Goldman Keeps Rate-Cut Call Seeing RBA Pivot: Australia Credit

Jul 14, 2014 6:46 pm ET

July 15 (Bloomberg) -- Goldman Sachs Group Inc. is holding out as the only bank predicting an interest-rate cut in Australia. It’s now winning converts to that position as the nation's bonds deliver world-beating returns.

The Reserve Bank of Australia will cut its benchmark in September as the non-mining economy shows weakness and Governor Glenn Stevens signals a shift to a more dovish stance, Tim Toohey, Goldman Sachs’s Melbourne-based chief Australia economist, said in a July 11 phone interview. Thirty-day interbank futures show a 54 percent chance the central bank will lower its record-low 2.5 percent cash rate by year-end, up from 30 percent odds on June 30.

Australia’s bonds surged in the past month and two-year yields fell below the central bank’s cash rate as Stevens said the economy has a way to go to be weaned off a dependence on mining investment and warned investors are underestimating the chance of a “significant fall” in the currency. Goldman Sachs is the only bank predicting a rate cut this year after Macquarie Group Ltd. and JPMorgan Chase & Co. changed their forecasts in June. Research firm 4Cast Ltd. also predicts a reduction.

“I don’t think it’s a case of the RBA just saying they’d like the currency lower and it’d be nice if market expectations got there,” Toohey said. “They’ve taken a position and they’re making an incremental step toward a more dovish stance.”

Strong Signal

Goldman Sachs is forecasting Australian policy makers will lower borrowing costs by a quarter-percentage point at their Sept. 2 meeting, the only company to predict that among 32 firms responding to a Bloomberg survey published yesterday. 4Cast predicts a decrease of 25 basis points in the fourth quarter. The RBA will probably raise its key rate to 2.75 percent by the second quarter of 2015, the survey’s median estimate showed.

“If the RBA shifts its bias and enacts a rate cut while most people’s forecasts indicate it’s clearly not anticipated, that would be a quite strong signal for financial conditions to ease via the currency,” Toohey said.

The Australian dollar has strengthened even as the central bank kept the cash rate at a historic low since August. The currency rose 5.4 percent this year to 93.99 U.S. cents as of 5 p.m. yesterday in Sydney, the biggest gain after New Zealand’s kiwi among Group of 10 currencies.

Overvalued Aussie

While there are indications of a transition away from mining-led growth, “these signs remain early ones” and “there is quite some way to go yet before the episode is completed,” Stevens said in a July 3 speech in Hobart. Mining investment as a share of gross domestic product has probably declined about a percentage point and is expected to fall a further three or four percentage points in coming years, he said. Stevens also said the Aussie “is overvalued, and not by just a few cents.”

The nation’s two-year note yield dropped 20 basis points, or 0.2 percentage point, in the past month to 2.49 percent yesterday. That’s the biggest decline among 21 developed markets tracked by Bloomberg.

Australian bonds maturing in 10 years or longer returned 4.2 percent during that period, the best performers among 144 indexes tracked by Bloomberg and the European Federation of Financial Analysts Societies.

‘More Significant’

Macquarie predicts the RBA will keep its key rate on hold through 2015, compared with a previous forecast for a reduction in September in a Bloomberg survey published June 16.

“An additional rate cut is possibly not really going to have that much more of an impact on the economy,” James McIntyre, the bank’s Sydney-based head of economic research for Australia, said by phone yesterday. “It would have to be something a lot more significant to get the RBA to cut.”

The statistics bureau said last week full-time employment in Australia declined in June, while the jobless rate climbed to match the highest in more than a decade. A July 2 report showed the nation had a trade deficit in May that was almost 10 times the amount forecast by economists.

4Cast’s Singapore-based economist Waqas Adenwala said the company is sticking with its call for a rate cut in the fourth quarter amid weaker economic data and after Stevens indicated on July 3 the RBA has room to revise its policy rate.

Traders are estimating the central bank will cut its benchmark rate by 13 basis points during the next year, after forecasting 22 basis points of increases as recently as April 10, a Credit Suisse Group AG index based on swaps shows. Policy makers next meet on Aug. 5.

“The underlying story of economic growth has deteriorated,” Goldman Sachs’s Toohey said. “Mining investment’s been declining and it’s got a lot further to go. Given the broader backdrop where a lot of the other components of the economy appear to be petering out somewhat, then that’s clearly a cause for concern.”