Why the RBA cash rate may not remain as steady as markets think, in one chart

Charlie Crowhurst/Getty Images
  • Australian overnight index swaps (OIS) aren’t fully priced for a 25 basis point rate hike from the RBA until early 2020.
  • Traders have not always correctly predicted when and what direction the cash rate will move next.
  • In particular, they’ve often been too optimistic about rate hikes in the post GFC era.

Like an increasing number of economists, traders, at least based on current market levels, aren’t convinced the Reserve Bank of Australia (RBA) will lift official interest rates until 2020 at the earliest.

While overnight index swaps (OIS) suggests there’s a risk of a 25 basis point move arriving next year, a full hike isn’t priced until early 2020.

However, as seen in the excellent chart posted on Twitter by Alex Joiner, Chief Economist at IFM Investors, traders, like most economists, have been saying a rate hike is looming on the horizon for quite some time now.

IFM Investors, Twitter

The chart shows the change in the RBA cash rate overlaid against market expectations for the cash rate looking 18 months ahead.

Two things stand out from the chart.

The first is that markets have often been wrong in the past, regularly predicting the cash rate will lift, or fall, only for the opposite outcome to occur. In recent years, the trend has been for markets to be too optimistic about when rates will begin to rise.

So just because financial markets, collectively, believe there’s a chance that rate may rise in the second half of 2019 doesn’t mean it should be taken as gospel. They could lift earlier, or later, than current expectations.

Secondly, should rates remain on hold for another 18 months, or more, it increases the risk that the next move in the cash rate may not be necessarily be higher.

A lot can happen in 18 months, especially during a time when geopolitical tensions are rising and policy settings are being tightened, or in the process of being tightened, by other major central banks around the world.

Should this lead to a slowdown in the global economy, it could see the RBA miss the window of opportunity to begin lifting rates, creating a scenario where rates are left unchanged even longer, or even cut again.

There’s a lot of hypothetical scenarios, and ones that may not necessarily come true, but as an economy that’s sensitive to the growth pulse in the global economy, especially China, it remains a risk.

As has been seen time and time again in the post-GFC era, financial markets have often anticipated rate rises only for the opposite move to be delivered.

You can follow Alex on Twitter here. He’s well worth the follow.

NOW READ: The RBA’s rationale for why it’s not rushing to lift rates

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