Credit Suisse: RBA won't hike until 2025

Economists and investors (and media) don't just enjoy interest rate speculation (I mean, we do enjoy it as well). But we also need to keep an eye on the Central Banks because an interest rate hike can be a game-changer for markets. 

For the past few years, the Reserve Bank of Australia (RBA) has set a firm course for lifting the cash rate in 2024. The attitudes of Governor Lowe and Deputy Governor DeBelle have been like the unofficial US Postal Service motto: "Neither snow nor rain nor heat nor gloom of night stays these couriers from the swift completion of their appointed rounds." But Lowe and DeBelle have yet to contend with Delta, the slow vaccine rollout and ongoing lockdowns. 

“These lockdowns will delay liftoff for the cash rate,” said Argyrou. 

By far, 2025 is the furthest out prediction I've seen for a rise in the RBA cash rate. The RBA has been consistently saying 2024, most of the major banks have brought that expectation forward - as close as November 2022. But this was all before Delta really set in. 

The possibility of a 2025 interest rate-hike horizon is going to change investors' decisions across a range of asset classes. Mia Kwok recently sat down with Jasmin Argyrou, portfolio manager and director at Credit Suisse to discuss: 

• Unpacking the signals for a 2025 rate hike,
• Why the labour market isn't as good as we think,
• What's next for the housing market, 
• Why the RBA won't change QE at the September meeting, and 
• What this all means for investors. 

Watch the video: 

This transcript has been edited for clarity.

Jasmin, we're just coming off the back of another record reporting season. But looking ahead, we've had a lot of economic disruption from COVID. What is your outlook for the Australian economy?

Jasmin Argyou (JA): 
In terms of our outlook for the Australian economy, we've had to revise downwards our expectations for GDP growth a few times. And that is because the September quarter looks like it will experience a much bigger decline than we originally thought when the lock downs and the pandemic first hit. 

So now, we're expecting GDP growth to contract as much as 3% in the September quarter. And although we expect a rebound to follow next year, it has implications for our longterm outlook for the Australian economy.

Previously, we expected the Australian economy to return to its pre COVID trend in 2024, early 2024. Now, we don't expect that to happen until 2025. And that's really an important point in the recovery phase of the Australian economy. Because it's only until GDP growth reaches the level that it would have achieved had the pandemic never happened, it's only when that point is achieved, that the RBA can really start seriously contemplate raising the cash rate, but we don't see that happening until 2025.

Yeah. Wow. That's quite different - because a lot of economists have sort of put the books on 2024. How does that change things, that extra year?

JA: 
So, a lot of economists and the RBA expect that 2024 might be the year when they can lift the cash rate. And the markets have, for a while, been pricing in liftoff in 2023. So, the way it changes things is actually it puts a lot of onus on other labours of policy to do a bit of the tightening work that might be needed. And probably the most important monetary policy tightening that we'll see, aside from the unwind of some fiscal easing, is what happens with macro- and micro-prudential measures to cool down the housing market.

One of the key indicators that the RBA has said it's looking at is labour statistics. So, if we're looking at the current situation, we're seeing a lot of new payroll data showing declines across the board, and in states that aren't even in lockdown. What's your outlook for the labour market?

JA:
So, there's various aspects of the labour market that we can look at. And at the moment, the unemployment rate makes the economy look really solid. 

But we think it flatters the state of the labour market a little bit too much at the moment. So, what is more important is hours worked and the rate of underemployment in the economy.

 Because the shocks that we're seeing, that are hitting the Australian economy, they're going to lead to adjustments and corrections, not in a headcount, but rather in how much people are working in terms of hours worked. So, it's really those measures that are more important. And what also complicates matters quite a lot is the fact that the working age population has stopped growing. And so, if we look at what goes into the unemployment rate calculation, a big swing factor has been the working age population growth.

Now normally, the working age population grows at a steady rate, so we don't really need to worry about that so much. But for the first time, that measure has behaved differently. And what it means is essentially our economy need not generate many jobs gains every month in order to bring the unemployment rate down to 4%. 

So, if we are just able to, on average, add 10,000 jobs every month to the Australian economy, by 2022, the unemployment rate will be heading towards 4%, maybe even lower than that. And we don't think that necessarily represents a tight labour market. And we don't think the RBA should hang its hat on that particular figure.

So, we're looking at somewhat artificial employment numbers at the moment, but they will normalise as we start to reopen. Is that right?

JA:
Yeah. I think the employment numbers reflect a resilience on the part of businesses, reflect a long-term focus, a focus on the economy getting back to normal, and borders reopening on increase in population growth. In fact, you can see it in the housing market. Investors are returning, have been returning, to the property market, even though demand for rentals is not that great.

Why is that? Because everyone knows that things will return to normal. There will be an increase in population growth. So, while rental demand for... While rentals might not be rising at the moment, rent prices, at some point down the track, things will normalise.

What is your broader outlook for the Australian housing market?

JA:
We're seeing a two-speed economy in Australia if you look at house price appreciation. On a six month annualised rate, it's as high as 30%. And that - even for Australia's quite active housing market - that is quite a fast rate of growth. 

But really, the data that we really should look at that paints the picture, is the data on new lending. So, new loans are up 80 to 100%, depending on whether you look at new lending for owner-occupiers or investors, 80 to 100% year on year growth. Whether you look at the level of new lending or the growth rates, and regardless of whether you look at it from year on year or a six month period, it is a frenzied market. And demand has exploded.

And it has not excluded any region of the country, or the states who are participating in this boom. And so, what is to come in the future? I think house price appreciation will only pick up speed. It's only been interrupted by the lockdowns. They've had the effect of pressing pause on demand for housing and on the house price appreciation trend, but I don't think they've reversed it. And I don't think that'll stop it.

One of the key things that is in the conversation at the moment is the upcoming RBA September meeting. There's been a lot of back and forth around whether the tapering that's due to come in will continue, or whether COVID has created a sort of disruption to that. I was wondering if you could take us through your expectations for the RBA over the next sort of three to six months and what we're going to see in terms of QE (Quantitative Easing).

JA:
I think the RBA will have to reduce their growth expectations. So, that's the first point. The second point is, if they've reduced their growth expectations as a result of the degree of lockdowns, will they respond? If they do respond, the main tool that they will respond with is the pace of asset purchases. They do want to be a bit more flexible. 

So, this would be their opportunity to introduce more flexibility in their bond-buying program. They have sort of set the path for reducing purchases up until from September to November. Will they unwind that? That seems to be a big hurdle. 

I think that they might wait until November, give themselves more flexibility, and then perhaps vary the purchases. And that will be an important time for the Australian economy, because I expect there will be some relaxation restrictions by then. 

And the RBA will have more visibility in terms of, first, the extent of the slowdown and B) the resilience on the part of business sentiment and house household sentiment, and so, based on that, how vigorous the rebound will be.

At the moment, the market is doing the work for the RBA, in terms of the financial markets where the biggest impact is the Australian dollar has performed really poorly relative to most currencies. And that reflects what's happening in terms of our lockdowns. The RBA would want... would be happy with that because it's a channel through which easing occurs. Bond deals are lower than they are in the US here in Australia. So, there's little need for the RBA to respond straight away. When they will need to make a more difficult decision is sometime towards Christmas.

What does that flexibility look like? Is it a matter of sustaining their plans to acquire bonds at $4 billion a week as opposed to bringing it down to (hypothetical) $3 billion? Or is it a matter of changing the bond-duration that they're buying? What are their options?

JA:
There are a few options. I think changing the maturity structure is probably not one of them because they're already influencing long-dated bonds. What they could do is introduce more flexibility in terms of the weekly pace of purchases, in terms of the duration. So, they might have an open-ended programme, and start to programme a step down in purchases. And they could also vary the proportion of state government bonds and Commonwealth government bonds that they purchase as they...

If the situation does start to become a little bit disorderly, that might be a tool that is useful for them. But I think the most likely option is the duration of bond-buying extends further, and the pace of tapering is a lot more elongated. And there's flexibility there, but they're probably hoping they don't need to call upon that flexibility, but it's just there as an option.

Fair enough. So, looking at all these different key indicators in the market, housing, lending statistics, the jobs outlook, and the RBA, what's the key message you want investors to take away from this? What should they be aware of and what should they be reacting to?

JA:
I think the key one is the outlook for the cash rate because the RBA has tied some very strict conditions to raising the cash rate. And those lockdowns will delay the liftoff in the cash rate.

If the cash rate remains low for a long time, it will have implications for the currency. It will have implications for how much the currency can appreciate, because interest rate differentials with the rest of the world matter.

It will also have implications for bond deals, because there's a limit to how much long-dated bond deals can deviate away from the cash rate. And I think we saw that earlier in the year when bond yields rose very sharply only to reverse a large part of that move globally. 

The lesson I think we can learn from that is there's... It's like pulling a rubber band. You can't stretch it too far. You can't stretch long-dated bond deals too far away from where cash rates are. 

So, expect stability in bond yields, expect cash rates to be low for a long time. And that has implications for how people invest their cash, or what they perhaps might have held in term deposits, what they might've held as cash. They might be, now, I think, looking at a long timeframe at which the cash rate will be close to zero.

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