RBA to hike by 25bps, according to the AFR economics editor

Christopher Joye

Coolabah Capital

The RBA will hike by 25 basis points tomorrow, according to the Australian Financial Review's economics editor, John Kehoe, bringing the target overnight cash rate to 60bps. Kehoe further asserts that the RBA will continue in 25bps increments until it reaches 110bps in August, following which it will reassess. This all seems like very sensible stuff. It is also the second time in the past few days that Kehoe has delivered what appears to be a message on behalf of Martin Place to actively recalibrate expectations (see the first piece here). 

Kehoe's 25bps call very much contrasts with other hawks in the media. The Australian's legendary columnist Terry McCrann is lobbying hard for a 40bps to 65bps hike, and has been incredibly critical of the central bank – marking a notable departure from his historic support of the RBA. And then we have Centralbankintel's founder Sophia Rodrigues, who has been similarly hawkish and advocated for a 40bps hike in June. It's worth noting that McCrann wanted a bigger hike in May (although he was early to call May) and Rodrigues did not expect a hike in May, pushing for June instead.

Kehoe's key argument, which I am sympathetic to, is that the RBA wants to send a "business as usual" signal. To quote the AFR directly:

The Reserve Bank of Australia will likely increase the cash rate by 0.25 of a percentage point on Tuesday, even with the money markets betting on a larger rise. RBA governor Philip Lowe said last month that an increase of 25 basis points was a “signal we’re getting back to business as usual”...
Lowe’s stated preference as recently as five weeks ago was for conventional 0.25 of a percentage point changes. Since then, the March quarter GDP result was solid. Wages and earnings data were mixed. Three or four rate rises in successive months would get the cash rate a bit over 1% by around August, and allow the RBA to reassess the monetary policy outlook in the back half of the year.

The RBA's monetary policy mechanism is unusually potent in Australia with most borrowers having variable-rate loans, or short-term fixed-rate products that roll over into floating rates within two to three years. 

We have highlighted that house prices are already declining quite quickly in the two biggest cities, Sydney and Melbourne, with auction clearance rates over the weekend continuing to deteriorate. CoreLogic reports that the national clearance rate is likely to slump below 60% for the second week in a row after the preliminary estimate printed at 62% (vs 71% a year ago). 

In Sydney, conditions appear to be in free-fall with the preliminary clearance rate printing at 59% (versus 76% a year ago), which will almost certainly be revised down once the final numbers come through. We've repeatedly argued that after the first 100bps of RBA hikes, national home values will fall by a record 15-25%, albeit in an orderly fashion. And we remain bullish on the Aussie economy's resilience.

Auction clearance rates are in free-fall

Kehoe noted that while GDP was solid, the data on wages growth was mixed. It is also clear that Australia's elevated inflation prints are currently being driven by supply-side influences. With the housing market turning sharply, and no current evidence of a wage-price spiral, the RBA has plenty of time on its side, even if it wants to get the cash rate to 150-175bps by the end of the year. 

Another interesting facet of current interest market pricing is the huge disconnect between variable-rate (or floating-rate) and fixed-rate pricing. Last week we saw Victoria borrow $4.4 billion at 1.3% for 8-year money on a floating-rate basis compared to the 4% plus they would have to pay if they were borrowing via fixed-rate products. Queensland borrowed another $500m via floating-rate products on Friday. Almost all these bonds have been sold to banks looking to build-up their high quality liquid assets. 

Households are in the same position: discounted variable-rate mortgages cost around 2.25% relative to the 4.5% you pay for 3-year fixed-rate loans. There is, therefore, a prospective arbitrage for borrowers if interest rate markets, which are boldly assuming the RBA will lift its cash rate to north of 3.5%, are getting things wrong. There is a case that a lack of liquidity in interest rate markets since the RBA blew-up the interest rate doves in November last year has exacerbated the current mispricings apropos the cash rate's future trajectory...

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Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs over $8 billion with a team of 26 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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