The Week Ahead and in Review: Oct 14

In Review

A fortnight ago, it was predicted that the RBA would lower the target cash rate on October 1st. This did indeed come to effect, with the rate dropped to a historical low of 0.75%. Philip Lowe has suggested he is averse to undertaking quantitative easing unless absolutely necessary but has opened the door to future rate cuts. A Goldman Sachs econometric model, designed to recreate the internal models utilised by the RBA, concluded that to achieve the target inflation rate that the RBA is striving for, the target cash rate would have to sit at -1.0%. Granted the Federal Government remains as fiscally complacent as they have been since their re-election, it seems that further rate cuts are inevitable.

The Week Ahead

Last week, the US and China reached a partial trade deal. In a crude summary, Trump will not tariff the Chinese imports he claimed he was going to, and China, in turn, will purchase up to $50bn USD worth of American agricultural goods. The impact of this on Australia is uncertain. While American indices soared in the wake of the good news, it could potentially leave Australia in the cold. China’s aspiration to remain ostensibly invincible during the trade war via their GDP growth and expansion fuelled a drastic increase in iron and coal prices, which naturally benefited Australian mining exports. Likewise, the disputes between US-China agriculture meant that Australia maintained its place as one of China’s leading meat trading partners. It’s unclear how the new agricultural agreement between the superpowers will influence Australian exports of agriculture; given that America primarily services soybeans and pork, Australian meat exports should be largely insulated from any impacts due to our general reliance on beef.

The impact on iron and coal is murkier. China is likely to want to capitalise on this positive trade news by reaffirming themselves as independent and economically strong, to ensure Trump cannot spin any destructive narratives that they were ‘desperate’ or ‘reliant’ on his cooperation. Therefore, given China’s political and economic history, it is fair to predict that Xi Jinping and co will continue to aggressively expand the Chinese economy through the expansion of infrastructure, thus fuelling continued demand for iron and coal. In the long-run, it is far less clear whether this effect will hold. A concept in Economic theory is the ‘Catch-up’ effect of developing nations, which cites that growth slows as the absolute possibility of expansion marginally decreases. Hence, the disparity in target GDP between developing countries (~8%) and developed countries (~2.5%). As China’s expansion reaches a natural limitation in the coming years, it would be reasonable to suggest that the demand for iron and coal would decrease and subsequently be reflected in the share prices of firms like BHP, Rio, and Fortescue (assuming this demand for resources was not replaced by another country, such as India). Due to these firms’ high exposures to China, the impact of such a downturn could be significant.

Ultimately, in the next 6-12 months, it seems likely that international demand for Australian minerals and resources will remain very stable, though a long-term outlook presents the possibility of a significant decrease in demand.

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