RBA Preview: Value Fading Hawkish Summer RBA Meetings into Yearend

Summary

• The Reserve Bank of Australia will have no choice but to continue to apply hawkish pressure. The risk remains skewed to a June or July hike.
• Latest inflation updates show inflation is unlikely to return to target while keeping the policy rate at 3.85%.
• The labour market is stronger than changes to headline figures suggest.
• Upcoming minimum wage agreement could spark worry around unit labour costs.

Market Implications

• There is value in fading hawkish June or July RBA meetings into yearend. We look for entry to receive AUD 2Y OIS.

Why Risks Remain for Another RBA Hike

The RBA caught the market by total surprise at the May meeting. Nearly all were prepared for a pause that never came. Instead, the RBA hiked the policy rate by 25bp to 3.85% and released a set of new forecasts that hinted they weren’t done yet. And while some domestic data has proven weak since, the latest inflation data and the incoming minimum wage agreement will keep the RBA in a hawkish mood. Here’s why:

Inflation is Missing Its Narrow Path Back to Target

The RBA’s latest forecast showed a narrow path for inflation to follow to return to target while keeping the policy rate at 3.85% (Chart 1). CPI increased +6.8% YoY through April, meaning CPI must print at 5.25% through May and June to align with the RBA’s forecast. Unlikely by historical standards. The fact that services inflation proved relatively tame could only shift focus to July, not off inflation completely. On that front, we will have a fuller services CPI data set at the next monthly CPI release.

This Isn’t the End of a Tight Labour Market

While the unemployment rate edged higher to 3.66% from 3.54%, this is largely in line with forecasts. The RBA has forecasted unemployment to remain at 3.6% through H1, keeping it steady for May and June would have the unemployment rate average at 3.62% for the period. An accelerating unemployment rate has typically come once our Unemployment Index has passed through 0 (Chart 2).

And while the number of employed fell 4.3k through April, overall, employment growth was strong through Q1. Moreover, there have been other months of weaker gains/losses followed by stronger months, which would follow seasonality (Chart 3).

RBA to Feel Impact of Worrisome Wages

On the headline, the Q1 Wage Price Index (WPI) release appeared a dovish positive for the RBA. However, we believe there are reasons to not be too optimistic (just yet). First, by the end of the week, the incoming minimum wage agreement (2 June) could settle above 5% and bring forth risk in future WPI prints. This would bring public wage rises in line with private wage rises (vs historical averages; Chart 4). To make the case worse, more than half of those getting pay rises are being rewarded with an increase inconsistent with the inflation target (Chart 5).

Summary and Market Implications

Hawkish pressures are firmly set on a data-dependent RBA. As a result, they very may well take the market by surprise once more and hike at their June meeting. Even if they deflect hikes further down the line, we believe they would be more likely to hike in July over August once they review May CPI and Q1 unit labour cost data. This should support front-end Australian yields higher. We see value in fading such a move through AUD 2Y OIS on the basis that the RBA will have no choice but to cut sooner than priced.

Ben Ford is a Researcher at Macro Hive. Benjamin studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively. 

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)