How to predict interest rates

The smarties tell me that our natural unemployment rate is 5.4% – above which, wage growth slows, inflation tends to fall and the RBA drops the official target cash rate.

According to the ABS, Australia’s unemployment rate is currently 5.8% and a large, 9.6% according to Roy Morgan.

Roy Morgan – for mine – is a better indicator. 8006135_xxl

Looking deeper, the ABS thinks that a further 8.4% of us are underemployed (i.e. we would work more hours if they were available).

Roy Morgan think similar, with an 8.3% underemployment rate.

When combined, the ABS think Australia has an employment underutilisation rate of 14.2%, whilst Roy Morgan’s work suggests it is 17.9%.

I do shake my head at all these technical terms.

In simple speak – when using RM stats – one in ten of us is looking for work and a further 10% (or thereabouts) want to work more.

This is some serious stuff and too important to hide behind BS terms and crappy survey (ABS) techniques.

At the time of writing, core inflation as also at 1.3% (March Qtr. 2016), which is well below the 2% to 3% RBA target CPI range.

Plus, new dwelling starts are down 9.1% on last year.

When isolating apartments, new approvals are down 18.2%.

Many think that our persistent high level of unemployment, low inflation and, now, falling housing demand should automatically lead to lower official interest rates.

But more often than not, the RBA leaves rates unchanged at their monthly gabfest.  

This leaves many of us wondering why.

Forget trying to read the economic entrails, let alone the RBA warblings.

It is a waste of your time.

Let me give you the drum – the best way to forecast the future direction of interest rates is the yield curve.

The yield curve is 10 year government bonds minus 90 day bank bills.

Recent history suggests that short rates 0.50% lower than long rates, should be regarded as neutral monetary policy.

Our chart, below, clearly illustrates how accurate the yield curve has been in the recent past when it comes to RBA cash rate movements.


The yield curve strongly suggests that the RBA should drop the target cash rate next Tuesday.

Monetary policy is currently way too tight.

For mine, the cash rate should drop by 0.5%, to 1.25%.

But that might really spook the horses.

So, what we are likely to see is a 0.25% fall next week, followed by another 0.25% in early November, timed under the cover of the September Qtr. CPI result.

It is likely to be a new low.

Looking further ahead, global deflation should force an active reduction in the Aussie dollar, which in turn means even lower interest rates.15353979_l

I think the cash rate target will fall to 1% sometime during the first half of next year.

However, for mine, the RBA should only need to meet once a year when it comes to setting interest rates.

I suggest that each July they meet to deliberate the future economic outlook and set interest rates accordingly.

In a world of increasing uncertainty, this approach would be a breath of fresh air.

Now, imagine for a minute that the RBA met a couple of weeks ago; wrote a simple, in plain English, two-page document (and in 12 font type face) about how they see the world ahead; and set the official cash rate for the next 12 months.

Let me spitball here …

“Here you go boys and girls, things are looking somewhat shitty and shifty moving forward.  There is really little we can do about that.  So, it is over to you.  We have dropped the cash rate by 0.75% to 1% for fiscal 2017.  Good luck.  See you next year.”

Yeah, and ‘pigs might fly’, you quip.

Well, in the meantime, the monthly RBA gabfest continues and the yield curve remains the best bellwether when it comes to forecasting future interest rates.

Want more of this type of information?

Michael Matusik


Michael is director of independent property advisory Matusik Property Insights. He is independent, perceptive and to the point; has helped over 550 new residential developments come to fruition and writes his insightful Matusik Missive

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