The Distillery: RBA growing pains

Jotters are mixed on the RBA’s next move following its growth downgrade, while a few spy danger ahead for QE-inflated equities

The Reserve Bank of Australia’s quarterly monetary policy has the commentariat focused on rates, the dollar and economic growth. With the central bank scaling back forecasts on the latter, one scribe argues the case for a rate cut is in pieces, while another highlights what it would take for a lift to the record low cash rate in the back half of next year. But what does this uncertainty mean for the still-surging sharemarket?

Elsewhere, governance concerns at David Jones receive a thorough assessment, while Qantas begins making tough decisions on the tricky road toward financial stability.

First to the RBA. The Australian Financial Review’s David Bassanese suggests the latest update is not one of a central bank ready to lift rates anytime in the next 12 months.

“All up, however, the Reserve Bank now estimates below-trend economic growth and rising unemployment will persist at least until the end of next year – which is still consistent with a rise in the unemployment rate to decade highs of over 6 per cent. That’s hardly a scenario under which it would contemplate a lift in interest rates by late next year – as the market now anticipates.”

Still, few economic forecasts have proven reliable over the past few years and while a rate rise might not be on the agenda just yet, there’s every possibility the worm could turn quickly.

Indeed, The Australian’s David Uren spotlights the prospect of forecasts shifting dramatically in the next six to 12 months.

“The bank's bleak outlook for the next year, outlined in Friday's monetary policy statement, assumed that the Australian dollar would remain at its current high level. It noted that if there were a further depreciation similar to that which occurred earlier this year, it would be enough to return growth to its long-term trend level, and put inflation into the upper half of the RBA's target band. This would open the way for the bank to return interest rates to what it would regard as a more normal level.”

However, don’t expect anything until the early results of a Fed taper are known.

Fairfax’s Michael Pascoe notes the bad news of forecasts for flat growth out to 2015, but like Uren, finds the potential for an upward revision.

“The potential good news though is that it wouldn’t take much to improve that outlook. The bank’s modelling is based on a couple of key set assumptions, including that the unpredictable exchange rate will remain where it is for the duration – in this case, 95 US cents.”

Yes, it’s all about the dollar. But, unfortunately for the central bank, that’s something largely out of its hands. When the Fed finally heads for the QE exit, it will be dragging much of the world along with it and that includes Australia. We only have to look at how the expectations for a taper smashed the dollar to anticipate the actual impact of a taper. Could we see the Aussie dollar at 85 US cents next year?

As such, plenty of uncertainty remains and for Fairfax’s Malcolm Maiden that includes the question of what it all means for the sharemarket. Should investors hedge their bets in a similar manner to the Reserve Bank?

“Share prices are capable of rising further from here,” he advises. “Picking the absolute top is a high-risk game as tighter US monetary policy looms, however, and index peaks are now not far away at 16.2 times expected earnings for the ASX 200 … and 16.2 times for Wall Street's S&P 500 index. Those valuations were struck in 2007, and as we now know, they were unsustainable.”

The AFR’s Chanticleer columnist, Tony Boyd, continues on the same path, pinpointing the confusing messages rampant in the marketplace and offering some words of advice.

“Investors trying to navigate their way through the confusing signals should remember that asset allocation is the single most important factor in achieving long-term returns. In other words, a balanced portfolio should provide the best protection against emerging risks both known and unknown.”

Moving back to the US Federal Reserve, the AFR’s Jonathan Shapiro foresees a December taper, earlier than many in the market are now expecting. The blow could be softened, however, through a move to push back the timeline for rate rises. There have been so many changes to expectations that it’s now a case of ‘we’ll believe it when we see it’.

In company news, David Jones continues to draw attention, with the Australian Securities and Investments Commission now reportedly looking into the intriguing director share purchases discussed in this column last week. The AFR’s Sue Mitchell believes the directors, and chairman Peter Mason, have some explaining to do, while The Australian’s Blair Speedy looks at the other skeleton in the DJs closet: the possibly fractured relationship between Mason and outgoing chief executive Paul Zahra. Is the former looking to buy Zahra’s silence? And how will shareholders respond?

Perceptions are everything in the market and what has happened at David Jones over the last few weeks has left a bad taste in the mouths of many investors. At least the most recent sales result was a better one for the retailer.

Meanwhile, the country’s national air carrier, Qantas, continues to adapt to its challenges, making what Business Spectator’s Stephen Bartholomeusz argues is a difficult but necessary decision to close its Avalon heavy maintenance facility.

Qantas’ rival, Virgin Australia, has its own big decisions to make as competitive stress takes a toll. The AFR’s Michael Smith believes the ultimate result could be a privatisation at the hands of Air New Zealand and Singapore Airlines. However, the other major shareholder in the airline, Etihad Airways, may have something to say about that.

In politics, The Sydney Morning Herald’s economics editor, Ross Gittins, contends real reform is not likely anytime soon, with Canberra hamstrung by the politics of self-interest.

The Herald Sun’s Terry McCrann, on the other hand, looks at how quickly this year’s budget deficit is growing and compares the moves of Treasurer Joe Hockey to those of a new chief executive with the logical move to “load the bad news upfront”.

The budget isn’t the only pressing issue for the Abbott government, with big decisions ahead on dairy and grain takeovers, as well as rescue packages for the car sector. According to McCrann – this time writing in The Australian – the way the Coalition responds will go a long way to defining the Abbott government.

Finally, the AFR’s China correspondent, Angus Grigg, notes the conflict at the heart of Beijing’s move toward “unprecedented reforms”. Can the economy truly be opened, while retaining the power of the Communist Party?

One suspects it is unlikely.