MARKETS SPECTATOR: Taking a punt on a rate cut

For the last 6 years, the best bet on Melbourne Cup Day has been for the RBA to move rates, in either direction. If they don't cut tomorrow, it will be the first time in 6 years that rates haven't moved on Cup Day.

Tomorrow's decision could be one of the tightest calls for some time as the RBA board weighs up recent domestic data against the backdrop of the global macroeconomic environment.


Source - Iress

In the chart above, the red rectangle represents October 3, the day after the RBA surprised markets by cutting rates by 25 basis points. And as you can see, Overnight Index Swap Futures were pricing in an interest rate of 2.80 per cent with a 72 per cent chance of a November cut.

Fast forward 4 weeks and a steady pick-up in both domestic and global economic data has seen the market reassess the chances of a November cut. Now the market is pricing in a 52 per cent chance of a cut with Overnight Index Swap Futures now trading at 2.93 per cent.

The AUD/USD chart above also confirms this view. It traded to a low of 1.0149 shortly after the October decision before firming over the last few weeks to twice trade above the 1.04 mark. It's currently sitting around the 1.0350 level.

Turning our attention to the equity markets and it looks like the recent weakness, especially the last few days has been hardest felt in interest rate sensitive sectors. This points further towards a market that is readjusting its expectations for tomorrow's meeting.


Source - Iress

Since last Wednesday, the above table shows that the interest rate sensitive consumer discretionary and financials sectors have been two of the three worst performers. The consumer discretionary sector is down 2.17 per cent, more than double the 1.1 per cent decline for the S&P/ASX 200 benchmark.

More specifically, some of the well-known retailers have been hit very hard with JB Hi-Fi (-2.54 per cent), Myer Holdings (-2.30 per cent), Harvey Norman (-2.76 per cent) and David Jones (-6.74 per cent) the worst performers.

So basically the high odds of a November interest rate cut have dwindled over the month of October and into November, although that doesn't seem to have dampened dovish economists with 20 of 26 economists surveyed backing a Cup day cut.

The RBA faces a very tough decision tomorrow as it tries to balance the pick-up in economic data against the uncertainty of the next few weeks.