In their latest meeting, the RBA raised rates by 25bps and were ahead of the central bank curve regarding slowing rate hikes. Have they done enough?
Economic Outlook
- The 25bps rate hike by the RBA has pushed interest rates to 3.1%; according to data from the OECD, 84% of mortgages in Australia in 2022 were variable. The RBA did a stress test on the sensitivity of rate hikes from May to October (2.5%) could have on households.
- A household earning $150,000 (gross, the median income for a family with dependent children) with debt of $800,000 may see their cashflow decline 13% or $1,300
- $150,000 household earnings with debt of $600,000 could see cash flow/disposable income decline by 10%.
- $150,000 household earnings with $400,000 debt would reduce disposable income by 7.5%.
- Around half of variable rate owner-occupier borrowers would see a cashflow decline by 20% over the next few years, with 40% facing a <20% decline. Higher rates are expected in the coming months, with the terminal rate of 3.6%, and the risks for some vulnerable households are increasing as rates rise.
- Michelle Bullock highlighted that many fixed-rate mortgages will expire over the next two years, with a large proportion in H2 2023. Over half of those on fixed-rate loans would face an increase in payments of up to 40%. The rising mortgage costs will lead to lower retail sales and consumer spending in the coming years.
- Owner-occupier loan value declined M/M at 2.9%; this was down from a revised 4.8%, as the home loans value also fell M/M to 2.7% in October, down from 4.4%.
- The Australian housing market has already slowed, with building approvals at -6% M/M and private sector houses at -2.2% M/M. This is causing house prices to decline, with the CoreLogic House price index falling by 1.1% in November, down 3.81% from its peak.
- The employment market is currently strong and remains very tight. There is growth in hours worked and employment through H1 2022. The forecast for unemployment is 3.5% in June 2023 before rising to 4.5% in 2024. When unemployment starts to increase, we expect to see stagflation that would equally damage the economy.
- October employment data shows that 32,200 gained full-time employment; the labour force availability is slowing. There are expectations that gains will slow in the coming months; however, we expect strong demand for employees in the coming months as consumption holds up.
- Retail sales declined for the first time in October 2022, down 0.2% M/M; this is the first contraction since December 2021. The monthly gains were marginal until now, highlighting the slowing consumer spending trend.
- Household spending increased by 20.7% Y/Y in October, and services and goods spending is still strong through 2022, at 34.2% and 9,3%, respectively. Expenditure on transport has been strong through this year, up 42.5%, with hotels, cafes, and restaurants at 39.9%. We expect this data to weaken in the coming months as costs remain high.
- Services and composite PMIs are declining at 47.6 and 48, respectively, while manufacturing PMIs are still expansionary at 51.3 for November for the S&P Global PMI, but the AI group Performance PMI fell to 44.7, down from 49.6.
- GDP for Q3 in 2022 has been strong and is forecast to be 6.3% Y/Y and 0.7% Q/Q. The economic data since Q3 suggest amoebic growth in Q4.
- Trade data for Australia has shown a moderate current account deficit for Q3 at -$2.3bn. Exports in September were stronger than the previous month, up 7%.
- Exports are likely to be stronger in October as China looks to restock material ahead of the winter period; however, the underlying demand is poor across the globe as economic growth slows.
- The China re-opening trade has prompted risk on sentiment for some assets, but there is a long way to go until restrictions are lifted, stimulus takes effect and demand increases.
RBA
- Members of the RBA indicated that while there was a case to increase rates by 50bps, the housing market was clearly starting to struggle, which would have increased the severity of the recession.
- Inflation remains high at 6.1%, and while it has cooled recently, we expect inflationary pressures to rise if the re-opening trade for China continues to push asset prices higher.
- The yield curve isn't inverted yet. The 10yr yield is at 3.396%, as of December 6th, with the 2yr at 3.07% and 5yr at 3.19%.
- The dovish tilt will see rates increase but at a slower pace, and as mentioned above, many homeowners are struggling as rates rise.
The Fed is expected to slow the rate hikes to 50bps this week, and we anticipate a higher terminal rate. The inversion of the 2yr and 10yr in the US is deepening, but the same trade is not happening in Australia. We expect this to change. The Australian housing market is expected to decline in the coming years as higher rates and fixed mortgages are renewed at higher levels in 2023, with some experiencing a rise of 40%. Consumer spending is declining, and this will continue in the coming months, but employment is still strong, and until this starts to slow, the economy can withstand slower rate hikes. However, in our opinion the China re-opening trade will push assets higher in the medium term. prompting inflationary pressures to emerge. Sentiment in the dollar has started to soften, and although positioning is cleaner, we expect the USD to weaken in the immediate term. The US economy will turn around before the others, and data is more resilient than other significant regions; this could prompt investors to favour the USD if stagnation in Europe and other regions is confirmed. We favour owning AUD against the USD with a near-term target of 0.6954 before 0.794 but also would look at the Australian yield curve inverting.
Volatility Commentary
Throughout the year we’ve seen a volatility consistently realise above implied which we see continuing into the end of year/opening of next year as economies struggle with continuing higher costs. With uncertainty still remaining around the exact size of future RBA and Fed hikes and uncertainty around the unlocking of China’s economy which would also have significant knock on effects on Australian trade and commodity prices we favour owning AUDUSD vega/gamma.
Trade Idea
Non directional trade – Both legs priced as 3mth expiry options with 10m AUD nationals each
- This is a non-directional short vol and gamma trade
- Selling a strangle in 10m AUD a leg (20m total AUD notional) at circa 13.1 vols generates 40k AUD (27k USD equivalent) Vega
- Note this trade idea is only appropriate for investors who are able to maintain and delta hedge a gamma position
Positioning Charts
USDBRL NDO Positioning Data 01/12/2022 - 08/12/2022
The charts below show an increasing demand for downside puts in USDBRL. The put notional value is small and this may mean reduced conviction, however the significant increase in volumes suggests we could see a change in trend. There is little upside coverage in the near term, the large notional values have an expiry in January. We expect spot to remain under pressure, but there is a busy week for CBs and these puts could be hedges.
USDBRL NDO Positioning Data 24/11/2022 - 01/12/2022
USDCNY Vanilla Positioning Data 01/12/2022 - 08/12/2022
There were less volumes traded last week but the strip of put options traded suggest appetite for lower prices. These are due to expire this week. The call options have a small notional value and trade the 7-7.20 range but this could trigger covering if there is a rally. The range for puts is narrower for the week to December 8th at 6.70-7.
USDCNY Vanilla Positioning Data 24/11/2022 - 01/12/2022
AUDUSD Vanilla Positioning Data 08/11/2022 - 08/12/2022
The charts below show a shift in options in line with spot. The range of puts traded is more concentrated than the previous month, at 0.60-0.675 compared to 0.58 to 0.65. Calls follow the same trend and provide upside cover with more options trading above 0.75. The options market while split suggests a continuation of the recent trend towards 0.70. 
AUDUSD Vanilla Positioning Data 08/10/2022 - 08/11/2022
Charts and Tables
FX Expiries
Volatility Grid
Historical Spot FX Volatility (30D Rolling)
FX Matrix (today)
Weekly Change
Technical Charts
JP Morgan Global FX Volatility
The index has declined sharply in the last week, after rejecting trend resistance prompting a sell off at 10.57. The stochastics are rising and the buy signal could trigger gains towards the trend resistance. The moving averages are declining, this will provide resistance in the coming sessions. The MACD diff is negative and converging on the upside suggesting higher prices in the near term. The tail suggests appetite for prices around 10.60. On the downside, a break of support at 10.57 would confirm the descending triangle. This would set the scene for lower prices towards 10.
Dollar Index
The downside trend has declined in recent weeks as the repeated reaffirmation of resistance could set the scene for lower prices. The stochastics are rising to 50 and MACD diff is positive and converging suggesting lower prices in the near term. The 50 DMA has been providing resistance, rejection of this level at 105.13 could trigger losses back to support at 104.71. A break of 104.71 would confirm the descending triangle prompting a sell off to 102. The reaffirmation for the Fib levels on the way down outlines the strength in trend in the near term. Conversely, on the upside, the index needs to break above the trend resistance and the 105.8725 in order to confirm a change in trend.
AUDUSD
AUDUSD has rallied in recent weeks as buying pressure prompted a test of resistance at 0.6840. The bearish divergence from the %K stochastic suggests lower prices in the near term, especially as the stochastics now fall back towards the oversold. This could trigger a test of trend support and the 100DMA, if this level holds firm we may see a breach of resistance at 0.6840. A break of trend support on the downside could trigger losses back towards the 200 DMA at 0.6627 before the 50% fib level at 0.6563.
