RBA tenterhooks

All eyes will be on the Reserve Bank of Australia’s latest policy decision today at 1130 SGT. In recent days, the RBA’s 0.10% yield target for the April 2024 GCB has been blown out of the water, with its yield rising to 0.80% on Friday, while the RBA yesterday, chose to buy bonds further out on the curve. With New South Wales and Victoria reopening along with international borders, and the economy seemingly firing on all cylinders, investors are waiting to see if the RBA does a massive U-turn on its previously ultra-dovish guidance.  Certainly, its absence from any action as part of its yield curve control in its target April 2024 tenor suggests that a change is coming.

Like central banks all over the world now, the RBA is now caught in no man’s land taking fire from both sides. On one hand, wanting to leave monetary policy supportive to ensure the post-pandemic recovery continues, on the other, facing inflationary forces that are increasingly noisy and testing the limits of the meaning of “transitory.” Although I do not expect an unthinkable rate hike, at the very minimum, the RBA should follow Canada and New Zealand’s lead and call a halt to its AUD 4 billion per week bond-buying programme.

I have no argument with leaving policy rates around the world at record lows, despite the recovery noise in the data globally, the recovery remains fragile. What needs to end is the quantitative easing, QE-forever basket cases like the Eurozone and Japan aside, which while necessary as a monetary tactical strike during the height of the pandemic, have quickly reached its use-by date. From the group-think lunacy of the crypto-space to housing prices and asset valuations in general, QE’s distortions are increasing economic and social inequality around the world. With inflation on the move everywhere, those left behind risk a double sucker punch as the spending power of what they do earn is eroded as well. Be brave RBA.

US manufacturing remains solid

More ominous inflation signs appeared overnight in the United States. The ISM Manufacturing PMI for October fell slightly to a still very impressive 60.80 overnight, however, it was the sub-indexes that caught my eye. ISM Manufacturing Employment rose from 50.2 to 52.0, ISM Manufacturing Orders fell to 59.8 from 66.7, still very healthy and likely reflecting the supply chain challenges we all know so well now. Finally, Manufacturing Prices rose to 85.7 from 81.2 suggesting that pricing power for goods sold remains strong, something the US earnings season has also been telling us all. None of that looks very transitory inflation to me.

As a side note, South Korean inflation hit 9-year highs this morning as well and the Bank of Korea’s policy meeting on the 22^nd now looks like a live one as well, with a second rate increase on the way. The rest of Asia, emerging from the pandemic later than most, looks like one of the few economic powerhouse regions where inflation is benign, for now. The US FOMC, whose two-day policy meeting starts today, has somewhat of a quandary on its hands. Friday’s Employment Cost Index was food for thought, as was the ISM data overnight. Having pimped up asset prices globally, made the cost of capital zero, and then back-stopped investor decisions by making sure they never lose money on anything, the window for putting that genie back in the bottle is closing rapidly.

Tomorrow should see a tapering of QE easing announced by the Fed at the FOMC. Chairman Powell will likely offset that by emphasising no rate hikes are on the horizon while continuing to beat the transitory drum. To be fair, he has some reason to do so. President Biden’s Infrastructure and Build Back Better programmes remain frozen and held hostage to factions within his own party. Being a Republican opposition is the easiest job in the world at the moment, your job is being done for you. As I have repeatedly stated though, I believe the taper trade has not been priced in by markets and there is room for the US dollar and US yields to spike higher as reality sets in. US equities may be record highs right now, but we can expect a lot more two-way price action instead of one-way traffic into the end of the year and into Q1 2022.

Elsewhere, the Bank of England faces a similar dilemma tomorrow. Although it appears that the BOE hike trade is losing steam ahead of Thursday’s meeting with Sterling underperforming overnight, having become a very crowded trade in recent weeks. Its fishing spat with France won’t be helping.

Post-RBA, Asia’s calendar is empty and with the FOMC policy decision due tomorrow night US time, along with what should be an interesting press conference, I am expecting markets to move into wait and see mode. Readers should watch for Australian dollar volatility in about an hour or so. If the RBA blinks, we could see a decent bout of AUD strength, although I believe it will be mostly seen versus the yen and New Zealand dollar.

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