Interest Rates to Rise Sharply…?

May 15, 2014 by Jon

Relax, I just wanted to get your attention… Now that I’ve got it, let’s have a grown-up discussion as to exactly what’s going to happen to interest rates in the next 12-24 months…

If you’re an investor, you need to read this… If you’re not an investor, sorry, you’re at the wrong place.

Let’s go…

Like the government, the RBA is trying to talk the economy down, but their eyes are squarely on the exchange rate. It’s a game of cat and mouse, but shows you that rate hikes are completely off the table until the AUD falls a lot further.

Through all the budget hoo-ha, which had very little of interest for property investors, the RBA has been keeping a low profile.

With the government all out to whip up a sense of budget emergency, the RBA has been careful not to go ‘off message’. It left rates unchanged for eight months in a row, but its public statements remain sombre.

In fact, surprisingly, if not suspiciously so.

Take for example the growth forecasts in the latest quarterly statement on monetary policy. At the moment, they’ve got growth slowing through the second half of 2014 and into 2015.

BUT – they had to revise UP their forecasts for the year to 2013/14 financial year. There wasn’t much they could do about this, after the stronger than expected print for GDP in the December quarter last year, and what we already know about the March quarter of this year.

So, to put it in perspective, we’ve got growth of about 0.8 percent a quarter this year, slowing to around 0.6 percent a quarter in the year after. So after ramping it up a bit this year, the economy shifts down a gear the year after.

But why?

It’s left a lot of folks scratching their heads. The outlook is surprisingly downbeat given what’s being going on in the economy lately. There’s been a clear lift in momentum in recent times. The household sector’s looking stronger, and the employment data have consistently surprised on the upside in recent months. There’s also a mini-boom emerging in housing construction, which is always welcome news.

(The impact a budget full of big cuts could have on dragging down growth is a real prospect, but doesn’t rate a mention…)

The only explanation the bank gives for cutting its outlook for 2014/15 is a 4% increase in the Aussie dollar since February. But even then, it’s starting to look like old news when you start thinking about FY14/15.

Still, the RBA has put the dollar front and centre again. It’s sending a very clear message about how sensitive the Aussie outlook is to the fortunes of the currency.

But RBA “jawboning” has also become a bit confused in recent times. The “I’ve got a gun and I’m not afraid to use it” rhetoric we saw at the end of last year is gone and all we got in this SMP was, “with resource prices expected to decline further, historical relationships suggest that the exchange rate could move lower over time.”

What a wet piece of lettuce.

So what’s going on? Is the RBA forcing their forecasts down so as not to offend Canberra, or should we really be worried about the outlook ahead? And have they stopped holding out for further falls in the dollar? And where does that leave interest rates?

I reckon what we’re seeing is a more nuanced approach to “managing expectations” in the market.

Last year, when Glenn subtly hinted that sometimes central banks do intervene to help their currencies down, and theoretically, he just might do exactly that one day, he would have been very well aware of what affect that had.

Nothing.

Markets barely battered an eyelid. There was a bit of a shock on the day, but beyond that, diddly squat. And why would the markets care? The RBA is small-fry compared to the banks of China and Japan, who are very actively manipulating their currencies.

And currency markets themselves are wild, untamed behemoths. No one has pockets deep enough to take them on in any serious way, even the RBA.

Jawboning Mark I: FAIL.

And so enter jawboning Mark II. In this version, the RBA tries to shift the consensus around what the longer-term outlook for the Australian economy is. If they can convince people that Australia is facing several years of below-trend growth, especially if the outlook for the US is improving at the same time, then that should take some pressure off the dollar.

Because the price of the currency today keys off expectations of the future. If there’s an expectation that the US assets of the future will perform better than the Aussie assets of the future, demand will swing around from Aussies to USDs, and the Aussie dollar should fall.

And with a government selling economic calamity, it’s the perfect time to do exactly that. Mime along with the words from the government’s hymn sheet, and hope that markets shift their views.

The only hiccup is the actual data itself – data that shows growth accelerating, and painting a strong picture over the medium term.

How inconvenient.

But the RBA doesn’t have a choice. Interest rates are sidelined for the moment. They’re already at record lows, and pushing them down even further risks driving property prices through the roof.

It also leaves you very little room to move in case of a genuine emergency.

But so long as the dollar remains expensive, it will weigh like an anchor on the sectors of the economy you want to get kicking. Growth will be unbalanced, with some sectors charging along, but others getting left behind.

The RBA has made it very clear it wants to see the AUD with an eight in front of it. And until the AUD goes to the lower end of US80 cents, you can forget about rate hikes.

Until it gets what it wants, talking the Aussie economy down is about all it can do. The only question is how many of us will see through the subterfuge.

Still the envy of the world

April 15, 2014 by Jon

There’s a lot of doom and gloom and frowny faces around at the moment, but the Aussie economy is still the envy of the world, and these charts show just how much momentum there is behind us.

Joe Hockey is paving the way for a slash and burn budget, carefully managing expectations so that if a velociraptor comes storming out of the Treasury papers and starts eating journalists, no ones going to be surprised.

And why wouldn’t he? The first budget is the one to do it. You make a few enemies now, in your first budget, and then you buy them off again in the budget before the election, and everything’s sweet.

And democracy’s the winner on the day.

But in all the hoo-ha, let’s take a look at this narrative that the Australian economy is sinking like the Titanic and the only thing that can save us are an militia of velociraptors dressed as Treasury officials.

Not that I don’t think there’s room to give the public service and nip and tuck, but do you have to scare the be-jeezes out of people in the process?

First up, the Australian economy is still the envy the world. Still. What’s that? Like 10 years in a row?

If we were Americans we would have declared some sort of parade and handed out little Aussie flags to everyone.

But check this chart out here:

Indexed to 2007, it compares our GDP (left panel) and employment (right panel) to the US, the UK and Europe.

Yep. Aussie Aussie Aussie!

Not only has our economy outperformed the world, we’ve done it with style. We totally side-stepped the GFC, and our economy continued to grow through it all. Employment growth stalled a little, but never really lost ground.

You couldn’t have really asked for more than that.

Of course the big story in that marvellous, dummy, side-step, goose-step manoeuvre we pulled on the GFC was the mining boom.

The mining boom reshaped the Australian economy. This chart here gives you the basic idea. This is the make up of Aussie exports:

From around level-pegging with services, agricultural and manufacturing exports at the turn of the millennium, mining exports have exploded in recent years, and totally dominate trade.

But recently they’ve collapsed and we’re all going to die. I mean, no they haven’t. They’re still rising, and recently reached new records. Nothing to worry about here. The goose is still laying golden eggs.

That’s not to say the transitioning mining boom is going to present us with some challenges. But it’s not in exports and earning potential. It’s in investment. The phenomenal pace of mining investment has eased some-what in recent years, with those head-line mega-projects becoming thinner on the ground, and so we’re looking for the rest of the economy to pick up the slack…

So how are we doing on that front?

Well, actually not as bad as some people might tell you.

The retail sector has had a rough trot in the past 5 years, but has actually bounced back in the last six months. Retail sales are currently growing around 6% a year. Growth’s been stuck around 3% in recent years, and it’s good to see growth get back to more ‘normal levels’:

The construction sector, also one of the pillars of the Aussie economy, is also bouncing back strongly, as I reported last week. Higher prices are bringing developers and banks back into the game, and that’s good news for output and employment.

This chart here follows loans for new housing construction (in billions of dollars). It’s bounced up to the highest level in 10 years! What we’re looking at is the emergence of a construction boom.

At the same time, the manufacturing sector, despite some high-profile closures, is also doing surprisingly well. Activity has picked up in the last six months, and this graph here tracks loans to the manufacturing sector. They’re the highest they’ve been in two years!

That’s good news, because loans tend to go hand in hand with expansions in production and output.

I think a lot of people don’t realise how tied Australian manufacturing fortunes are to the rest of the world.

That’s what this chart here shows. Australian manufacturing business confidence moves very closely with The Global Conditions Index. We have a very open manufacturing sector.

This is good for trade, but does mean we can cop a beating when the Aussie dollar starts to soar. In fact, I reckon most of the recent pick up probably has to do with the depreciation in the Aussie we’ve seen over the past year.

And so the Aussie dollar remains one of the biggest challenges we face, and one of the key pivot points for the Aussie economy. This is unfortunate because there isn’t really much we can do about it.

But what it does do is put a lid on interest rates. If the RBA hikes rates, then AUD-denominated investments (like government bonds) start paying more, and foreigners start buying more Aussie dollars, pushing the price up.

The RBA’s got to keep a close eye on the interest rate differential, and pretty much all those countries in the first graph have zero or close to zero interest rates.

This keeps hefty downward pressure on rates.

Which in turn pumps more and more cash into the housing sector, further fuelling the construction boom…

… as well as retail spending and loans to the manufacturing industry.

So do what you need to do, Mr Hockey. I understand how politics works. Sometimes you need to scare the patient to get them to take their medicine.

But I’m not buying into this ‘economy in tatters’ story.

NO B.S. FRIDAY: Is your financial adviser ripping you off?

February 21, 2014 by Jon

“Here’s my card, give me a call…”

Back-Story #1:

I’m at the MCG, in the members (15 years ago), watching the cricket. For the life of me, I can’t remember who Australia was playing. It doesn’t matter. During the lunch break, I somehow end up on a table with a couple of guys from the financial advice industry.

Over a beer, the conversation rolled from trivial to specifics about their advice services. Young and naive, I asked the question…

“What’s the best product to invest in right now?”

These two blokes looked at each other and smiled.

Their response?

The one that pays the highest commission. Here’s my card. Call me if you need anything.

Seriously!!!?

Back-Story #2:

5 years ago I walked into a financial planning firm, just as a test to see what they would say to someone in my position. I was totally transparent and disclosed my current financial situation.

At the time, my assets were 80% real estate and 20% cash.

Their advice?

I was dangerously overweighted in real estate and I should have a 70% equities portfolio, 20% real estate and 10% cash.

These guys went as far as to say that real estate is a terrible investment in comparison to equities and I should thank my lucky stars that I haven’t lost any money yet.

Lucky for me, I was never there to actually take their advice. I was just curious to see what they would say.

So today, I write to you about my opinion of the financial planning industry based on my experiences.

… I know I’m going to piss a few people off, I’m prepared for that. I’ve got the full metal jacket on.

Let’s begin…

Financial advisers have always been a dodgy lot, but new legislation is going to allow that dodginess to be taken to a whole new level.

The politicians know which side their bread is buttered on.

And once they get into power, they waste no time in fixing up their mates. It wouldn’t look right if they dilly dallied with stitching them up. No time for modesty or scruples about the poor public’s interest.

When the last Labor government came to power it wasted no time in abolishing the Australian Building and Construction Commission and removing laws that controlled union behaviour. There you go boys.

Now that the Coalition is back in power it’s swung that pendulum back round and launched another Royal Commission into union corruption.

That’s just what Coalition governments do. Launch Royal Commission torpedos at the unions.

On the face of it’s about helping out Aussie businesses of course. That it directly attacks the foundations of the Labor party, ties up union resources that might otherwise be spent campaigning for Labor.., well that just can’t be helped.

And I’m sure a lot’s changed in the world since the last Royal Commission. It’s bound to be money well spent.

(But don’t think defending unions here. It’s politicians on both sides that have got my back up today.)

And what’s got on my goat in particular, is that the Coalition government, in helping out its mates, is actually looking to unwind some legislation that was actually pretty useful.

And that’s the Future of Financial Advice (FoFA) legislation.

This was all about regulating the financial services industry, and wiping out the worst (and did someone say corrupt?) practices in financial services and financial advice.

These laws required financial advisers to invite clients to opt back in to their services every two years, produce detailed annual fee statements, and generally do their best to not rip their clients off.

And the heavy hitter in the legislation was removal of the conflicts of interest through the ban on volume-based commissions for all financial advice.

Because you see, when you go to see a financial adviser, you’re usually seeing someone employed by, or licensed to, a bank or other financial institution. And back in the old days, they were often rewarded with bonuses based on the volume of product they sold.

See the conflict of interest? Sure financial advisers are incentivized by performance fees, but volume-based commissions incentivize brokers to flog as much crap as they can and who cares if you need it or not?

Imagine if a plumber charged you an extra fee for performance if, after he came to fix the toilet, the toilet actually did what it was supposed to do. That’s extra.

And then you see he’s taken money out of your wallet and bought 20m of plumbing to pipe sewage into your bedroom, and then another 20m to pump it back again. All because he gets a commission from the plumbing supply store based on how many metres of tubing he sells.

Because that’s the other thing about financial advisers. Not only were they getting volume-based commissions, financial advisers don’t have to invoice you for their services. Not like, well pretty much every other profession – doctors, lawyers, accountants.

But not financial advisers. You give them your money and they simply take a little tiny bit of it each month and tell you later that they’ve done it – in deliberately confusing and misleading fee statements that require a NASA engineer and the Loretta stone to decipher.

The FoFA legislation tried to stop all this – to put an end to conflicted remuneration. To get financial advisers to actually start working in your best interests.

Is it ridiculous to anyone else that we need legislation for this? It’s like food standards that stop people from packaging poisonous crap and selling it to us as food. Seriously, we need a law to stop people doing that? I wonder about this planet sometimes…

And so if the FOFA legislation is unwound, it will be back to the bad old days. And in the bad old days, inside the industry, the banks were actually calling the financial advisers their ‘distribution arms’.

Can you imagine the uproar if drug companies were calling doctors their ‘distribution arms’?

Hey Doc, I think I’ve got a broken arm.

I’m going to prescribe some Viagra for you.

Via… Wait, what? Will that help heal my arm?

Um… yeah. Sure. It’s ah… good for bones.

(Actually this might be a little too close to the truth I’m afraid.)

So while FoFA had been trying to clean up this industry, the Coalitions proposed amendments will remove the requirement for clients to “opt-in” every two years, amend the “best interest duty” to allow scaled advice, “streamline” the annual fee statement, whatever that means, and exempt general advice from the ban on “conflicted remuneration”.

In other words, FoFA would be gutted, and it’s a free for all for financial advisers again.

It makes me sick.

Not that I really expect more from politicians. They’ll all look after their mates, and shamelessly pretend that they are the champions of honesty and integrity, protecting the honour of Australia from the corruption of unions.

And all the while helping entrench conflicts of interest and corruption in the industry so many Aussies trust to provide for their retirement.

And that’s what really stings. That so many people will think that they’ve got their money with someone they can trust, who’s got their best interests at heart…

… and they just couldn’t give a stuff.

It’s just another reason why I manage my own money.

Always have. Always will.

Signed with Success,

Jon Giaan

P.S. Of course not ALL financial planners are rotten. But the way the commission structure and incentives are laid out, they really don’t have much of a chance, do they?

Another predictable crisis?

February 4, 2014 by Jon

The so-called crisis in emerging markets was entirely predictable. That’s why those in the know aren’t that worried…

Some people were asking me over the weekend what I made of the Emerging Markets Crisis.

Whoa. Hang on. We’re in a crisis already?? That was quick. I’d better check with the Google.

Yep. Sure enough. There it was. “Emerging Markets Crisis.” In some of the more sophisticated publications it’s been labelled the GEC (Global Emerging Currency Crisis.) Wait, should that be GECC?

Anyway. I read it on Google. It must be true. The world has been thrown into the pit of another crisis.

But I’m as suspicious of the internet as I am of the main-stream media.

“Restore value to your currency with this one weird trick.”

So let’s back it up a bit and see what’s going on.

It is true that we saw some pretty wild devaluations to a lot of currencies last week. Three particularly large emerging markets in particular were rocked hard. The ‘ART’s. Argentina, Russia and Turkey.

But Argentina bore the worst of it. It even fell a massive 8 percent in one day, and event then that was only because the central bank got involved, once it saw that the peso was down 15 percent and it wasn’t even morning tea time.

Ok, sure, the peso has never been a bastion of stability, and it’s been on the slide against the USD for two years now. But in a week when a lot of currencies were on the skids, it was fuel to the fire for the crisis narrative.

At the same time, Russia’s ruble was posting all-time lows against the Euro, and the Turkish lira was also in free fall. Turkey’s central bank jacked up rates from around 7 to 12 percent just to try and stem the bleed.

So far, not so bad. 3 countries does not a crisis make.

Thing is, they weren’t alone.

Currencies were heading south in Brazil, South Africa, Mexico, Malaysia and Indonesia. In fact, they’ve all been coping a beating over the past year.

All up, a Bloomberg tracker of 20 emerging market currencies is now at its lowest level since 2009, while emerging equity and bond funds have witnessed outflows of almost $5 billion in the year to date. That adds to over $50 billion from last year.

That’s some serious coin.

And yes. It’s starting to sound like a crisis.

But this “crisis” feels different. It’s not like the South American crisis of the 80s or the Asian crisis of the late 90s. In those crises, the impact was felt in a particular region.

This time round it’s happening to a whole range of countries across the world. And what do the Russian and Argentinian countries have in common?

In that way, the term “Emerging Market” Crisis hides more than it reveals. Emerging Market can describe almost any economy. And not all emerging markets are in crisis.

However, the “crisis” does have a single origin.

The US.

Back in the GFC, people pretty much gave up on America. The banks were run by crooks, the government couldn’t do anything about it. The population were up to their eye-balls in debt.

And the Fed, having already run interest rates into the ground, turned to Quantitative Easing (Q.E). Effectively, it just pumped trillions of ‘fictional’ money into the banking system in a hope that it would fix the problem.

The smart money was a lot of places those days, but it wasn’t in America. The economic prospects were bleak and the Fed had gone crazy. It was only a matter of time before money printing lead to inflation.

And so money fled the US. It didn’t really know where to go, and it kinda didn’t care as long as it was out of the US. The BRICS (Brazil, Russia, India, China, South Africa) ended up with a lot of it.

In part it did reflect superior performance. In 2009, when GDP fell 3.4% in the advanced economies, emerging market economies grew 3.1%.

But in part, it was also any port in a storm.

But now the story has reversed. The Fed is starting to unwind QE, already tapering it’s spend by $20bn a month. And so it turns out, the world got it wrong. The US currency didn’t implode, and there was hope the US was coming through the storm.

Whether you believe this narrative or not, the world is ‘normalising’. The money that fled the US in a massive flight to safety, it’s now looking past safety, and is hunting for returns.

The first stage in this dynamic was the massive unwind in gold positions over the past 12 months or so.

And so now the unwind is calling the chickens home to roost from the emerging markets.

As such, there’s method to the madness. Argentina has finally given up on currency control, and with massive inflation, an outflow of capital was to be expected. Russia’s economy is flagging, and Turkey is beset by political unrest.

But money is not fleeing those EMs that are doing well. Places like the Philippines, Sri Lanka or Vietnam.

If this is a crisis, it is a very selective one.

So what does it mean for us?

Well, the short answer is, not much.

Some of the money that fled the US ended up here, and the recent depreciation we’ve seen in the Aussie reflects some of that money going home, but we’re still looking strong. The factors that brought the money here – economic stability, relative high interest rates – they’re still in play.

There is a chance that the Fed might take a bit of a breather to see how EMs adjust to the new QE levels. They don’t want to knock over one of their biggest export destinations.

And that means the money taps will stay on for longer. And that will keep the money flowing into real assets like property.

It will be interesting to watch how it unfolds, but it doesn’t change the investment game-plan.

Keep calm and carry on.

Inflation Shock: You must NOT panic!

January 28, 2014 by Jon

The inflation data gave everyone a shock last week. Do they really mean a rate rise is on the cards? Not if you look at where that inflation’s actually come from.

The inflation data last week went down like a fart in an elevator. And it was a rude shock to markets, who had been feet up in the sun, drinking martinis, safe in the knowledge that Cap’n Glenn was taking us all the way to cheap-town.

Suddenly, with one wild bit of data, that story’s all come undone. Suddenly, out of nowhere, a rate hike is on the cards…

… apparently.

Just calm your farm there sonny. Let uncle Jon take a look at the problem and see what’s going on.

First up, this graph here charts the underlying inflation rate. Remember the RBA has a mandate to try and keep that measure of inflation running at between 2 and 3 percent a year.

Well, look at that. 2.6% Smack bang in the middle of the target band. Makes you wonder what’s got everyone so worked up.

If there’s a wolf got in the hen house, it’s not obvious from here.

But it was really the change in the quarter that came as a shock.

The market consensus prior to the release was for a 0.5 percent change in ‘core’ prices in the quarter. Core actually came in at 0.9 percent.

That’s a big difference.

And that’s what put all those bees in all those bonnets. If inflation keeps this pace up, we’ll be up over the target band by the end of the year.

And if that happened, then you could pretty much lock in a rate rise. Glenn’d have no choice.

But I don’t think that’s going to happen.

Because if you go looking at where this pick-up in inflation came from, most of it seems to have come from the fall in Aussie dollar over the past 6 months or so.

The big-kicker items in the quarter were overseas holidays, audio and visual goods (all imported) and imported fuel. All things we buy form overseas and all things which are now, thanks to the fall in the AUD, more expensive.

On the domestic front, the only stand out threat to inflation is coming from house prices themselves. House prices were up 1 percent in the quarter thanks largely to ongoing growth in Sydney.

Another way to get at this idea is to look at the split between tradeables (things that can be bought and sold across country borders, like computers, and non-tradeables, which can’t – like fresh fruit and veg.

That’s what this graph here shows:

Non-tradeables have gone nowhere in the past couple of years. It’s the tradeables that have driven all the action. And most recently they’ve spiked. As I said, thanks to the fall in the Aussie dollar.

And so the surprise numbers last week are not a story about an economy starting to run a little hot. They’re all about a falling currency feeding through into higher prices for the things we buy from overseas.

And remember, inflation is all about measuring the change in prices. The level doesn’t really matter. That means that something like a fall in the dollar has an immediate impact on prices, but then washes out over time.

We’d only see more currency-related inflation if the currency fell further. That could happen, but it’s not something to worry about yet.

So step back and think it about it from Glenn’s perspective.

You’ve been banging on for ages about how you like to see a lower Aussie dollar – about how you think an over-valued Aussie is hurting the economy.

Finally, the Aussie dollar steps down a rung or two. But this creates some temporary feed-through into inflation.

But, there hasn’t been enough time for the lower dollar to light a fire under the domestic economy. There have been early signs of improvement, even in manufacturing, but it’s still early days.

Not only that, some of your other measures of economic performance are actually running a little lean. The week before the inflation data the jobs numbers surprised on the soft side. The unemployment rate was mostly unchanged, but a fall in full-time employment raised a few eyebrows.

And the outlook is far from certain. You’re still banking on the global economic ship not running aground or running into mines. And you’re still waiting to see how orderly the transition away from the mining boom at home is going to be.

And so even if you wanted to raise rates, it’d be a very hard-sell. You’d cop a lot of flack for it. You know at least Jon Giaan would come after you with a very big stick.

Put it altogether, and a rate rise seems practically impossible.

And so I reckon the only thing that changes with the latest inflation data is the timing of the next rate cut. I had been looking for something mid-year. Now, it might be a little later. Say September?

But one things for sure. Glenn’s going to be in no hurry to raise rates. He would know that rate hikes have no become a double-barrelled shot-gun.

In one barrel, there’s the shot to the domestic economy. Higher rates would crimp lending and activity, put a brake on consumption, and be an all-round poop in a bag.

But in the other barrel is a stronger dollar. If Glenn raised rates, AUD denominated assets would pay a better return, and demand for them would increase. This increased demand would increase the price, and the Aussie would go up.

Now Glenn’s already told us a hundred times how bad the over-valued Aussie has been for the economy. He won’t want to take us back there.

And so Glenn will be more than happy to sit on his hands, knowing that he’s got a powerful double-barrelled shot gun under his coat that could quickly restore things to balance if the inflation data turned out to be worse than we expected.

But he has the luxury of letting it run for a while before he needs to show his hand.

And so, for my money, all this means is that a rate hike is still off-the-table, and my money is still with another rate cut before the year is out!

RBA Guv'na reads my blog..?

November 27, 2013 by Jon

Turns out Glenn Stevens is an avid reader of my blog.

Early last week, I was talking about how Glenn had taken to jawboning the Aussie dollar, trying to convince everyone that it should be a whole lot lower.

And I also explained why it wasn’t working.

That was Tuesday. On Thursday, he’d taken my advice that some light jaw-boning wasn’t going to do the trick, and Glenn started getting heavy. All of a sudden markets were jumping all over the place at the sight of ‘gun-happy’ Glenn waving his piece all over the place.

He let people know he had the cash and the will to try and drop the dollar if needed.

It was more jawboning, but it wasn’t the lite stuff we’d seen before. This was some ‘full-cream’ jaw-boning.

The dollar’s too high and I’m not going to stand for it!

Pow! Pow! And it worked! The Aussie dollar broke through support at around 92 cents, and free of the range that has held it captive for months.

Markets applauded the sheer power of his voice, the fathom of his speech, the persuasiveness of philosophising.

Such a cunning linguist.

But while I’m a fan of Glenn Stevens, I think we may at risk of casting him in a mythical light, and giving him more power than any man (even a central bank governor) could have.

So let’s recap. It all started with a speech the Guv’na gave celebrating the float of the Aussie dollar. After a fairly bland lesson in economic history, he came to the juice.

He opened by restating a theme the RBA’s been running with for a while now (and as I picked up in my blog last week) – the dollar’s higher than it probably should be, and we’d like to see it a whole lot lower.

In his words:

My judgement is that the Australian dollar is currently above levels we would expect to see in the medium term.

That’s a straight as straight talking gets. But as I said, it hasn’t been enough. And so Glenn took it to the next level.

Here’s the money shot:

So far, the Bank has not been convinced that large-scale intervention clearly passed the test of effectiveness versus cost.

But that doesn’t mean we will always eschew intervention. In fact we remain open-minded on the issue.

Our position has long been, and remains, that foreign exchange intervention can, judiciously used in the right circumstances, be effective and useful… it remains part of the toolkit.

I’ve got a gun and I’m not afraid to use it.

Note that he didn’t say he was going to use it. He was just reminding people that he had one, and if the circumstances required it, he might just do that.

I seems bland to us ordinary folk with our ordinary language. But in the world of markets and central bank governors, these were stern words in deed.

If you ask me, what Glenn and the RBA have been doing for the past month or so is trying to get people to focus on AUD fundamentals. For a long time all the significant movements in the AUD/USD exchange rate have come from the other side of the balance – from what’s going on with the US dollar.

It’s had such a huge effect, that people stopped looking what was going on in Australia, and were only worried about what was going on in the US. Glenn was just trying to bring attention back to ‘Aussie fundamentals’ – the terms of trade, the economic outlook etc. – none of which supported the level of the Aussie where it was.

Trouble was though, no one was listening. What was going on in America, the madness of QE and the coming taper – it was all too exciting, too sexy.

So Glenn had to get some attention.

Reminding people he had a gun, got people wondering if he was going to use it. Why would he wave that thing about if he wasn’t?

And if I bet with the Governor, back a falling dollar, will the market support me? What actually are the Aussie fundamentals?

And suddenly everyone’s talking about Aussie fundamentals. The newspapers are full of it.

Genius. Such a cunning linguist.

This is a longer term play. Bringing attention back to Aussie fundamentals will get momentum going south over the next couple of months. Well played Mr Stevens.

But it’s wrong to say that last week’s fall in the Aussie was all due to Stevens’ fighting words.

Because the really big news last week was reports from the US Fed that the Taper was back on… From the Fed Minutes:

…During this general discussion of policy strategy and tactics, participants reviewed issues specific to the Committee’s asset purchase program. They generally expected that the data would prove consistent with the Committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months.

This is real news. And it dwarfs any posturing on Stevens part.

Because the markets, and Glenn, know full-well there probably isn’t much that the RBA can do about the currency anyway. The RBA just doesn’t have the pockets.

Global currency markets are massive. MA-A-A-A-A-SIVE. And the AUD-USD pair is the fourth most traded currency in the world.

Central banks just don’t have the reserves to take that kind of battle on – to push markets where they don’t want to go.

And it opens up the possibility for currency speculators to start betting against you. Betting that you don’t actually have the money to keep the currency where you want it to be. Think George Soros in the Asian financial crisis.

Once the speculators side up with the market, you’re on a hiding to nothing.

Glenn’s talking tough, but he’s not stupid enough to start picking fights with the market.

The best he can do is exactly what he’s done. Get people thinking that the AUD is currently overvalued, and that is has a ‘true’ equilibrium value closer to 80 than 90 cents.

Bravo Glenn. It’s a clever play. I hope for your sake (and ours) it pays off.

P.S. Obviously I can’t be sure if Glenn actually reads my blog. My opening question is tongue-in-cheek. You get that, right? But what is certain, is that what I recommended actually happened. Like a lot of other things that I have predicted in the last 12 months. What does it all mean?

…It’s worthwhile reading my blog and being part of my community.

Interest rates up or down? Here’s what I think…

November 19, 2013 by Jon

I saw a recent survey that said 83% of economists now think that the next interest rate move is likely to be up. That’s almost a dead-ringer for it going the other way.

Here’s what I think…

But first, before we get to that… Let’s look at two big issues that are giving the RBA headaches.

Let’s start with a chart that shows just how much the game has changed in Australia over the past 20 years.

This is the share of export trade going to our three biggest trading partners – the US, Japan and China.

It’s a stark reminder of just how important China has become. The share of exports to Japan and the US have been in steady decline over the past twenty years. China on the other hand has gone bang.

China’s share has gone from less than 5 percent at the turn of the millennium, to just shy of 35 percent this year. Over one third of our exports are now going to China!

This is an incredibly rapid ascendancy into an amazingly dominant position. We have become hugely reliant on the fortunes of China, and just how much of our stuff they can buy.

To a large degree this is a resources story. If you look at the breakdown of Aussie exports, there’s been a similar surge in the resources share of exports, again kicking off around the turn of the millennium.

But while resources have dominated the China story, we’re also exporting rural (=food) and services to Chinese buyers.

And this is why everyone is watching China so closely these days. China does have a big impact on how things are flowing here.

What’s interesting about the explosion in exports to China is that it’s come at a time when the Aussie dollar has remained persistently and stubbornly high. And it’s remained a thorn in the side of policy makers – especially poor ol Glenn at the RBA.

Because the high dollar – and pretty much everyone agrees it’s too high – is real headache for those Aussie businesses that have to compete with companies overseas.

When the Aussie dollar is strong, it’s not just the price of our exports goes up and foreigners don’t want to buy as much. It’s also that the price of competing imports goes down.

So if you’re an Aussie manufacturer – making cars for example – a higher AUD makes your overseas competitors’ cars cheaper.

And so you’ve either got to cut your price as well (decreasing profitability) or find ways to cut costs, or both.

But the AUD’s been high for a long time now. The low-hanging fruit of efficiency gains have been picked. And so it’s tough times for Aussie companies.

This chart here sums it up.

It compares inflation (the annual change in prices) of tradeable and non-tradeable goods and services in Australia. Tradeable goods are those goods where an import from overseas would do just as well – like cars. Non-tradeables are those things were you can’t import them from overseas – like haircuts.

What it shows is that inflation in non-tradeables has been pretty consistent – hovering around 4 percent over the past three years.

Prices of tradeable goods and services however have been falling since the beginning of 2012. Inflation has been negative from that time on, and is only now just starting to push back towards positive territory.

It’s likely that the high AUD has a lot to do with this.

But what that means is that if you’re a company producing tradeable goods and services, then you’ve had to cope with a climate of falling prices. You’ve either had to cut your own prices as well, or risk being priced out of the market.

This, of course, would eat into your profit margins and make for very lean times.

And so the high AUD is making for tougher economic times. If it’s hurting company profits, then it’s also taking a swipe at employment, which in turn means consumer confidence and retail sales.

And so everyone would like to see the dollar move lower.

But it won’t.

It’s currently stuck in a band a few cents either side of US 95c, and has been for months. And the fortunes of the dollar are largely being dictated by what’s going on overseas, and there’s very little anyone here at home can do about it.

And for the time being, the headwinds coming off the high AUD are keeping downward pressure on rates. If the AUD is slowing us down, then interest rates need to be speeding things up.

(We could be asking fiscal policy to chip in here as well, but the Abbott government went to the election with a cost-cutting agenda, so they’re on the side-lines for now.)

Glenn Stevens would like to avoid cutting rates if he can. With official rates already down to 2.5 percent, and a lot of nations already pushed to the zero-bound, he’ll be doing everything he can to avoid a similar fate.

Once rates go to zero, your options really narrow down. And you end up with crazy experiments like Quantitative Easing.

And so it would be a dream come true if the AUD fell another 10 to 15 percent. It would make Glenn’s job a whole lot easier. And it would be a big shot in the arm for the Aussie economy.

But the AUD just won’t move.

Glenn’s even got into the ‘jawboning’ game. At the beginning of the month he threw up his hands and took the unprecedented step of trying to talk the Aussie down.

He said: “these levels of the exchange rate are not supported by Australia’s relative levels of costs and productivity. Moreover, the terms of trade are likely to fall, not rise, from here. So it seems quite likely that at some point in the future the Australian dollar will be materially lower.”

It might not sound like such tough-talking to us, but for central bankers and markets, these were fighting words.

And it worked… for a bit. Glenn’s statement knocked more than a cent of the Aussie dollar that day.

But the effect was only temporary, and was unwound when another central banker – this time in Europe – said that Europe could be on the way to quantitative easing too, and the AUD jumped again.

And the net effect is that this month, the AUD has held fairly steady.

Stevens is right. In theory the dollar should be lower. And everyone would like it to be lower. But it doesn’t matter. It’s what happening overseas – particularly in the US that’s driving the dollar’s fortunes.

And this means, that for the time being, the RBA’s easing bias remains in effect.

Investing in a Rigged Game

November 8, 2013 by Jon

I just wanted to follow up on a couple of the comments I got on my last post.

In that post, in cased you missed it (it was a cracker), I explained why I wasn’t buying gold.

I don’t think the price will go up, (more than likely will have further to fall from here) so I’m not a gold speculator. And I don’t really think gold at these prices will protect my wealth should there be some sort of economic calamity. I’m not a gold insurer.

And I’m not a gold investor, because gold doesn’t pay you any returns.

So I’m not buying gold.

Now, pretty much every time I run this line (in these blogs, at dinner parties, at committal hearings) people accuse me of having my head in the sand.

The system’s corrupt, our currencies are fantasies, a global meltdown in inevitable.

Winter is coming.

So first of all, let me make it clear that I’m not some profit/loss Pollyanna, skipping through sunlit fields of blue birds and butterflies.

I’m well aware that there are dozens of icebergs lurking in these waters. At any one time, there are dozens of roads that would take us to economic ruin town.

But will they?

Murphy’s Law doesn’t apply to economics. Just because something could go wrong, does NOT mean that it will go wrong.

I mean I could think of any number of scenarios that could lead to a house price bust from here.

Maybe for some reason the US banks decided to monetise their massive balance sheets. This leads to run away inflation in the US. The world’s reserve currency collapses, global trade shrivels up, Australia follows the rest of the world into depression.

Maybe the reform program in China comes off the rails, or the Chinese property bubble pops. Chinese demand shrinks, wiping out what’s left of the mining sector’s contribution to the Australian economy. Incomes fall, unemployment rises, and the collapse in housing demand leads to a ‘Steve Keen’ correction to prices.

Or maybe the Italians and Spaniards follow Greece into debt delinquency, the European Union collapses, Germany starts an “Occupy Rome” movement, and the following debt crisis paralyses global credit markets. Home lending at home freezes.

I’m not ignorant to the risks.

They’re all perfectly reasonable scenarios. All perfectly feasible. And if they did occur, future generations would wonder how we could have been so blind to the risks. Hindsight is 20/20.

But the question is not ‘could’ they happen? But ‘will’ they happen? Just because the trigger exists, doesn’t mean it will be pulled.

People have been talking about all sorts of economic boogeymen since before the dog was a pup – the break-away colony of America, the rise of fascism, communism, the departure from the gold standard.

Oh that last one was a classic. People were predicting that the new currency wouldn’t last five years. That gold was again the only way to store your value.

But that was over 40 years ago.

That’s not to say that there were no risks. There were risks. There still are. It just didn’t play out that way.

There are always things that could go wrong.

But I tend to think that a heightened level of risk is just the price you pay for living in a complex global economy. It’s like driving a sports car. If your top speed is 240km/hr, then there’s obviously a lot more that could go seriously wrong.

But that’s also the point.

Likewise, we live in an era of unprecedented leverage, trade and economic speed. There are more risks associated with such a system, but I for one wouldn’t be taking us back to the 1950s.

As much as I love Elvis.

The other argument I don’t get in all this is from all those people crippled by conspiracy theories.

The central banks are owned by space reptiles. The currency has no real value. The Illuminati pulls the strings of government. The whole financial system is about implode. Justin Beiber has genetically modified talent.

Again, I’m not saying I’m ignorant to the stories that are out there. And I certainly believe that if individuals found themselves with the ways and means to twist the fate of the planet to their own benefit, they would.

And there’s a lot of things about 9-11 and the GFC that make me very, very suspicious.

But what I don’t understand is why this is a reason to buy gold.

I mean, if there was going to be a market that the Illuminati would get their claws into first, surely it would be gold.

And according to the official figures (as much as you can believe them) the biggest holders of gold are the global central banks. They account for 18% of the gold ever mined. And 72% of that is held in the US (most of it belonging to foreign central banks).

(Just why does Bundesbank store their gold at Fort Knox?)

So what would the central banks do if the sh$t hit the fan? Would they resign themselves to the will of the market? I doubt it.

To me, gold seems like a very unlikely commodity to put your faith in. Particularly if you don’t actually have the gold sitting in your basement.

“Excuse me space reptile, but now that Armageddon is here I’d like to exchange this piece of paper for some shiny metal.”

But who knows what the actual truth is. I don’t. And if I did I’d probably be lock up in Guantanamo Bay.

But am I going to let this stop me from getting ahead in life?

No way!

You’ve just got to do the best you can with what you’ve got. Life’s just like that.

Maybe the game is rigged, but it’s still a game. And it’s a game that’s treated me very well up til now.

You can’t conscientiously object to the current economic system (which is not to say we couldn’t change it over time if we all worked on it). But for now, it’s all there is.

And so you’ve just got to do your best with what there is. Be the best person you can be. Invest your money as best you can. Be a loving friend and family member.

Choose to be an active investor. Not a side-line philosopher.

One last thing… Sometimes I read the comments on my blog and think, “Dude, we’re just not meant to be together.”

Oil and water don’t mix.

I don’t mind people disagreeing with me, I’m always happy to consider another view of the world. But if you vehementtly oppose my views, opinions and call me an idiot then I suggest you get off my bus and find yourself another one that’s a bit more to your philosophical views and likings.

Gold is NOT a safe investment

November 6, 2013 by Jon

This will surely create some controversy…. Add to that the conspiracy theories and certain stock market reports that use gold as the ultimate fear-axis to get attention, what you end up with is a lot of disillusioned and misled investors.

The only truth is the result.

If you only had one chart to wrap up what’s happening in global markets right now, it would be this one – The price of Gold.

Since a 2011 peak at around $1900 an ounce, the price of gold dipped… and then sank… and is now trading around $1300 an ounce, with every threat that it could be falling further.

That’s a 30% fall in less than two years.

The golden days of gold seem to have run their course. For a long while it could do no wrong, from a launching pad of around $250 an ounce before the turn of the millennium, it posted gains from pad to peak of over 600%.

And all this through the most ‘challenging’ of economic times – through the popping of the dot.com bubble, the Enron scandals, The Iraq wars, and even the GFC.

Gold was the thinking man’s safe haven of choice.

But not this year. Gold’s been on the skids since George Soros indicated in April that he thought that gold was no longer the safe haven it used to be, and the smart money was getting out. Then in October, Goldman Sachs’ head of commodities research said gold was a “slam dunk” sell and that it was headed for $1,050 an ounce.

(No, I don’t know what a ‘slam dunk’ sell is, but it sounds serious.)

But you still hear people saying that gold is a ‘safe investment’.

So let me spell it out loud and clear, in flashing neon lights…

GOLD IS NOT A SAFE INVESTMENT

First of all the idea that gold is ‘safe’ is ludicrous now. “Safe” investments are things like term deposits, that pay you a predictable amount of sod-all a year, with zero volatility.

“Safe” investments DO NOT fall by 30% in 18 months, or have volatile lurches in price every time Bernanke farts.

Secondly, as I’ve argued, gold is not really an ‘investment’. Not as I see it. Gold doesn’t pay you a return. There’s no rent or dividends.

If you’re buying gold, then you’re probably doing it for one of two reasons. The first is that you expect that the price will keep going up, and you’ll be able to sell it for more than you bought it. This isn’t gold investing, this is gold speculating.

But if you’re speculating then you’re completely at the mercy of the market. You’re “investment” is only worth as much as everyone thinks it’s worth, and if George Soros tells everyone that it’s not worth as much as they thought it was worth, then you take a hit.

The second reason people have bought gold, especially since the GFC and the launch of the Quantitative Easing era, is as a way to preserve wealth in the face of global economic calamity. If the economic system completely melts down, or even if we only have run away inflation, then gold offers you a way to preserve your wealth.

In this sense, it’s really just a shiny insurance policy.

But you know, I’ve never really understood this.

Let’s say a door-to-door sales comes to your house and offers to sell you zombie apocalypse insurance.

“If you pay us a certain fee, we promise to return your wealth to current levels, should there be a zombie apocalypse.”

There’s a few things you’ve got to ask yourself.

How did this guy get past the security gate?
How likely do I think a zombie apocalypse actually is?
If there is a zombie apocalypse, is this guy actually going to be able do what he’s promising? If the world is actually taken over by brain-eating zombies, who’s going to give me my pay-out? What will a pay-out even be worth if I don’t own a shot gun?

Now, when it comes to gold, I think most people get to 2., but never make it to 3.

What’s the risk of total economic melt down? I’d actually have to say to me, it looks like an incredibly small risk. Our standards of living are built on the foundations that the current economic system survives and prospers. Everyone wants to see the game continue – from the vested interests of Wall Street, to the mums and dads of back street Australia.

So a bet that the economic system will fail is to bet against the ingenuity and endeavour of the entire human population. I’ve seen humans do some pretty crazy and amazing stuff. For my money, if we had to find a way to avoid economic ruin, I reckon we could. We have the social, political and technological will.

But more to the point, if the economic system did collapse, what would a piece of paper that said you owned a chunk of gold in a basement in London actually be worth? Who’s going to honour it?

If there’s total economic collapse then no one’s paying the police. There’s a break down in the rule of law. Even if you had it in your hands, would some one give you their last can of beans for it, if there was no food to be found?

My point is, when people buy gold to insure themselves against economic collapse, they forget that a post-collapse world would be fundamentally and radically different, and if that is what they’re worried about, a piece of paper that says they own some fairly useless metal isn’t going to save them.

And before you say I’m missing the point that QE is debasing the USD, and inflation is inevitable… if that’s your argument, look at the inflation data. 5 years into QE inflation is falling not rising.

Who knows how it’s going to end? It’s radical stuff. But there is nothing to say that it has to end in hyper-inflation. If there was such a certainty, then it would have been priced into the market already.

Nope, the gold boom was a gold bubble. The further we get from economic calamity, the more it will unwind.

So if you want to speculate, buy something else. If you want insurance, buy a shot-gun and a bunker of canned food.

And if you want to invest, buy property.

But you knew I’d say that, didn’t you?

The big interest rate debate rages…who wins?

October 30, 2013 by Jon

Will rates go up? Will rates go down?

Come in spinner!

There’s a lot of people talking interest rates in both directions right now.

The inflation data last week sparked a few rounds of grumble and rumbling that maybe a rate hike was now on the cards. A few eyes were watching the fall of the coins very nervously.

Could that be true? Are rates on the rise?

It’s true that the inflation figures did come in stronger than expected, but not by a lot. Headline CPI rose by 1.0 per cent in the September quarter, to be 2.3 per cent higher over the year.

That’s still squarely within the RBA’s target band.

Remember, the RBA targets annual inflation of between 2 ~ 3 percent.

But it’s the quarterly strength that took a few people by surprise. Annualise that rate and you’re looking at inflation of 3.5 ~ 4 percent. A CPI print of 4% would likely be enough to provoke an immediate response from the bank.

4 percent is way outside the target band, at least by the standards of recent experience (though of course some countries would be very happy with inflation of 4%!). The RBA has one of the best track records in the world in terms of hitting its inflation targets, and inflation’s been anchored firmly to the target band for almost twenty years.

It’s a stellar achievement.

In fact, inflation’s pretty much fallen from the public mind. No one really worries about it any more. I wonder if a lot of people even remember that that inflation is the RBA’s primary focus.

It’s not the economy, as such. Ideally it wants to keep a lid on inflation AND keep the economy humming along.

But if push came to shove, and the RBA had to chose between inflation and growth, it’d shoot for inflation, every time.

In fact, that’s the agreement it has with the government. The RBA, like pretty much every central bank in the world now, is an inflation targeter.

The idea is that interest rates on their own can’t be used to fix both inflation and growth. Sometimes, it’s one or the other.

And a key force keeping inflation down is the belief itself that inflation is going to stay down. Inflation expectations have a huge impact on inflation outcomes.

So the policy response to inflation needs to be ‘credible’. But credibility only comes if the public believes that if push came to shove, growth would be sacrificed for the sake of keeping a leash on inflation.

It sounds a bit scary, but it’s a doctrine that has served us incredibly well. With inflation and inflation expectations anchored to the RBA’s target band, we’ve been able to bring rates down to 50-year lows.

That has freed up the financial sector. With capital flowing more freely to business (and of course to investors like us), the economy has expanded quickly.

Everyone’s a winner.

But these wins did not come cheaply. Central banks had to ‘break the back of inflation’ first. That meant super high levels of rates, which meant recessions and a very grizzly public.

So the RBA would be very unwilling to let their hold on inflation be taken from them. Once it’s gone, it’s expensive to get it back.

And so you’d still have to think Glenn wouldn’t be thinking twice if push did actually come to shove.

I’m sure Glenn’s been happy to be every body’s hero with the rates cuts we’ve seen under his watch. But I’ve seen that steel in his eye. He looks to me like a man who’s as happy kicking heads as he is handing out flowers.

And he knows that his reputation, and the bank’s credibility, is built upon him doing just that.

And everybody in the markets knows that too. So that’s why a stronger than expected CPI print, sent a quick shiver down people’s spines.

brrrrrr.

So is a rate hike on the cards now? Could the RBA be forced into raising rates at the same time as the AUD bumps back toward parity, and growth outcomes remain soft?

It’s not a pretty scenario.

Personally, I don’t think it’s something to worry about for the time being. And I certainly don’t think they’re hitting the panic buttons down at Martin Place just yet.

Partly the CPI data had a couple surprises, but if you look at the ‘underlying’ (more stable) inflation measures, there’s no sign of an inflation break out there.

Second of all, a higher AUD actually offsets some of the risk of inflation.

That is, if the AUD is stronger, the things we buy overseas are cheaper for us, which means the final price when those goods hit Australian shores, is cheaper. Inflation falls.

So the increases we’ve seen in the Aussie dollar in recent months, will in the next 6 months or so, put back some downward pressure on inflation.

And if inflation remains a non-issue, which I expect it will, that puts the focus back on growth outcomes. And as the RBA noted in the last minutes, economic growth is still expected to remain “below trend over the next year or so.”

And at the same time, the AUD keeps pushing higher. And with a taper to Quantitative Easing now pretty much completely off the table in the US, there’s nothing driving US dollar strength, which means we could see the AUD trade even higher against the Yankee Doodle.

If that happens, and that happens before the a solid pick up in non-mining investment, particularly housing construction, then I think the RBA will have no choice but to cut rates even further.

But it’s too early in the game, and too late in the year for the RBA to do anything about that now. They’ll want to see how it plays out in the near term, and will be closely watching what happens to retail sales through the Christmas period.

If the Grinch is haunting Christmas, then I reckon we’ll see another rate cut, possibly in March or April next year (of course, in the absence of any other major surprises).

And so as investors, we can take heart that rate hikes still remain a long way off. And that also means that the fire that’s been lit under the property market will be left to run on full bore.

And the emerging boom in property we’ve seen will just keep charging ahead in the time being.

So let the CPI data be a reminder. At some point, the RBA may need to raise rates. That’s what they do. We need to build that into our planning.

But for the time being, under the firm hand of captain Glenn, it’s steady as she goes.