The Big Short...

Christopher Joye

Coolabah Capital

In the AFR I write today about The Big Short (brief except only enclosed). Specifically, since late last year, we’ve had several contrarian views. First, US markets needed to price in the Federal Reserve lifting its cash rate to 2.5-3.0 per cent. At the time, markets were pricing in a tiny 1.5 per cent terminal Fed cash rate. They’ve now lifted that to around 2.9 per cent.

A second forecast was that the US 10-year government bond yield needed to rise above 3.2 per cent. Markets strongly disagreed, pricing in just a 1.3 per cent yield. Yet four months later, the US 10-year yield is now above 3 per cent.

A third expectation was that US equities would mean-revert back to normal, cyclically-adjusted, price/earnings multiples. This required a 30-60 per cent draw-down in US stocks. Since that time, the S&P500 has fallen about 14 per cent while the NASDAQ is off 24 per cent. We estimate that the S&P500 has another 20-35 per cent to go. The NASDAQ should fall much further.

A fourth view was that while Aussie house prices would continue climbing for a while, they would have to correct 15-25 per cent after the first 100 basis points of cash rate hikes, which we thought would commence in mid 2022. The Reserve Bank of Australia obliged this week with its first 25 basis point increase. It was a classically jejune Martin Place: doing the one thing nobody on the planet expected just to prove everyone wrong. Markets and economists thought no hike, 15 basis points, or 40 basis points were all possible. Desperate to claim a supercilious victory, the RBA lifted its target rate 25 basis points.

Kudos to columnist Terry McCrann for bravely calling early hikes ahead of everyone else, and to CBA’s Gareth Aird for generally being ahead of the curve.

The RBA’s governor, Phil Lowe, then gave an impressive press conference, where he delivered a mea culpa on the central bank’s woeful forecasting track-record, describing it as “embarrassing” and something that had to be fixed. This extremely rare bout of humility was way overdue, but nonetheless carried an enormous contradiction.

It is not just that the RBA’s forecasts have been pathetically poor. It is that the RBA has then lurched into huge, multi-year policy pre-commitments on the basis of these specious perspectives.

Recall the commitment to not raise rates until at least 2024. This was also accompanied by the promise to keep buying the 2024 government bond yield to ensure its yield remained equal to the 0.1 per cent cash rate. And, more recently, the pre-commitment to wait for the May and June wages data before hiking rates, ruling out a May move. All these de facto promises have been overturned, torching the RBA’s credibility.

Despite admitting that his economists could not forecast their next footstep, Lowe then repeatedly told the world that the RBA expected to lift its cash rate to a 2.5 per cent “neutral rate”. Over and over again. On what planet can the RBA have confidence in this expectation? Why even utter these words? What happened to just being data dependent?

All of this tells us is that the RBA has learnt absolutely nothing about the perils of pre-commitments. It demonstrates that it is not yet willing to concede defeat about its deep intellectual deficiencies. It cannot help but reflex into pretending to be an all-seeing, all-knowing diviner of our destinies.

The bad news is that the RBA has an especially distinguished track-record of getting the Aussie housing market's reactions to its cash rate changes horribly wrong. This is all the more surprising because the housing cycle is exceptionally easy to forecast.  

Read my full column over at the AFR here. If you want to read my Livewire expositions of both the Big US Equities Short and the Big Aussie Housing Short, click on those links.

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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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