Cut by how much?

The US Federal Reserve took the “bang” rather than the “whimper” approach last month, surprising almost everyone with a 50 basis point cut. With stocks at or near a record high, credit spreads at their tightest, and macro data cooling, but not crashing, it is a bold move.

The question then becomes for the RBA - to pinch the title from The Cranberries debut album (showing age here) - ‘Everyone else is doing it so why can’t we?’

We take little signal from the Fed, or indeed the Bank of Canada, RBNZ, ECB or Bank of England, as to the likely near-term direction for policy in Australia.

Why?

Inflation

Core CPI has been meandering sideways in Australia since late 2023 in the high 3%/low 4% area. It is not close enough to the 2%-3% zone for the RBA to have conviction in a line of sight. In the US, core CPI is already sub-3% and heading lower giving the Fed the conviction it needs to begin ‘normalising’ rates. In Australia, the equivalent measure is close to 4%, which is still not close enough. Looking at the trend, Australia could conceivably have core CPI closer to 3% by early 2025, but we’ll see.

Core inflation % y/y

Labour market

The employment market in Australia has simply stayed stronger for longer. RBA Assistant Governor (of Economics) Sarah Hunter said last week, “…our current assessment is that the labour market is operating above full employment but has moved towards better balance since late 2022.”

Both the US and Australia have unemployment at 4.2% but monthly jobs growth has been persistently solid locally, growing at an average of ~37k per month over the last six months. There aren’t any warning signs flashing. The RBA is sensitive to the employment market and keen to ensure the landing is soft in this regard, but so far all it is giving them is permission to be on hold for longer whilst they await progress on the CPI front.

We could point out the concentration of jobs growth in the public sector and non-market industries, etc. It is what it is, and as Governor Bullock has repeatedly said, the aggregate economy is what matters. Whilst monthly jobs growth has been solidly sideways in Australia, it has clearly been decelerating in America.

The GDP conundrum

The GDP result for Australia’s third quarter was miserable. There is weakness everywhere as it concerns the key drivers of the economy – household consumption, business investment and corporate profits. The headline number was awful at 0.2% for the quarter and a puny 1% for the year (the lowest annual growth since the early 90’s recession, excluding COVID).

But the headline would have been a firm negative if public demand had not boosted the number with the private sector contracting 0.2% over the quarter. Basically, the interest rate sensitive parts of the economy are responding to high interest rates. The old GDP per capita has now been negative for four straight quarters!

Household consumption -0.2% for Q3 2024

Public spending remains strong

Again, as the RBA keeps saying, it is the whole economy that matters. The private sector looks like it is in retreat and clearly responding to higher rates. But the aggregate story is still one of growth, albeit muted.

The timing can be debated but the endgame is in the price. Markets have priced the RBA to get back to the low 3% area over the next 12 months or so.

This, of course, will feed quickly into retail deposit rates in coming months. So markets do not need to and will not wait for that first cut to reprice.

For now we can relax. The jumbo move from the Fed means little to an RBA nervously seeing CPI still up near 4%. The RBA has two meetings before year end. It is hard to believe we are going to sail through the whole year with Australian monetary policy being a big nothingburger but that looks to be the most likely scenario.

Managed Fund

Franklin Australian Absolute Return Bond Fund

Australian Fixed Income

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