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Economic and Financial Market Update: Frodo & REM

05 August 2020

Summary:

Financial markets are saying the next rate move is up, but not for some time;
Monetary policy can do more, but not much more;
It is up to fiscal policy to do the economic heavy lifting;
My ‘simple’ AUD model has fair value at 73c;

Right now the expectations are that the next move in the cash rate in Australia (and most other developed countries) will be up. The move up is not expected for some time. But it is a forecast that the economy will improve enough for the next rate move to be a hike. The clear risk for at least the next 12-18 months is that the Australian economy will need more assistance.

The RBA believes that it is far from clear that the benefits of negative rates outweigh the costs. I agree. Interest rates could decline a little further, but not by much. There are scenarios when negative interest rates can occur although at this point these look unlikely. Overall, monetary policy has only a little more it can give. Fiscal policy is the main game.

The AUD has had a good past few weeks reflecting the bounce-back in the global economy, lower volatility, relatively high interest rates and a current account surplus. The AUD is getting closer to my ‘fair value’ estimate of 73c (and close to its long-term average). My preferred scenario is that the economy over the next year travels in a two-steps forward one step back way until a vaccine/treatment is found. In that event the AUD should head higher. But a return to pessimism about the global economy could see a renewed move back under 70c.