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A rate cut will make this market surge sustainable

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By Peter Switzer 

What in the hell happened yesterday? 108 points up on the S&P/ASX 200 index? Unbelievable, but it happened. What explains this excessive optimism and is it sustainable?

Well, the Yanks couldn’t pull it off for two days in a row, with the Dow down nearly 120 points at the close.

Let’s rewind a day and try to make sense of this market optimism that started in Washington at the Federal Reserve and went right round the world.

This is how CommSec’s Craig James, my fellow economics buddy, who wakes up to market madness each morning, summed up the interest rate meeting in the US yesterday: "The Federal Reserve has given no indication of when it’s likely to lift rates, actually softening its view on the outlook for the economy.

The Committee anticipates it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2% objective over the medium term. This change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range."

The Fed boss, Dr. Janet Yellen actually said this to reporters, who grilled her after the rates ‘no change’ decision: “Just because we removed the word patient from the statement doesn't mean we are going to be impatient."

Yep, the experts thought the Fed would drop that 12-point scrabble word — ‘patient’ — which implied it was not in a hurry to end the era of zero interest rates. However, saying it wasn’t going to be impatient to raise rates meant stock players said “Yahoo!” and again chased stocks, especially dividend payers, like our banks.

That said, this is how our ABC reported the event, arguing it was “the biggest hint that the Fed had dropped a previous assurance that it would be "patient" on any timetable to move rates higher.”

In summary, the Yanks are closer to a rate rise but the economy has to be perfect before Janet Yellen will risk a bad market reaction going too far. I expect she wants the economy to be so doubtlessly good-looking that the expected immediate market sell-off will drag in bargain hunters and dip-buyers to ensure the stock market rebounds and not derail the economic recovery.

Okay, that all makes sense, US-wise, but why did our market add 108 points and push the dollar over 78 US cents? Unbelievably, it’s only 76.17 US cents this morning, which has to mean that foreign exchange traders expect the Fed’s reluctance to raise should push our RBA to cut in April. When I saw the currency at 78 US cents, I instantly thought our central bank boss, Glenn Stevens couldn’t like that, given he wants our dollar in the low 70-cents region.

The next thought was that a cut had to be a priority. There are three arguments against a cut in April.

First, house price rises in Sydney are worrying a lot of people. Second, rate cuts could be spooking some Australian businesses and consumers that the economy is so weak that we need very low rates. This is only partly true — the economy is weaker than the RBA (and I) thought about six months ago — but it’s also a relative interest rates story. Our cash rate at 2.25% (with the Yanks close to zero, and the Europeans and Japanese close to zero too), makes our dividend stocks really popular. And when they chase our stocks, they increase the demand for our dollar.

Have a look at this weird chart on Japanese interest rates from the website Trading Economics. 

This is the best case for another rate cut to make sure our dollar doesn’t go too high to wreck the slow economic comeback I think is on the way.

Employment data out yesterday showed 76,300 jobs were created in the three months to February, the fastest growth in two years. While 50,000 jobs were lost in mining over the year, 186,000 were created in the rest of the economy! And the ANZ job ads numbers have gone up nine months in a row.

Economies turn slowly but I think record low interest rates, lower petrol prices, a lower dollar (that would go lower with another rate cut), a related positive stock market and a Federal Government, which is taking my advice to stop the debt-doom talk and is talking about a more stimulatory budget, will help our economy.

I know Sydney house prices are a worry but we need to worry about the economy overall — jobs, investment, economic growth and confidence.

The Yanks are getting closer to a normal economy, where you worry about inflation and rising interest rates because confidence drives investment and growth — and that’s where we need to head.

I know it sounds weird but worrying about those kind of things that have been missing since the GFC explains why consumer and business confidence have been so poor.

This is why the RBA needs one more cut and it should be next month.

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Published: Friday, March 20, 2015


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