Rate cuts in 2024 - we don’t think so
What’s on our mind: The consensus view is that rates will be cut in the second half of the year. Today, we show why this is unlikely to happen…
What happened this week: Australian unemployment rises to 3.8%
What are we watching next week: Australian March quarter inflation numbers are due on Wednesday.
Prelude:
What’s on our mind:
The property market right now is “challenged”, “patchy”, “confusing” all at once.
The number of properties passing in is growing by the weekend, and the time it takes to sell a property has blown out compared to 2020-2023.
When we speak to anyone in the industry, the most common response is that “rates are going to get cut soon” and that the rate cuts will “take the market higher”.
The developers are clinging to the idea of rate cuts in the second half of 2024, which they expect will make “everything go back to normal”.
But we think there are two unpopular realities here:
Rate cuts are unlikely to come any time soon - if anything, the pressure is on rates to go higher
Historically, rate cuts tend to signal bad times coming….
Today, we break down both of these theories.
Why we think rates can’t be cut -
Two factors weighing the RBA’s decision-making process are signalling higher rates, not lower.
The first is the Australian dollar exchange rate relative to the rest of the world.
One of the RBA’s core duties is to ensure “the stability of the currency in Australia”:
(Source)
Why? Because a lower exchange rate means higher domestic inflation.
When the AUD is weak relative to the rest of the world, we need to pay more for our imports.
Anyone driving a car would have noticed stubbornly high fuel prices despite the oil price being much lower than in 2021-2022.
Put simply, a lower AUD exchange rate means higher domestic inflation…
Higher inflation pressures the RBA to increase rates, not decrease them.
🎓 Lean more about how exchange rates impact inflation here
So, the RBA has every incentive to try to keep the exchange rate as stable as possible and, ideally, prevent it from becoming too weak.
One of the most significant ways the RBA can try to influence the direction of the AUD exchange rate is by increasing and decreasing the cash rate.
The thinking is that as the cash rate increases, it becomes more tempting for overseas capital to flow into the Aussie dollar, chasing yield.
The basic premise is that higher cash rates mean more demand for the Aussie dollar, which in turn means a higher exchange rate.
And vice versa…
🎓 Learn more about how interest rates impact currency here
So, when the AUD/USD exchange rate is falling, the pressure is on the RBA to increase rates to maintain a stable currency.
If it cuts rates, it risks accelerating the decline in the exchange rate, which could lead to higher domestic inflation rates.
The big issue for the RBA is that the AUD/USD exchange rate has been falling…
We think the weakening AUD is due to lower cash rates relative to the rest of the world and falling prices for our main exports.
For context, Australia's cash rate is 4.35%, compared to 5.5% in the US and 5% in Canada.
AND Iron Ore (~15% of our exports) prices are down ~50% over the last six months, and coal (~15% of our exports) prices are down ~30% from the previous year.
A combination of the above factors makes rate cuts by the RBA extremely unlikely anytime soon.
We think the RBA is more inclined to protect the Australian dollar exchange rate and keep rates higher for longer.
The only thing that could change all of this is something like a world war…
(Which brings us to the next point)
Historically, rate cuts happen AFTER problems become apparent in the economy…
We touched on this concept in a previous article here: Rate hikes paused
In the lead-up to the Global Financial Crisis in 2008, the rate cuts only came AFTER financial conditions had started to deteriorate.
Problems in the US property market had started to become obvious, and by the time the US Fed started cutting rates, the bubble had burst, snowballing into a worldwide financial crisis.
As they continued cutting rates to 0, the problem got WORSE… not better…
Contrary to what most market commentators say, IF/When rates get, people should prepare for more challenging times…
Here is a month-by-month summary of the events that led to the first-rate cuts by the US Fed back in 2007…
(Source)
The snowball effect of a weakening economy -
Our view is that rate cuts signal financial conditions are weakening.
AND weaker financial conditions mean banks are willing to take less risk (lend less money), and people have a lower capacity to take on new debts…
As a result, credit growth falls off a cliff and it snowballs into a recession:
The cycle repeats until the central bank cuts rates back to a level at which demand for credit starts to normalise and new credit starts to increase.
That process can take years/decades to sort itself out.
Thanks for reading,
Aus_Prop team.
You can contact us here:
On Twitter @Aus__Property
Via email at Auspropertymarket@gmail.com
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