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Asia-Pacific’s Week Ahead (Jan 13-17): Australia’s Bushfires Could Be Catalyst for RBA Rate Cut

By:

Senior Market Analyst at Interactive Brokers

Investors focused on the Australian economy in the week ahead are set to receive updates on new home sales and consumer confidence, as bushfires continue to ravage much of the nation.

The devastating fires, which have been notably severe in areas of New South Wales (NSW) and Victoria, are widely expected to pose adverse impacts on consumer sentiment, spending and the broader pace of economic growth.

Overall damage from the bushfires could result in an estimated 0.4% hit to the rate of Australia’s gross domestic product growth (GDP) in the first quarter of 2020, after which it may rebound if rebuilding efforts prove successful.

In the near-term, the agriculture, tourism and retail sectors are most likely to suffer from the devastation, spurring many market participants to anticipate further monetary policy stimulus from the Reserve Bank of Australia (RBA), as well as increased fiscal, as well as climate change, measures from the country’s government.

Australia’s Prime Minister Scott Morrison, who recently announced deployment of A$2bn worth of aid for the calamity, said that the country has undertaken “the single largest federal response to a bushfire disaster” in its history, both in “the scale of the Defence response, the Call-Out of reserves, and the establishment of the recovery agency.”

He added that the government is “responding to an unprecedented crisis with an unprecedented level of support.”

Meanwhile, the International Monetary Fund (IMF) in mid-December said it thinks Australia’s economy will expand by 2.2% in 2020 following growth of about 1.8% in 2019, as it expects private domestic demand to slowly recover, supported by monetary policy easing and personal income tax cuts.

Spending

The bushfires have certainly taken a toll on the country’s inhabitants, as well as generally convinced many tourists that choosing Australia as a travel destination may pose too much danger.

Shane Oliver, AMP Capital’s chief economist and head of investment strategy and economics, noted that the Australian bushfire season, which started in September 2019, has been “horrific with more than 7 million hectares of bush destroyed, more than 25 deaths, significant loss of livestock, estimates of more than a billion wildlife animals killed and more than 1,800 homes destroyed” – while over 200 fires continue to burn.

Against this backdrop, economic activity in Australia is likely to place significant pressure on consumer spending, Oliver said, as “the constant news of the fires and the smoke haze in several capital cities weighs on confidence.

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“Australians were already very hesitant about the economic outlook after the slowdown in growth seen last year and continuing weak wages growth and high underemployment.”

Rate Cut?

Many strategists point to the bushfires as likely catalyst to push the RBA towards further stimulus, at least until the central bank reaches a zero, or closer-to-zero, interest rate policy. This may mean reducing the cash rate by another 50bps, effectively two additional cuts, before further accommodative measures, if appropriate, are introduced.

A lower cash rate will also most likely lead to a softer Australian dollar and lower government bond yields – which are already quite low. In fact, the yield on the Australian 10-year government note was last bid at around 1.25% ahead of the weekend.

The RBA’s dovish stance appears to have worked to prop-up the value of certain stocks.

The iShares MSCI Australia ETF (NYSEARCA: EWA), for example, which has among its top holdings financial sector firms such as the Commonwealth Bank of Australia (OTCMKTS: CMWAY) and Westpac Banking Corp (NYSE: WBK), as well as retail giant Woolworths Group (ASX: WOW) – has gained roughly 3.58% since hitting its latest 52-week trough set at the start to January 2019, according to the IBKR Trader Workstation.

The EWA ETF was last up around 0.62% to 22.87, while the S&P/ASX 200 (INDEXASX: XJO) had risen 0.8% Friday to 6,929.

Marc Chandler, chief market strategist at Bannockburn Global Forex, also pointed out that since the middle of this past week, the Australian dollar has found a base near $0.6850, but it is showing “little enthusiasm to the upside.” He added that the 200-day moving average is a little below $0.6900, and a close above it would “lift the tone.” 

To date, the market appears to be leaning more towards the RBA keeping its cash rate at 0.75%, when it next unleashes its monetary policy decision on February 4, with those calling for a 25-basis point cut amounting to around 42.9% intraday Friday compared to 57.1% who expect rates will remain unchanged.

However, the RBA, led by governor Philip Lowe, continued to strike a dovish tone at its December meeting, noting that it was prepared to ease monetary policy further if needed to support sustainable growth in the economy. 

In its latest meeting minutes, the central bank recognized “the importance of income growth as a key driver of consumption growth,” while households’ expectations about future economic conditions had “declined significantly since June” – when the RBA began its rate-cutting cycle in 2019.

The RBA added that “the prolonged period of slow income growth had affected both consumer sentiment and growth in household consumption.”

The adverse economic impacts from the bushfires may influence the RBA’s decision to further reduce its cash rate February to 0.50%.

The Economic Calendar

Meanwhile, Australia’s economic releases in the week ahead are set to be unveiled in the latter part of the week, including fresh new home sales figures, as well as a look at consumer confidence.

Thursday, January 16

  • Housing Industry Association (HIA) New Home Sales (Nov)
  • Westpac Consumer Confidence (Jan)

New Homes

The HIA highlighted that new home sales remained steady during the three months to October 2019 (-0.5%) and fell 3.1% from the same year-ago period, when the market had started to cool “rapidly.”

The association generally attributed access to finance as a “significant barrier” to new home construction over the past year, with new home valuations not living-up to buyers’ expectations and bank requirements.

HIA said that new home sales were relatively flat in Western Australia (0.0%), Victoria (-1.2%) and South Australia (-1.0%) compared to the previous three-month period, while Queensland rose by 5.7% and New South Wales declined by 4.8% over the same timeframe.

Indeed, conditions in the new housing construction sector in Australia have remained lackluster, despite the RBA’s halving of its cash rate in 2019 from 1.50% to 0.75% and subsequent increase in the demand for home loans – all of which may be further evidence for an additional 25bp rate cut in February.

Consumer Confidence

Investors will also receive an updated gauge of the Westpac-Melbourne Institute Index of Consumer Sentiment for January, after the prior month’s reading fell 1.9% from November to 95.1.

The Index has plunged more than 6.0% since the RBA began slashing its cash rate in June and has resided below the 100 level, signaling a stronger pessimistic tilt over optimists throughout the second half of 2019.

Westpac chief economist Bill Evans recently noted that the poor performance of the Index is “broadly consistent with the sharp deterioration we saw in consumer spending in the September quarter.” He added that over the RBA’s rate-cutting cycle since June, the favorable/unfavorable balance has been around 30/70, offering “further evidence that the rate cuts in this cycle have had a much less positive impact on consumers than in past cycles.”

However, Australian retail sales in November seems to betray a lack of confidence, as the index rose by 0.9%, far more than expected and the strongest in two years, with October’s figures upwardly revised to 0.1% from flat. As the latest uptick could be due to early holiday-related purchases, December’s numbers could well disappoint to the downside.

Investors will likely be watching Australia’s environmental and economic conditions closely for any developments that may lead to further monetary policy or fiscal easing, as well as consequences of such actions on its domestic, as well as the global financial markets.

In the meantime, select the Event Calendar option in the IBKR Trader Workstation for a full list of U.S. and global corporate events and earnings, dividend schedules, economic data, IPOs and more.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

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The author does not hold any positions in the financial instruments referenced in the materials provided.

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