Rory vs The Kouk vs McCrann?

Wed, 19 Mar 2014  |  

Rory Robertson, my old mate and former RBA 'lumpy items'* co-conspirator, and I have a wager about the RBA meeting in May.

I quite emphatically believe the RBA needs to hike interest rates soon from the current historically low 2.5 per cent. This is because there has been a flood of information showing a move in the Australian economy to above trend growth, rising inflation, the unpleasant consequences building from a reflation of house prices and an unambiguously stronger world economy.

As has been the case over the last 15 years or so as I have made and refined my interest rate forecasts, my view must be placed in context of the market pricing for interest rates. At the moment, the market is pricing in a small chance of an interest rate cut, yes cut, in May. It may only be a basis point or two, but it is a cut nonetheless. While no one surveyed in the recent Bloomberg survey on interest rates expects the RBA to cut in May, there are still four forecasters expecting a cut by the third quarter of 2014.

For me, this is absurd given the dynamics in the economy mentioned above and elsewhere on my blog in recent times. My forecast is relative to market positioning and the trade is to sell the May, June and July futures and wait. I say the June and July futures as well as May because a rate hike in May will parlay through pricing along the curve, plus there is the bonus of a time buffer if I am wrong with the timing of my call and the RBA hikes in June or July and not May.

This is the drill and is the vital point of trading one's views on policy against market pricing.

If the RBA does in fact hike in May, I make a thumping 23 or 24 basis points on May (less than 25 due to the RBA meeting being on the 6th of the month) and 26 or 27 basis points on the June and July contracts even on the assumption the market does not price in a further hike in those months.

If the RBA holds rates steady in May, I make one or two basis points profit for the May position and still have the open positions for June and July. I only lose money if the RBA cuts interest rates.

Rory, who is undoubtedly one of the best RBA watchers and interest rate strategists over the past couple of decades, knows this, hence his agreement that the bet we make is at the odds of 25 lunches to one.

While I am not privy to Rory's work and thoughts on the outlook for RBA policy, he obviously has a strong view the RBA will not hike so soon.

I would have been delighted to pay for lunch with Rory in any event, but that is what was agreed.

What was a little amusing was an article this morning from number one greyhound follower and aspiring RBA watcher, Terry McCrann, in the Herald Sun.

Among other flotsam, Dishlicker McCrann noted that "Rory has leapt to figuratively snatch candy from the baby Kouk — former, ahem, Gillard adviser Steven Koukoulas, who has over-excitedly predicted a rate rise from the Reserve Bank in May. At least Rory is only asking the Kouk to buy him lunch if he's wrong. He could have asked him to bet the house."

Apart from spelling my name incorrectly, McCrann failed to note the 25 to one odds. I would have thought McCrann would have known about odds from his time at the dog track. He also failed to note the market pricing I refer to above and the fact that I actually make money if my forecast is wrong and the RBA leaves rates on hold. What is even more enlightening is that McCrann cited the RBA comments from two weeks ago as the reason for his expectations that "there is ABSOLUTELY NO — way the RBA would raise rates in May" (Terry's own emphasis.)

I note that in the intervening two weeks, there has been news confirming stronger than expected news on GDP, exports, retail trade, employment and house prices.

I think these matter and there is no doubt the RBA does too. There is also some genuine risk that over the next six weeks to the RBA meeting in May, these trends are reinforced and that the inflation result on 23 April could well continue the trend of rising inflation pressures. Indeed, it is likely that the March quarter CPI will show annual headline inflation at 3.0 per cent with the underlying measures close to 2.75 per cent. I suspect the RBA may get antsy over this in a climate of stronger economic growth.

I am happy to offer McCrann the same odds as Rory, 25 to one, on a rate hike in May, although I would prefer the stakes to be cash, rather than lunch for what I think are obvious reasons.

So Terry, I you want to bet your house on "no change by May", shoot through an email or call.
___________________
*   Oh, the reference to lumpy items above: When I was in forecasting section in Treasury in the late 1980s or early 1990s (I cant recall the exact years), Rory was my counterpart at the RBA. We used to have to call to reconcile the JEFG forecasts for private new capital expenditure and reference the distortions to the headline numbers from asset sales and privatisations – so called lumpy items. I wonder if that role still exists?

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