The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Monday, November 28, 2011

Economists' rate forecasts clash with financial markets (chart)

An interesting, although fairly typical, conflict between economists' RBA rate forecasts in December and the predictions of the SFE's 30 Day Interbank Futures Contract, which is the purest cash rate proxy. In short, only 27% of economists believe the RBA will cut next week, according to Bloomberg data. In contrast, the financial markets are putting a 100% probability on a cash rate reduction to 4.25%, and have been doing so for weeks.

As discussed here before, the RBA does not normally like "surprising" market expectations with a shock decision. While the RBA is understandably quite focused on financial market expectations, it also includes economist views in this camp and, of course, is acutely aware that the two frequently diverge.

But what expectations are most important? It is hard to say. On the one hand, it cares most about the expectations of participants in the domestic economy. A key cohort are consumers who, I suspect, are not sure what the RBA will do (ie, closer in spirit to economists).

Yet financial markets are also significant insofar as they set the long-term price of money that prevails in the economy via the yield curve. There has been huge inversion of the Aussie yield curve, which has reduced domestic interest rates and therefore supplied additional financial accommodation over and above what the RBA was planning to bestow via its cash rate decisions.

The bottom line: the RBA can rely on whatever it wants to rationalise a decision; eg, economist expectations or financial market pricing. This time around, it probably does not mind the conflict between the two, especially if it intends on pausing: the financial markets are already providing the "insurance" many investment bankers are begging the RBA to supply while the current inertia in economist views means that the RBA does not feel that its arm is being twisted in one direction. What will they actually do? Frankly, I don't know--and neither do they. One will not have a more confident feel for the probabilities, which hinge almost exclusively on Europe, until we have full information on the day of the decision.