RBA infallibility.

As someone who was brought up in the Catholic Church and attended a Christian Brother’s School the concept of “Papal infallibility” is a familiar one. But as a student of markets and of economic history the creeping notion of Central Banker infallibility leaves me cold and I think does the Central Bankers a dis-service. So today I want to look at an article by David Uren over the weekend and just question where the RBA is at and whether what we’ve seen over the past month or so from them was really mis-communication or mis-reception on behalf of the market and the pundits.

Let me say up front, lest I get misunderstood that I believe that the RBA are the best central bank in the world. They have a small open economy with a currency that trades well above itself in terms of the volume of global trade it represents and the RBA must try to balance out all of the competing forces to keep HMAS Australia on an even keel. So everyone must recognise the size of the task and the achievement of 22 years without a recession.

But they are not infallible and it is ok to question them, disagree with them and challenge them as we often do.

Which brings me back to David Uren’s article in the Australian on Monday. In the article Uren says,

THE Reserve Bank has a communications problem with the financial markets, where its commentary is being disregarded.

The market chatter is that the bank’s signalling is inconsistent: it hints it’s going to lift rates, but then doesn’t or, worse, moves when least expected.

The bank has no obligation to signal its next move to the markets — it works to a monthly cycle that culminates with a decision on the day of the board meeting. In principle, it does not know which of the three options — hike, cut or hold — it will adopt until then.

Let’s deal with the first point first. Uren says that the RBA’s commentary is being disregarded but says later in this piece that after the SoMP in May that,

Markets responded briefly to the warning. Before the statement, they were trading bank bills on the basis that there would be 28 basis points of rate rise over the next 12 months, and this jumped immediately to 43 basis points.

But by last week’s board meeting, this had drifted back to 19 points and was down to 10 points by the end of last week. Markets do not have a full 25 basis point rate rise priced in until the end of next year.

To me he has just debunked his own point that markets aren’t listening. They did listen and repriced according to what they heard in the SoMP BUT MARKETS AND ECONOMIES ARE NOT STATIC.

So by the end of last week we had seen a run of pretty poor domestic data, very poor US data, a slowing China and a moribund Europe in a slow motion train wreck toward a peripheral default. Oh, and an RBA that produced a much more dovish Statement to accompany their June meeting as I discussed here last Tuesday. So to me market pricing is entirely appropriate.

The idea that the “bank’s signalling has been inconsistent” has some merit after last month’s minutes to the May Board meeting and then SoMP but I also think this underplays the value of jawboning of which the RBA itself is on the record as valuing.

Equally I believe that there is too much short termism in market thoughts and processes these days. As I discussed in this post at MacroBusiness back in April the RBA certainly has, I believe, a structural bias to tighten but they also assess the risks around their central tendency when setting monetary policy. In writing this piece I went back to every RBA speech since 2005 which was relevant to both the conduct of monetary policy and the China boom to draw an understanding and my conclusion.

Not to say I am always right but I think this deeper analysis is what is lacking in the markets and particularly from pundits at present. Indeed I believe some of the disquiet comes from pundits and commentators who try to play the man, RBA, instead of the constantly moving ball, economy, and so are embarrassed that they stay anxious and static while the RBA stays stoic and flexible.

The markets granted themselves much more flexibility than the pundits and just because a market pundit or commentator calls a rate move by the RBA  doesn’t actually mean traders are listening. Years of watching economists and strategists play the man not the ball has left markets to often discount the cries of the punditocracy.

Which brings me to the final point I would like to make. That is, I think Uren, and many commentators out there who think the RBA is only focussed on China and the Boom,  is missing the point when he says,

However, at the heart of the gulf between markets and the Reserve Bank is a difference of opinion about the outlook.

Whether US-centric or not, markets think that, just as in 2008, the problems confronting major world economies will overwhelm the Asian growth on which the Reserve Bank’s medium-term outlook is based.

I don’t think this is the key driver at all, its not just about offshore – not even close. Certainly pricing does reflect the recent pullback in investor sentiment but the market, like the RBA, understands that Australia’s domestic goddesses are struggling and the economy is no-where near as strong as the long term macro fundamentals indicate at the moment. I’ve been raging about it for ages and I think the RBA is also watching closely.

The RBA retains its central tendency that the China boom is a once in a century boom that will place pressures on our economy but they see the risks around the current outlook give them time for pause. they know they can hit us with one or two hikes if they see the need in the month’s ahead and still retain their outlook. There is no rush in the current Australian economic landscape. Except of course if you’re a pundit wanting to be right – thankfully the RBA has a different time horizon.

The RBA knows they are not infallible. It’s time for the market and pundits to recognise it as well and grant themselves the flexibility the RBA does. We’d all be better of.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial adviser we are happy to help and if you are an adviser and would like to join our network we are also happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

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