In today’s Money Morning…interest rates stay on hold, and east coast real estate keeps bubbling over…Aussie gas price crunch getting worse…and more…
The RBA held its monthly board meeting yesterday and, as expected, decided to keep interest rates on hold.
There was no hint that strengthening demand in the Aussie economy might see interest rates begin to rise soon. This just goes to show the asymmetric nature of policy making in a post credit crisis world.
That is, the RBA is quick to cut rates at the first hint of trouble, but is terrified of raising rates, even as growth picks up. As I pointed out the other day, nominal economic growth (which factors in the higher prices received for commodities over the past year) hit 6% in the year to 31 December.
So we have official interest rates at 1.5% and nominal economic growth at 6%. While that growth rate might be momentarily high thanks to the big increase in commodity prices over the past year, there is still a big disparity between the economy’s growth rate and official interest rates.
In other words, monetary policy is still incredibly loose. That’s why the Sydney and Melbourne property markets refuse to die down. Yet the RBA doesn’t seem too concerned…about anything. From yesterday’s statement:
‘Conditions in the housing market vary considerably around the country. In some markets, conditions are strong and prices are rising briskly. In other markets, prices are declining. In the eastern capital cities, a considerable additional supply of apartments is scheduled to come on stream over the next couple of years. Growth in rents is the slowest for two decades. Borrowing for housing by investors has picked up over recent months. Supervisory measures have contributed to some strengthening of lending standards.’
Apparently, the considerable additional supply of apartments should sort things out. A couple of interest rate rises would sort things out much faster, but that isn’t going to happen.
Instead, the RBA will keep rates low for some time, and the government will more than likely throw more tax payer money at the housing ‘problem’ in the May budget. Which will make things worse…
Interest rate hike already in effect
Ironically, there is a quasi-interest rate hike washing over the eastern states as we speak. It’s just hitting the wrong part of the economy. And it’s all thanks to more political and regulatory ineptitude.
The Financial Review this morning reports that the east coast gas crisis just keeps getting worse:
‘Eastern Australian manufacturers will be left short of gas this winter unless the new $80 billion Queensland LNG industry diverts gas away from export to sell it to local users, AGL Energy has declared.
‘The shock advice from one of the country’s biggest gas retailers shows that the shortages that some have long feared in east coast supplies are much more imminent than are being assumed by government and some regulators.’
AGL head of wholesale markets Richard Wrightson said, ‘If there’s an exceptionally mild winter then we could scrape through, but if it’s a cold winter, no. We are actually out of contracted gas, we don’t have any left in our portfolio.’
That means AGL will be forced to buy gas on the spot market, where prices are much higher than contracted prices. If that happens, some businesses won’t survive. And the ones that do will pass the higher costs onto consumers.
This event, or price ‘shock’, is a negative one for the economy. It’s like a couple of interest rate rises happening all at once. So while this problem remains, and it will for the time being, the RBA must grapple with the effects.
That is, it must understand that the inflationary impact of higher energy prices (which effect businesses and households) is the result of an adverse supply shock, and not the result of strengthening demand.
Added to all this you have the threat of energy prices continuing to move higher. The underlying cause of the east coast gas crisis is the linking of the Australian gas price to the international gas price via the LNG export industry.
International gas contract pricing is linked to the oil price. So for the first time, Australian gas producers have the opportunity to obtain higher international prices for their product. That’s why they’re sending gas to the LNG plants in Gladstone, rather than to domestic consumers at much lower prices.
If the oil price continues to move higher, as I speculated it would yesterday, it will only increase the incentive to send gas overseas.
A crowded trade
However, there is one flaw in the bullish argument for oil. That is, it’s a crowded trade. The amount of ‘managed money’ (hedge funds and speculative traders) betting on higher oil prices is just shy of an all-time high.
As at 28 February, the hedge funds were net long 387,000 crude oil futures contracts. That’s up from a low of 87,000 contracts in August 2016.
The bearish argument here is: just how many buyers are left to push the price higher? In addition, the contrarian argument goes that, whenever there is a record amount of traders betting on higher prices, you can usually expect the opposite to take place.
I am wary of the positioning of traders in the futures market. But I don’t necessarily see it as a major bearish signal. Sure, it might mean we get another correction in oil before prices eventually push higher…or that the consolidation period carries on for months longer than expected, flushing impatient traders out of their positions.
But as long as the global economy continues to remain healthy and even strengthen, there are fundamental drivers that should keep the oil price elevated. For this reason, a return to bear market conditions is a low probability outcome.
Unlike the debacle unfolding in Australia’s energy market. Here, there’s a high probability that the situation will only get worse…
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