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."

Thursday, September 9, 2010

A lot of big hedge funds have lost a lot of money betting against the lucky country

Bring it on. Today's job numbers have well and truly put an October hike in play. The interest rate futures market has been mispricing the probabilities of hikes by a long margin for some time now.

Until recently, we were staring down the barrel of rate cuts, if the futures market was to be believed. The retail spending, GDP, and now jobs numbers have all shown that to be a farce.

What was happening was too-smart-by-half offshore investors were looking at Aussie rates and arriving at the crude conclusion that they were way too high vis-à-vis the rest of the world. They were convinced of a double-dip in the US, a slowdown in Europe, and the advent of deflationary pressure across the board. China would not hold up in the face of these headwinds, they argued, forgetting that it is a strategic geo-political imperative for the Chinese authorities to foster internal demand to reduce their reliance on the US export market. The Aussie housing market was massively overvalued and was a bubble waiting to burst, we were told. When all of this came undone the RBA would be forced to slash rates.

Well, readers, a lot of very big hedge funds have lost a lot of money betting against the lucky country. Yep, it has been a very bad trade indeed to bet against Aussie growth since 1991. One thing I have personally learnt is that you should listen carefully to the RBA. These guys have around 10-20 times the number of analysts that most banks or hedge funds have studying the economy. Sure, they got the Aussie consumer’s conservatism wrong, as correctly anticipated here. But deep down I don't believe they really took at face value their own rhetoric regarding the 'new normal' in consumer behaviour. It did not pass a simple sanity test. I think was more about the RBA seeking to exercise some moral suasion--paternal liberterianism, as Jeremy Cooper might say.

Now all of the rates strategists are hawking up big time. Let's start with ANZ:

"Today’s report paints an unambiguously healthy picture of the Australian labour market. The annual rate of employment growth continues to trend upwards, and most encouragingly, three-quarters of newly created jobs over the past year have been in full-time employment (267.1K out of a total 349.7K).

At 5.1% the unemployment rate is now at the lowest level since January 2009. With forward-looking indicators of the labour market such as ANZ job ads pointing to further strength in the demand for labour, it is looking increasingly likely that the unemployment rate will soon approach inflationary levels. Our estimate of the natural rate of unemployment (or the NAIRU) is between 4.5% to 5%.

Strong labour market outcomes also question the likelihood that households will maintain a cautious approach to spending and saving as the RBA is predicting. Historical analysis suggests that it is unusual for the household savings rate to rise while unemployment is falling. There is thus a clear risk that rapid growth in household incomes (due to strong employment and wages outcomes) will start feeding into stronger household spending and consumption outcomes. We saw a hint of this in last week’s retail sales numbers which rose 0.7% in the month.

The RBA has little room for error on inflation with its core CPI forecasts already near or at the top of its 2 to 3% target band. With the central bank concerned about the inflationary consequences of a twin terms of trade/investment and household consumption boom, we maintain the view that the RBA will need to tighten monetary policy further by year end."

And to one of the sharpest tools in the shed, Matt Johnson at UBS:

"Following a stronger than expected August employment report, it’s fairly clear that the RBA has a current demand problem – which may mature into an inflation problem. Q2 GDP was stronger than expected, consumers have lost their caution, business investment intentions have risen further, and the unemployment rate has resumed its decline.

Given better than expected current conditions, an unchanged policy path will lead to a higher inflation forecast. When deciding policy in October, the RBA will choose between higher rates and a higher inflation forecast for 2012/13. Given that the RBA currently forecasts CPI at 3%y/y in 2012, the RBA may respond by tightening rates on the 5th of October.

Q2’10 CPI won’t have much impact on the RBA’s 2012/13 CPI forecast and a low number may make it difficult to explain why the RBA is tightening. Given this, it may be tactically simpler to move in October, and point to stronger than expected GDP, consumption, investment intentions, and employment...

A precedent for tightening despite the uncertain global backdrop has recently been set by the Swedish Riskbank, and the Bank of Canada."

Finally, Peter Jolly at NAB reiterates this theme, albeit with a more dovish tone:

"Today’s very robust August labour force report has at least cocked the trigger for the next hike and has certainly put the RBA back in play....For mine, the unemployment rate is the single most important guide to inflation pressures in Australia, and the 2006-2008 experience tells us this economy becomes very inflationary below 5%.

The RBA know this very well also, with a recent discussion paper of theirs [highlighted on this blog]...suggesting that the unemployment rate (more specifically the Phillips Curve) was the best guide to future underlying inflation trends. So an unemployment rate nearing 5% tells us the RBA has an inflation problem brewing for 2011.

I’d add to this that by definition a falling unemployment rate means the economy is already growing above trend. Further on this, total hours worked jumped 0.9%mom in August and so far Q3 hours worked are averaging 0.8% above the June quarter average...

Practically, the chances of RBA hikes this year have gone up considerably and the October 5 Board meeting is certainly “live” – they already warned us on Tuesday that the 4½% cash rate wouldn’t last for long so we've been warned."