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Economic and Financial Market Update: When Low Is Not Low Enough

02 October 2020

Summary:

A further big fiscal stimulus is needed;
But a further (modest) reduction in interest rates wouldn’t hurt;
The USD and Yuan were the strong currencies in September;
My fair value model for the $A is still around 75c.

The Budget announcement on 6th October is very important. If the rumours are right the budget deficit for this year could be the largest ever in peacetime. The budget strategy will be to boost economic growth for the next 1-3 years and then (hopefully) step back to allow the private sector to take over the growth baton.

Given the already extremely low level of interest rates fiscal policy must lead the way. But monetary policy will likely also have to do more. The RBA has made it clear there is some room (0.15%) to further reduce the ‘target’ cash rate. Some analysts thought that a rate cut could be as soon as October. More recently investors’ have (rightly) backed away from that view.

When the rate cut happens the RBA is also likely to reduce its yield curve target for 3-year interest rates on Government debt (from 0.25% to 0.1%) as well as further reducing bank funding costs. This will ensure lower interest rates are passed to the wider economy.

The dominant foreign exchange theme over the past month has been the strength of the $US. The US economic data has been generally stronger than expected. As a result US GDP forecasts have been revised up. At the same time a renewed virus wave has hit Europe. Concerns about the sustainability of global growth has hit commodity and emerging market currencies. The exception to the strong USD theme has been the rise of the Yuan and the Japanese yen.

I still think the $A has not hit its peak in this cycle. The $A continues to get strong support from a current account surplus and high iron ore prices. My ‘simple’ fair value model currently has the $A at 75c. Providing the global economy has a decent final quarter I think the $A can hit the models’ value by year-end.