JP Morgan just delivered an excellent critique on why the RBA hasn’t suddenly turned hawkish

KARIM SAHIB / AFP / Getty Images

Suddenly, the outlook for Australian interest rates has changed, prompted by the release of the Reserve Bank of Australia’s (RBA) July monetary policy meeting minutes yesterday.

The chart below from JP Morgan underlines the dramatic shift seen in rate hike expectations following the release.

Source: JP Morgan

Using Australian overnight index swaps (OIS), it shows that markets are now close to fully priced for a rate hike by the middle of next year.

Quite a shift, helping to explain the surge in the Australian dollar and bond yields over the past 24 hours.

The upbeat tone of the minutes, in stark contrast to the July monetary policy statement released two weeks earlier, along with a discussion among board members as to the neutral policy level for interest rates in Australia, saw some jump to the conclusion that the RBA was priming markets for an increase in interest rates.

Looking at the scale of the market reaction, it’s clear many adopted just such a view.

While some think it’s a game-changer, Sally Auld, chief economist and head of Australia and New Zealand fixed income and FX strategy at JP Morgan, does not share that view, suggesting that markets have jumped the gun in pricing in a hawkish shift from the RBA.

Here’s a snippet from a report she released today outlining four reasons why, in her opinion, markets got a little ahead of themselves:

First, it should be remembered that the RBA delivered a strong refute to expectations that it was shifting in a more hawkish direction just two weeks ago. It is not clear that enough has changed for the RBA to warrant a shift in emphasis so soon.

Second, even assuming that the RBA wanted to signal something different from the July Statement, was a paragraph on the neutral rate estimate in the minutes the way to execute this change in message? We doubt it.

Third, we should note that the agenda for RBA Board meetings often includes items for discussion that are not directly related to the assessment of economic conditions in the past month. This is particularly the case for the RBA Board, which unlike other central banks, is not comprised of professional economists. Rather, the majority of RBA Board members are usually drawn from business, and hence there is sometimes a need to “educate” Board members on theoretical topics that are related to economics and monetary policy. In this context, the discussion around the neutral rate doesn’t look so unusual.

Fourth, the conclusion that policy is already accommodative is not “new news”. The RBA has made such an assertion every month in the minutes since May this year.

A pretty solid critique of the market’s interpretation if there ever was one.

While the tone of the minutes was certainly more upbeat on the outlook for the economy and labour market conditions than the abbreviated policy statement, outside of the those areas and the discussion on neutral policy settings, there really wasn’t all that much new to garner from the minutes, including that current settings are “clearly expansionary”.

Rates are, after all, at the lowest level on record, even with the neutral policy setting now far lower than what was the case in the past.

Looking ahead, Auld says we’ll find out soon enough as to whether or not the RBA intended to deliver a hawkish message.

“A test of our view will come with speeches from the deputy governor and governor in coming days,” she says.

“While it is typically not the RBA’s ‘style’ to micro-manage unwanted market reactions — the AUD is not yet meaningfully overvalued and the RBA might welcome renewed talk of hikes as another way to jawbone an overextended housing market — we don’t expect either speech to validate current market pricing and anticipate that RBA officials will push back hard on the perception that the central bank is on the cusp of starting policy normalisation.”

Guy Debelle, deputy RBA governor, will speak this Friday on “Global Influences on Domestic Monetary Policy” from 12.40pm AEST. That will be followed up by a speech from governor Philip Lowe on “The Labour Market and Monetary Policy” next Wednesday at 1.05pm AEST.

Just 95 minutes before Lowe’s speech, Australia’s Q2 CPI report will also be released.

Make sure you get those events in the calendar pronto.