RBA delivered the tapering without really tapering

Local market started positive and then moved into the slide mode all day despite no lead from US market (i.e. closed last night for July 4th long weekend). The main news for the day was RBA tapering QE by extending QE and keeping rate hikes cycle in 2024. We will come back to this in the next few paragraphs. Our market was falling before the RBA update and after the update. RBA insiders in the media were pumping out stories about QE tapering for a few days to prepare the markets for it. It is the usual trend with RBA. Somehow certain media organizations always flag a policy change that was not mentioned in any RBA commentary. This time it may be different. Energy and Utilities were the only green sectors while Telecom and Tech were the worst red sectors. Size damag e by order Micro Caps, Large Caps, Mid Caps and then Small Caps. Retail were not selling as much as fund managers and global investors. AUDUSD bounced with bond yields and Spot Gold. OPEC+ delivered no deal and Oil went up on cuts remaining.

RBA tapered without tapering. RBA was so scared of the market, they extended QE while reducing QE. The reality is that tapering was inevitable. Global economies have had a massive bounce on endless debt and inflation was starting to bite. If they didn’t act and inflation took over, then economy will slow down and that will force Central Banks to add more QE and the world becomes a ponzi scheme that is Japan or EU. There was nothing more certain than RBA following US Fed in the hike cycle. If they didn’t, AUDUSD will tank on yield differential and we will get high inflation. 

If you were dovish, you got QE extension and rate hike kept in 2024. If you were hawkish, you got QE reduction. If you were the government, you got QE extension to allow you to call an election before the economy goes pear shape as asset bubbles unwind. If you were bullish, RBA gave you the best tapering scenario you could hope for. If you were bearish, RBA basically threw the economy under the bus by saying wages growth will not be coming for years. Then why did the market fall? The market is trading at all time high multiples that can only be supported by continues earnings and stimulus beats. This by any definition is the weakest stimulus downgrade but yet it is a downgrade. Markets can’t handle downgrades!

The historical trend suggests markets are 30-40% over valued on historical normal bond yields around 4-5%. Let us be realistic and say bond yields at 4-5% will not happen for at least a decade…if not for a few decades. We have historical high asset prices in all asset classes supported by historical high debt. In the new paradigm, bond yields at 2-3% is comparable to 4-5% in pre 2012 cycle. RBA is stuck with “Hope” as the main strategy. RBA is hoping that US Fed and US Government can walk the fine line and keep their economy from getting into trouble from asset bubbles. If they get it wrong, RBA will fall right back into expanding QE cycle again. RBA is also hoping that the Australian Government will call the election and the winner will deliver reform and growth while raising taxes and paying off the debt. Given the lack of reform, structural economic problems, massive debt and massive inequality, it would be naïve to think that any government will be able to pull that off. The likely scenario is that the economy is going to see a few tough years ahead. Stimulus through debt brings forward growth and expenditure. Inevitably that leaves a hole that has to be fixed in the future years. RBA allowed the government to run on stimulus and debt for years, it is going to take years to undo that mess.

RBA just showed the market that they are weak like most Central Banks. Markets will return serve with taper tantrum when things get tough…like corporate downgrades driven by cost inflation in August. We will see the mettle of RBA policy statement in the next 6-12 months. We know the current government is not going to do any reform. They are in damage control ahead of the election cycle. RBA just flagged that the economy needs more time to move from ICU to Emergency department after taking the debt to $1 trillion over 18 months. The risk weighted economic and business cycle trend suggests that RBA will be facing another QE upgrade cycle well before their rate hike cycle. What could go wrong? It may be different this time!  

Let us run through the main data points released in the last 24 hours…

France's industrial production contracted 0.3% from a month earlier in May 2021, following a revised 0.1% growth in April and missing market expectations of a 0.8% increase. Manufacturing output fell 0.5% (vs -0.1% in April) led by a 5.4% decline in transport equipment output due to shortages of raw materials in the automotive industry. In addition, production was also down for machinery and equipment goods (-0.8% vs 0.9%) and for other manufacturing (-0.2% vs -0.3%). On the contrary, it grew for coke and refined petroleum (5.2% vs -1.0%), food products and beverages (1.4% vs 0.1%) and mining and quarrying, energy, water supply (0.9% vs 1.1%).

The IHS Markit Eurozone Services PMI was revised slightly higher to 58.3 in June 2021, from a preliminary estimate of 58.0, signaling the steepest pace of expansion in the service sector since July 2007 due to the easing of coronavirus-induced measures in many eurozone member states. Growth in new work was the best recorded by the survey since July 2007 and employment rose the most since October 2018. Meanwhile, capacity came under noticeable pressure as evidenced by a rise in backlogs of work outstanding for the third month in succession. The net increase was the sharpest recorded since May 2000. On the price front, input costs rose at the strongest rate since July 2008; while output charges were raised in response to the greatest degree since October 2000. Finally, business confidence about the future was the best since August 2000.

The IHS Markit Eurozone Composite PMI was revised slightly higher to 59.5 in June 2021, from a preliminary estimate of 59.2, signaling the fastest rate of increase in private sector activity since June 2006 as the economy continued to open up from COVID-19 related restrictions. Services sector activity grew the most since July 2007, while manufacturing production continued to expand at a solid pace. Overall new order growth hit a 21-year high, with new export business rising at the sharpest rate since composite data were first available in September 2014. Capacity has come under pressure over the month, as evidenced by a record rise in backlogs of work, while the pace of job creation was the strongest since the start of 2018. On the price front, input cost inflation hit the highest since September 2000, while output charges were up to the sharpest degree in nearly 19 years of data availability. Looking ahead, business confidence hit an all-time high.

The Business Outlook Survey indicator in Canada rose to 4.17 in the second quarter of 2021 from an upwardly revised 2.95 in the previous period. It was the highest reading on records, signalling both low base year effects, as comparisons are drawn from business conditions of a year earlier, and broadening positive sentiment, with most firms saying the uncertainty related to the pandemic was gone. There were no records of deterioration in sales performance and an unprecedented number of companies showed improved indicators of future sales, although sales in 4 out of 10 businesses were still below pre-pandemic levels. Plans to invest and increase staff levels were widespread as firms prepared to meet an unexpected rise in demand, while capacity and labor shortage pressures were also higher.

Household spending in Japan rose 11.6% in real terms from a year earlier in May 2021, after a 13% gain in April and above market expectations of 10.9%. This was the third straight month of increase in personal consumption, amid base effects from 2020's sharp fall due to the initial impact of the COVID-19 crisis. Spending continued to rise for food (2.1% vs 3.5 in April), housing (28.9% vs 15.3%), clothing (13% vs 84.8%), medical care (14.9% vs 8.9%), transport & communication (23.5% vs 20.1%), education (22.8% vs 15.5%), and culture & recreation (24% vs 25.1%). On the other hand, consumers spent less on fuel, light & water charges, which was the second time since May 2020 (-2.4% vs -5.1%). Also, spending on furniture & household declined for the first time in three months (-2.6% vs 9.2%). On a monthly basis, household spending fell by 2.1%, less than consensus of a 3.7% drop and after a 0.1% gain in April.

Average cash earnings in Japan rose by 1.9 percent year-on-year in May 2021, following a downwardly revised 1.4 percent rise in the previous month. This was the third straight month of increase in wage growth and the steepest pace since June 2018, with earnings increasing in mining & quarrying (3.8%), construction (1%), manufacturing (2.3%), information (0.6%), transport (3.4%), wholesale & retail trade (3.5%), finance & insurance (3.8%), real estate and leasing (2.8%), accommodations (2%), education (1.9%), and services (5.1%). In contrast, earnings fell in utilities (-6.2%), and scientific research (-1.8%). Regular pay, meantime, went up 0.8% yoy, rising for the fifth month in a row. Overtime pay, a barometer of strength in business activity, jumped 20.7% yoy in May, the biggest monthly gain since comparable data available in 2013. Special payment rose 1% yoy.

Comments on US market last close… 

US market closed for July 4th Independence Day holiday long weekend. European markets were positive on holding pattern. Asian markets wobbly with Japan and China in the wobbles. OPEC+ can’t still get a deal and oil moved higher. Currencies barely moved while commodities were positive.

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