outlook for the next few years had improved. The Board therefore concluded that it remained prudent, over time, gradually to reduce the degree of monetary accommodation.

In considering the pace of that adjustment, members were conscious of balancing risks. On the one hand, business and consumer confidence could prove fragile, and economic activity at home and abroad might slow more than expected as the effects of stimulus measures faded. Also, the rise in the exchange rate would constrain output and dampen inflationary pressure, and credit conditions for some borrowers remained quite difficult. On the other hand, a lengthy period with interest rates at a very low level carried its own risks, particularly once the threat of serious economic weakness had passed.

After giving careful consideration to these issues, members judged that it was prudent to take a further step to lessen the degree of monetary stimulus. Looking ahead, members expected that if economic conditions evolved as expected, further gradual adjustment in the cash rate would most likely be appropriate over time, though the pace of the adjustment remained an open question.

Employment Numbers

Economists were a little surprised yesterday with total employment growing by 24,500 as they had expected a drop of 10,000. All but 2,900 of the jobs however were part-time. The unemployment rate rose to 5.8% due to the participation rate (numbers looking for work) increasing.

The all important Monthly Hours Worked however fell by 1.9 million hours to 1.52 billion according to the ABS.

NSW fared worst out of all the states with it's unemployment rate rising to 6.1% from 5.5%

The government recently lowered it's expectations for the peak unemployment rate from 8.25% to 6.75%

These results should ensure the RBA lifts rates another 25 points in December.

NAB Releases

NAB released their Monthly Business Survey yesterday showing confidence is still strong. I look a little closer at their Qtly survey results so won't mention more about it here. They did however release a "WORLD ON TWO PAGES" document today which gives a good summary of the state of play at the moment. If you're interested in reading it click here.

First Home Buyers In A Mad Rush

A number of institutions I speak with have reported very strong loan growth at the moment, particularly with the first home buyers. This could explain the interest in funds being shown by institutions such as Bankwest.

This sentiment has been borne out in home loan figures released showing a 5.1% jump in September after an upwardly revised increase of 4% in August. Analysts had predicted a 3% rise. First-home owners made up 26.1 per cent of the total, up from 24.7 per cent.

These figures reflect the last month for the full first home buyer bonus but the scaled down bonus is in effect until the end of the year. The RBA will be keenly observing what happen in the new year - perhaps good justification for a pause after December.

Established house approvals also rose substantially, by 5 per cent showing broader strength in housing demand.

RBA Qtly Statement on Monetary Policy

The above named statement was issued on Friday. There has been a bit coming out of the RBA lately in the way of speeches and statements etc. Emphasis has been placed at each time on a "gradual" removal of the emergency stimulus levels. For instance from Friday's statement "The cash rate remains at a low level, and a further gradual lessening of monetary stimulus is likely to be required over time if the economy evolves as broadly as expected" . The statement talks about inflation as well and their prediction is for underlying inflation to fall back within their 2-3% band next year. They expect the easing in inflation to be gradual as well. The point is, there is no need for them to panic with respect to inflation. Lifting the cash rate by large amounts will spook consumers at a time at which it would be unwise to do so. Expect another 25 points in December therefore with a chance of a pause for a while. Depending of economic releases there's every chance though that they will slip a couple of rises in early next year.

RBA Speech

RBA Governor Glenn Stevens spoke yesterday. Much of the speech was about the space capacity being soaked up quickly and the need for extra housing supply. One part of the speech worth highlighting, where he referred to the medium term is below.

It means unwinding temporary measures as appropriate. It means keeping a focus on flexibility. And perhaps most of all, it means resisting the temptation to assume prosperity is easily achieved, or easily managed.

"Unwinding temporary measures" could be interpreted as more rate hikes to come (no surprise). The last sentence I interpret as meaning that they have to make the tough decisions (raise rates) creating short-term hardship for long term prosperity.

Retail Sales

The lack of government handouts and perhaps the thought of future interest rate tightenings are have had a dampening effect on retail spending. Figures released yesterday showed retail spending dropped by 0.2% in September after a 0.7% rise in August. Quarterly figures paint a more accurate picture showing a fall of 0.4% in real terms over the September quarter following a sharp 2% increase during government handout period of the June quarter.

Building approvals however rose by 2.7% in September. Private sector house approvals rose for the ninth consecutive month while total approvals have now risen by 26.7% since the start of 2009.

RBA RATE RISE

As I'm sure you're aware the RBA raised the cash rate to 3.50% yesterday. Despite this, wholesale rates (futures) rallied immediately dropping rates by about 10 points within minutes. This was partly due to the market hedging it's bets in case the tightening was 50 points. The other reason was that some players in the market interpreted the last sentence in their statement to imply that they will pause now. I don't think this is likely however. A 25 point tightening in Dec and then a pause over January as they don't meet then is far more realistic. I've pasted their last paragraph below.

The Board noted that the rise in the exchange rate is likely to constrain output in the tradeables sector and dampen price pressures. Nonetheless, growth is likely to be close to trend over the year ahead and inflation close to target. With the risk of serious economic contraction in Australia now having passed, the Board’s view is that it is prudent to lessen gradually the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker. The adjustments at the October and November meetings will work to increase the sustainability of growth in economic activity and keep inflation consistent with the target over the years ahead.

Cup Day Tightening

The shortest odds today were that the RBA would tighten and 25 points was the favorite. The RBA didn't disappoint and we now look to the next tightening also likely to be 25 points. The market had factored in the 25 points and even a little of a possible 50 points. Now the 25 or 50 question has been answered some of the rates out there look pretty attractive. 90 day BBSW for instance was 3 points off 4.00% this morning. The market is likely to think likewise and we could see rates pull back momentarily until those who are short start pushing the idea of 50 points in December.