Brace Brace Brace: the RBA’s August rate decision Ignores the global macro thematic and turns a blind eye to rising insolvencies
By Johann Kenny, CFA (8th August 2024)
On August 6, 2024, the Reserve Bank of Australia (RBA) opted to hold the policy cash rate at 4.35% p.a. despite a confluence of challenging local and global economic factors. This decision came amid significant turmoil overseas, including a global equity market sell-off, severe fluctuations in the JPY-USD carry trade, heightened geopolitical risks in the Middle East, and a sharp depreciation of the Australian Dollar (AUD) from USD 0.678 to USD 0.652 within the space of a month.
Maintaining restrictive policy rates poses risks to jobs and businesses under the best of global macro-economic and geopolitical climates, and we are amid anything but such a circumstance.
As domestic businesses go up in flames, the RBA is sitting on its proverbial hands. Business health ties into employment and mortgage delinquencies. Once insolvencies pass the point of no return, the self perpetuating cycle of defaults, unemployment, wealth-destruction followed by curtailed retail spending and an evaporation of business investment will drive the local economy into recession.
The OIS curve implies a rising likelihood of a cut as we approach the end of the calendar year. The outlook for a rate-cut based on the OIS curve executed a parallel shifted down immediate after the RBA rates announcement suggesting that market has tempered its expectation of a rate-cut before the threat to the economy crystalises in the coming months.
Global Economic Context
The global economic landscape is marked by uncertainty and potential instability. Notably, the yield curves in the European Union, United States, and Australia have inverted, signaling market anticipations of impending rate cuts. Inversions typically indicate investor pessimism about near-term economic growth and are viewed as precursors to economic recession.
The Strain in Major Economies
The twin growth engines of the world, the US and China are also on the wobble and supportive of an easing of monetary policy. China's Real GDP prints mask the reality of its domestic inflation situation.
China claims its YoY CPI growth is a mere 0.2% p.a. (as at June 2024). If you revise this to the mean of the rest of the cohort of major economies tabulated above of 2.8% p.a. then China's Real-GDP growth would be closer to 2.1% p.a.
In a similar vein, the July spike in US unemployment suggests that restrictive monetary policy is taking its toll on growth and will likely tip the economy into a slowdown in the runup to elections.
Source: Bloomberg
Monetary Policy Responses
The US Fed funds have followed a pattern of cutting rates within 3-4 years of start of the rate rising cycle. The current hiking cycle commenced in march 2022 so the trend would suggest an easing of the restrictive monetary policy stance in 2025.
“We think that the surprisingly sharp increase in the unemployment rate was due primarily to layoffs and people taking longer to find jobs. Not only is a September rate cut [FED Funds Rate ] now likely - a 50-basis point cut is in play.“
Bloomberg, Winger and Ou, (08/05/24)
In light of these pressures, central banks of the other major global economies may be inclined to execute a synchronised easing of policy rates as they have done in the past to support global growth.
Investment Outlook in a Low-Yield Environment
Given the volatile state of equity markets and the ongoing normalization of previously inflated tech valuations, particularly exacerbated by the unwind of the JPY-USD carry trade, investors are rightly concerned about where to park their funds for low-volatility cash yields.
Opportunities in Private Credit
Private credit often offers higher yields compared to traditional fixed-income investments and can be structured with covenants that provide greater security in volatile markets. Private credit's appeal is enhanced in environments where traditional lending tightens, as businesses still need capital to operate and grow.
Infrastructure and Real Assets
Investments in infrastructure and real assets offer another avenue. These investments typically provide stable cash flows and are less susceptible to market whims. Additionally, they can offer inflation hedging characteristics which are particularly valuable in an environment where inflation concerns are reemerging.