The Fed presses pause

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Hello and welcome to Talking Finance, I’m Alan Kohler.  It’s all happening this week.  Last night the Fed went on pause and the markets went for a run.  Yesterday was the CPI from the Australian Bureau of Statistics and again, it’s below 2%.  And we’ve got all these conservative candidates, Independents, running against Liberals in safe seats, so the politics is starting to really heat up and of course we’ve got the Royal Commission final report going into the government tomorrow and being publicly released on Monday, so we’re going to preview that as well. 

On politics, Bernard Keane, Political Editor at Crikey.  On the markets we’ve got Kyle Rodda from IG.  We’ve got Jo Masters who used to be at ANZ, but is now Chief Economist at Ernst & Young Oceania.  And just to talk about the impact of the Royal Commission on governance, not just for banking but on Australian companies generally, we’ve got Professor Ellie Chapple from the QUT Business School, who shares her thoughts on what we might expect from the Banking Royal Commission.

Listen to the podcast or read the full transcript below:

And now to discuss politics, here’s Bernard Keane, Political Editor at Crikey.   Bernard, there’s a very interesting phenomenon of course going on now, which is conservative independents standing against relatively safe Liberal people, the Liberal MPs such as Frydenberg, Greg Hunt, now Julia Banks standing in Flinders, Oliver Yates in Kooyong, Zali Steggall in Warringah… It’s amazing.  I wonder – it seems to me therefore that getting rid of the NEG last year, the National Energy Guarantee, was a bit of a mistake.

It’s playing out very poorly for the government across a number of fronts.  It’s left them entirely bereft of an energy policy.  I thought it was very interesting that Scott Morrison gave a major economic speech this week and literally did not mention energy except in the most passing of ways.  This was supposed to be a huge issue for the government that they were going to use against Labor, but it’s almost as if it’s, don’t mention the war.  It’s left them bereft on the policy front but it has also shone a bright light on the complete gap that exists on climate policy and that’s an area where we saw Karen Phelps move into in Wentworth very successfully and you’re right that since then there’s been a slew of independents or ex-Liberals moving into that space as well. 

Basically, we’re picking up the dropped mantel, or dropped standard of moderate Liberals who want to do something about climate change.  I don’t think we’ve seen the last of these Independents or adventurous Independents taking on Liberals in safe seats.  It’s a combination of a couple of factors, a long running factor which we’ve seen in Indi for the last couple of years, which is if you’re a rural Independent and you want to run successfully against a major party, aim for a safe seat, don’t go for a marginal seat, aim for a safe seat because they’re very likely to have been neglected by their member and there’s Cathy McGowan was very successful in playing that particular card. 

We’ve also seen that at the state level in New South Wales, where the Coalition lost an extraordinary safe seat in Dubbo.  But that’s now coupled with this new problem that the Federal Liberals have got which is this perception that when it comes to climate change and the related issue of energy, there’s simply a void.  They’re not prepared to do anything and that’s a void that these Independents are very happy to try and fill.

Do you think that they’ve got a particular problem in safe Liberal seats with women because of the way that their gender problem adds to the climate change problem?

I think it’s one of these things that exacerbates a perception problem.  I don’t think it’s the sort of thing that changes votes.  We’ve got to be careful about the way that we talk about a lot of these issues.  A bit like it reminds me, of say, marriage equality.  Marriage equality was an issue that occupied a huge amount of political real estate in 2017.  It’s not ultimately an issue that shifts votes except for obviously a small number of very committed people, but these issues can take on a perceived importance that they don’t have in terms of shifting votes.  They may be very, very important issues socially and politically and morally even, but they’re not necessarily vote changers. 

I think the problem that the Liberal Party has around female candidates, female MPs, the complete dearth of, the decline of female representation in Federal Liberal ranks is one of these problems where it’s a significant issue, it’s an emblematic issue, doesn’t necessarily change votes, but if you’ve got a problem that people see you as stuck in whatever decade, the 70s, the 80s, whatever, and you’ve got these antediluvian views about social issues and you don’t want to do anything about climate change at all, makes for a package that’s very electorally unappealing.  It just makes life tougher for you rather than being the sort of thing that people say, “Well, the Liberals have put up yet another white male candidate, I’m not going to vote for them.”  It’s simply a perceptual thing that reinforces the difficulties that they’ve got.  

Do you think that Josh Frydenberg and Greg Hunt and Tony Abbott are in trouble in their seats?  I mean, I live in Hawthorn and John Pesutto, the state member, lost his seat to John Kennedy, which was amazing!

Yeah, before the Victorian Election I would have laughed at the idea that those seats were in danger.  I thought they might have suffered a substantial swing, but not enough to put them in danger.  Now, it looks like all bets are off.  There’s a lot of talk-back – Kelly O’Dwyer, and her seat.  The idea that Higgins might be in danger was the sort of thing that you would have dismissed out of hand before the Victorian Election.  But that was the, to use the dreaded word, Alan, a game-changer in terms of perceptions, about just how badly the Liberals are going to perform.  I think Josh Frydenberg will be okay.  I think Greg Hunt does have a problem.  He’s perceived as being linked to the Peter Dutton camp, he’s perceived as being hollow in terms of his principles, he might struggle.

Tony Abbott, I think will be fine.  His social views are obviously at odds with the kind of people who live in his North Shore seat in Sydney, but I think he’ll hang on.  He’ll need a really high-profile Independent candidate to really shake him up.  I’m not sure the ones – a number of people with some sort of profile have put their hands up to run against him so far, but I can’t see him being knocked off.

Just on the other side, the momentum against the Labor Party seems to be building over the franking credits thing, particularly in our business, we’re seeing a lot of opposition to it.  Do you think that that’s going to hurt them significantly or not?

I said, when they first announced this policy that there was likely to be a very strong backlash against it, but it’s going to come primarily from people who never voted Labor in their lives and probably wouldn’t vote Labor if you put a gun to their heads and I continue to be of that view.  But I think the problem for Labor is that it just sucks up political oxygen.  Do they want to be talking about franking credits all the way to the election?  Well, they may not have a choice, and that may be times that they would prefer to be talking about something else.

On the other hand, this is the sort of issue where maybe the old political rules don’t play out so much.  I think the last couple of years we’ve entered a period where more populist ideas that might have traditionally been dismissed out of hand, resonate more with the community.  And maybe the idea of what’s perceived perhaps rightly, perhaps wrongly, as punitive taxation measures might actually resonate with the election rather than be perceived for what they are.  One of the big sort of broad brush themes of this coming election, which is basically in a sense a referendum on neoliberalism and policies that are linked, sometimes rightly, sometimes wrongly, with neoliberalism.  That’s where that issue’s playing out in terms of the franking credits. 

Yeah, but if week after week, day after day, penurious retirees show up on TV saying that they’re going to be losing money because of this problem and they’re going to be eating more baked beans, then that’s, as you say, going to continue to suck oxygen out of the Labor Party. 

Yeah, it means you’re not talking about exactly what you want and it means your enemies are dictating what the agenda is every night.  That’s where the problem’s going to be.  Labor will want to shift that debate on and they’re a bit stuck.  They can’t really walk away from that policy.  There was discussion of some groups calling for grandfathering of existing arrangements.  I’m not quite sure how you do that in relation to franking credits, but any change in that regard is going to cost Labor a lot of money.  These various new taxation initiatives that they put in place, including capital gains, including negative gearing the sums of money involved in that are enormous and they have committed a lot of that spending ahead of time, so they don’t have much room to move in terms of, well, can they back off from that policy in a big way? 

They can maybe talk about adjusting it, they can talk about consultation in the implementation phase, but they don’t have a whole lot of room in terms of saying, “Well, okay, we’re going to back right away from that.”  Because they’ve actually already earmarked a lot of that money for various purposes.  As we know of course, Chris Bowen’s going around saying, “We’re the true fiscal conservatives in this election, we’re going to put away even more money over the longer term than the government’s going to be.”  Chris Bowen will be very anxious to protect his fiscal buffers rather than giving up a lucrative source of revenue, so not much room to move.

That’s going to be interesting to see how that plays out obviously.

Yeah, well this is going to be one of the most interesting elections for a while.  There’s real policy differences over big issues between the parties and as I said, this is an election that’s taking place in the shadows of the death of neoliberalism as a dominant policy.  2016 was kind of the first election along those lines.  That’s why Malcolm Turnbull got such a big fright and barely won, because I don’t think the political parties fully understood at the time, but the electorate really was reacting strongly against what’s perceived as an economic system that is working in the interests of elites and corporations and the wealthy rather than the electorate.  I don’t think either party fully understood the extent to which that was the case last time around.  Labor did more than the government did. 

This time around I think both sides, but particularly Labor understand that the path to resonating with the electorate is to tap into this perception that the economy and indeed, the entire political system is working in the interests of elites rather than the electorate and promising to actually do something about that.  That’s what underpins a lot of Bill Shorten’s rhetoric.  It’s called ‘class warfare’, etcetera, etcetera… Yeah, it is to an extent, but it’s actually not so much about class, it’s actually about perceptions around how the system’s working in the interests of people or not.

Thanks Bernard, great to talk to you.

No worries.

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And now to talk about the markets and in particular, what the Fed did last night and how that affected the markets, here’s Kyle Rodda, Market Analyst at IG.  Kyle, what did the Fed say last night and how has that affected the markets? 

Well, the Fed, in our own words, effectively came out and expressed to the market that with their policy going forward in 2019 they would be a lot more patient.  I mean, that’s probably the phrase that’s going to be on market participants’ and punters’ lips today.  Effectively, the way that was being interpreted is that with all the financial market turmoil and the tightening financial conditions across the globe which is one of the major concerns of market participants recently, is that the Fed would adjust their policy settings according to those concerns. 

Probably most importantly, I think the commentary coming into the event was concerning how the Fed would communicate in what way they would approach normalising their balance sheet moving forward, whether it’s on a fixed path or whether they are willing to somewhat adjust that path of normalisation to be able to support markets.  Effectively, Powell, in his communications and his press conference gave that message all the more, so we saw a real rally in risk assets.  US Treasury has rallied as well, the Dollar got smashed, the Aussie Dollar went on a tear as a result too.  It was a more dovish outcome than what was really being priced in, to what was already supposed to be a dovish Fed and has given that boost of sentiment that perhaps markets were craving, particularly after the sell-off we saw through December.

The Financial Times headline says, “Fed Puts Rate Rises on Hold.”  Do you think that’s what’s happened here, that basically the rate hikes in the US are now on hold?

Well that’s the way markets are interpreting it.  If you look at the implied probabilities and interest rate markets overnight effectively, it’s suggesting that there will be no interest rate hikes from the Fed in the year ahead.  It must be said, throughout the volatility we got in December, there were stages where markets were even pricing in a cut, you could argue that it’s become a much more balanced view on the market.  But as far as markets are concerned, and I mean, this is carrying in a backdrop too which the Fed even acknowledged last night of the global growth story that is, I suppose, wavering if not entering some kind of narrative now focusing more on a slowing of global growth, particularly in geographies like Europe and China.

The Fed effectively acknowledged that that’s the backdrop they’re working within now and when they communicate it to the markets, when Powell was talking, expressing the fact that they’re going to remain patient again – this word, ‘patient’, came up constantly as if it was, I suppose, a very, very calculated use of words going into the actual press conference.  This emphasis on being patient and accommodating for the markets needs and according to what markets were telling them has more or less delivered the message that they’re going to remain on hold for now, in their path of rate normalisation.  And yeah, in 2019, as far as markets are concerned right now, there’ll be no hikes, there’ll be no movement at all from the Fed.

I suppose the reaction to the markets reinforces the fact, the idea, that the Fed really remains the main factor for markets.

It does, and I think there’s probably an interplay between two major stories that are moving markets and have since probably about the last quarter of last year, or Q4 2018, to use the American calendar there, and that is that on one hand we’re looking at a reasonably cyclical slowdown in global growth, probably largely exacerbated by the effects of the trade war, and then tightening financial conditions globally so liquidity is being sucked out of the system.  I mean, if you put it into a timeline of events, when markets really started to kick off and started to wain a little bit, volatility really lifted and equities came off their highs.  It coincided with the date on October 3 – in fact, when Powell first made his comments that the Fed’s funds rate was a long way from neutral. 

That’s what really caused the volatility.  When you have, like we did through December, an interplay between those two variables there, one, global growth looks like it’s slowing down sharply particularly in Europe and China, and then for a long time there the Fed didn’t seem too worried about adjusting interest rates to accommodate for that changing macro outlook globally, then you’ve got this concern in that market participants, not only in the global economy is slowing but the support that we’ve become used to over the last decade is all of a sudden going to be sucked away. 

This is a massive reversal from the Fed and it probably does in terms of the way that you look at equity markets in particular, the way asset prices have behaved for the last decade, it probably adds weight to the notion that perhaps prices have been boosted to, I suppose, unnatural levels and have been somewhat distorted by this easing monetary policy and it’s not going to easy to unwind this now with that as its basis.   Effectively, Powell puts here, the Fed blinked and they don’t want to push the envelope and try and sink markets on the basis of trying to normalise policy in response to perhaps data in the real economy.  And we’re probably back to a situation like we saw in the Bernanke-Yellen years where Powell, where he hadn’t been throughout 2018, will be much more receptive to markets, rather than trying to lead markets towards a path of normalisation and much more traditional monetary policy settings.

Fascinating.  Great to talk to you, Kyle, thank you.  

Thanks for having me.

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And now to talk about the economy, here’s Jo Masters, who used to be an Economist at ANS Research and now is Chief Economist at Ernst & Young, the big accounting firm.  Jo, yesterday we saw yet another CPI print below 2%.  Last night the Fed Reserve more or less said it’s going to be on pause now.  Do you think it’s time for everyone to realise that what you might call the neutral interest rate is much lower than anyone thought?

Look, it’s certainly lower and I guess we’ve known that for some time.  It’s hard to know how much lower is the new normal.  But I think globally we have seen a loss of economic invention and totally appropriate for the US Federal Reserve to become more data dependent and probably slow down the pace of monetary policy tightening and I think you’re going to see that globally.

What about Australian inflation.  The RBA’s been trying to get it above 2% for a couple of years now and just cannot do it.

Absolutely, inflation’s been undershooting that target for some time.  I think it’s important to remember for the RBA, that that inflation target is between 2-3% over time and actually that got extended beyond the business cycle with a new Governor.  I’m not too concerned about inflation running a little bit below the target.  I think the bigger issue for the RBA at the moment is what seems like a loss of momentum in the economy and how that may flow through to the labour market and jobs growth.

Where do you stand on Australian interest rates, do you think they’ll be cut this year?

No, I don’t think so, I think the RBA is certainly on hold.  They’ve obviously had very strong messaging around the next move is more likely up than down, although not any time soon.  I think the risks to the economy are tilting to the downside.  I think it’s important not to overplay the risks.  There are parts of the economy that are still doing quite well and we of course know from history that the AUD does provide a solid buffer for the economy.  I’m not too negative on the economy at the moment, but I think rates on hold for the moment.  

How worried about the housing market are you?

I think the issue with the housing market if you think about it from an economic point of view or a policy point of view is the interaction with the consumer.  The consumer is 60% of our economy.  I actually think housing market for the moment has been quite an orderly correction.  We need to look at the falls in the context of the very sharp prices that we had.  At the moment, consumer spending has held up reasonably well.  I think a large part of that is because we’ve been creating a lot of jobs.  I think the key to re-watching this year is whether we continue to create enough jobs that over time should lift wage growth and that the housing market correction remains orderly.  

Thanks very much, Jo.

Thanks.

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And now let’s hear from Professor Ellie Chapple from the QUT Business School.  Ellie, in the interim report and obviously during the hearings, the Royal Commissioner, Ken Haynes, focused a fair bit on remuneration of banking, but also what he was talking about particularly in the interim report applies to companies more broadly, which is to say that they’re too easily getting their bonuses.  Presuming he comes out with some recommendations in the final report on that subject and suggest that boards take more notice of how the bonuses are being paid, that that is going to have an impact more broadly on corporate Australia?  

Yes, I think that’s the case if we look at the recommendations of we were chatting before – they’re not really just going to be about the banking sector, they’re going to be about, I think more broadly looking at governance in the big companies and that trickle down effect to the smaller companies.  As we know, over 2,000 companies have listed, over 2 million companies in Australia all have boards and all have board practice.  If we look at the more transparent end of the market which is the big cap companies that we’re talking about here, the banks for example, the evidence that came out in the commission was extraordinary about how the amount of time that the bank has spend examining their own remuneration. 

This goes back to the records that they were keeping.  The bankers would insist that they spent more time talking about this than their records actually reflected.  Their records reflected they are only spending a number of minutes – it almost looked like they were sort of just rubber stamping the agenda item rather than actually tackling them in detail.  Then another point, I’ll make a second point, is there’s some concern then that the bankers only look at – when I’m saying bankers I mean people on the board at the top end, the directors – they’re really only looking at performance when something has gone wrong.  It’s like, head in the sand, not really examining performance with open mind, but really just, I guess, disaster managing in way.

The trouble seems to me that the Royal Commission can make recommendations, but the trouble is that those sort of remuneration practices aren’t really subject to legislation.  I mean, I suppose it’s a matter of influence on boards rather than recommending the Government pass laws about how executives are paid.  

I think for a long time in Australia and overseas, remuneration practice is what we really call that a soft law, about recommendation and guidelines and how best practices suggest that the decision making process should occur.  But there’s actually no hard law, as you’re saying, legislation or recommendation about pay.  I guess what we’re going to expect from this, I would imagine, is more around the soft law, it’s more around how can we build better practices and better guidelines for boards to follow?  The whole time in corporate Australia, as we’ve seen various reviews, we’ve never really seen anybody come out and recommend caps on pay or formulas that need to be followed, have we?  I mean, you’ve certainly seen a lot in corporate Australia and we’ve never really seen it get that far, have we?  There is of course the Productivity Commission.

There was also the banking executive practices law, which wasn’t exactly about remuneration but it does prescribe how they behave and to some extent, I suppose, how they’re paid. 

Yeah, so that’s more about practices though, isn’t it, more about I guess, scaffolding those practices and how decisions are made than I guess if we asked people what would be an ideal setting mechanism, it would be like almost I guess a public type system where there’s inquiries and there’s evidence and there’s benchmarks and all this is made publicly available.  I mean, it would start to get closer to mandates on that for many working environments.

That’s very unlikely to be either recommended by Hayne or implemented…

That’s right, really unlikely.

What else are you looking for out of the Royal Commission report, anything in particular? 

There was also some talk about the board composition.  We’d go back to those guidelines and practices that we were talking about.  Many people in corporate Australia know those guidelines and practices quite well.  And they talk about, the board should be preferably comprised of a majority of so-called independent directors.  Boards should also be comprised of people with the appropriate skill matrix for whatever the operation of the sector that that company for example is operating in.  One of the things then came up in the discussions about – maybe there was just too many experts on boards, but if people – the fall back of a lot of sound qualifications and not a lot of that idea of diversity, that idea of true diversity.

What I would be looking for, after following the commentary, the commission outcomes, the evidence and then the debates that we’ve discussed afterwards, I’d be looking for some comment around those guidelines about independence and what does having a majority of independent boards actually mean?

Well, thanks very much, Ellie, it’s been interesting.  We’ll be looking closely at the Royal Commission report for those things, thanks.

Oh yes, very closely for the implications I think for governance for all companies in our capital market, not just our banking sector.  Thanks.

Thanks for joining us.

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And happy birthday Phil Collins, who turned 68 yesterday.  Phil was in town the other day and I didn’t go to the concert, but apparently he walked on stage with a walking stick.  I guess something is in the air and it’s the fact that we’re all getting older.

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That’s all from me, have a great week. 

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