Australia Dollars Tumbles After Reserve Bank Chief Hints At Interest Rate Cut

Financial freedom eludes so many people these days who by all logical conclusions and observations should have obtained it. It’s commonly cited as one of the most important and sought after goals in life and yet is rarely attained. This article does not attempt to give you a magic formula for success but I do share with you the choices that made a difference to me and can, if you choose put you well on the path to freedom.

Consumption
You can choose to spend some or all of your money on “consumption” items. These include food, entertainment, holidays, housing, motor cars, hobbies, and so on. These are things we need to live on a day-to-day basis. They also consist of items that service the things we want and so improve lifestyle.

Investment
You can choose to spend some or all of your money on investment items such as revenue producing real estate, shares, interest bearing deposits, businesses that produce revenue, etc.

Consumption or investment
Two important factors need to be understood about the simple concepts of consumption and investment.

The first factor is that spending on “consumption” items results in reducing the total value of your assets (net worth). Spending on investment items aims to increase your net worth. The second factor is that you have choice. You can choose between spending on consumption or investment items.

Of course, the best spending patterns are those that aim to attain a balance between spending on consumption and investment items.

Choosing consumption or investment
You now know the difference between consumption and investment spending and that you can choose between the two.

All you need to do is to think before you spend. Consumption spending can contribute to your lifestyle (driving a new car is fun, even if it was bought on credit and has created a liability of three to five years of payments). Investment spending provides income and wealth.

Shades of Grey
There is, of course, some spending that is not clearly defined as consumption or investment. Buying your own home is considered by many to be an investment. It isn’t! The purchase usually is financed and the repayments are a liability. The upkeep of a house costs money. There are rates and taxes payable on it. You do not get any revenue from it. If you plan to sell it in a few years to make a profit on its increased value, then it may be an investment. However if you have to buy another house to live in are you really any better off?

Investment spending is necessary for building wealth
In order to build wealth, some investment spending is necessary. The more that goes into investment spending, the bigger and quicker your wealth will grow. However, if too much goes into investment spending, and not enough into consumption, then lifestyle can become meagre. But you can choose.

Accumulation over time
Most people are not born rich. Certainly, some inherit wealth, but consequently may not appreciate it. A few win wealth in lotteries, but ironically, perhaps because they have not worked for it, or are not used to it, could end up squandering the temporary riches.

Everyone, however, has one thing in common. The same amount of time goes past for each of us, and at the same rate. How you employ that time is significant.

Imagine that at the age of 21, you invested $1,000 at an average annual rate of return of 10%, and then by the time you reach 65, you would have accumulated over $70,000 without doing anything else.

If at the age of 21, you invested $1,000 at an average annual rate of return of 10%, and each month invested an additional $100, then by the time you reach 65, you would be a millionaire, without doing anything else.

If you did neither of these things, then the same time would pass, and you would not have accumulated any wealth.

These examples of investment, quite deliberately, use amounts of money that are affordable by most, and if spent on investment, rather than consumption, would probably not be missed.

In terms of investing, time is on your side.
Of course, you may not be 21 any more and you may wish to accumulate wealth at a faster rate. This is possible by increasing the amount invested, and the annual rate of return. It is not possible to systematically accumulate significant wealth (millions) without looking at a timeframe of several years (say 5 to 10). If you are trying to make more money in less time, then your objectives may not be realistic. Perhaps a lottery ticket, crossed fingers and large amount of luck could produce your desired result, but don’t hold your breath waiting.

The power of compounding
In the above examples there is an additional factor at work. The entire return was reinvested and participated in earning the same rate of return as the original investment. None of the investment return was withdrawn and spent on consumption items.

Today’s headline:  

The Australian dollar continued to fall overnight after Reserve Bank governor Philip Lowe opened the door to a possible rate cut on Wednesday amid growing economic risks.

In a shift from the RBA’s long-standing tightening bias, Dr Lowe said interest rates could move in either direction, depending on the strength of the labour market and inflation.

“We have a clear trading range for the Aussie dollar. The shift in the RBA’s stance will likely make the Aussie test the $0.70 level versus the dollar,” added Michael McCarthy, chief markets strategist at CMC Markets.

The policy shift caught some investors off-guard because a day earlier the RBA steered clear of an easing signal as it held its official cash rate at a record-low 1.5 per cent.

The Aussie finished the session 1.8 per cent lower at 71.05, its largest percentage decline in more than a year.

The sell-off weighed on the New Zealand dollar and the Canadian dollar, with both logging declines against their US counterpart.

Dr Lowe’s speech highlighted a difficult balancing act facing policymakers as they try to manage market expectations and ease pressure on growth.

Both the US Federal Reserve and the European Central Bank have signalled cautious monetary outlooks in recent days. The Fed’s pause proved a relatively bigger surprise for markets.

 “A year and a half ago, a lot of the chatter was about central bank tightening,” Mr Trang said. “That narrative has changed to, not so much easy monetary policy, but certainly not as tight, in terms of where interest rates lie.”

More broadly, the dollar index, which tracks the greenback versus the euro, yen, British pound and three other currencies, was up 0.34 per cent at 96.391.

The greenback was supported by data that showed the US trade deficit fell in November for the first time in six months.

“While the greenback has fared better of late, headwinds could resume if the economy starts to show signs of succumbing to the global slowdown,” Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington, said in a note.

Traders were focused on the near-term outlook for monetary policy as well as any sign of progress in trade negotiations between Washington and Beijing as a March 2 deadline for an increase in US tariffs on Chinese goods nears. US Treasury Secretary Steven Mnuchin said on Wednesday that he and other US officials would travel to Beijing next week for trade talks.

Sterling was steady on Wednesday as Prime Minister Theresa May tried to persuade the European Union to modify her Brexit deal to avoid a disorderly British departure from the bloc.

So finely-balanced, in fact, that the Reserve Bank governor assesses the probabilities of either an increase or decrease in the cash rate as evenly balanced. Previously the central bank had considered it more likely the next move would be an increase.

It isn’t surprising that Lowe is cautious about the direction of the economy. While the starting point for his discussion of both the global and domestic economies is that the year just ended provided relatively strong bases, there are increased risks in both.

The global economy is slowing, with weaker growth particularly evident in Europe and China.

Monetary policy tightening in the US, the trade tensions between the US and China, Brexit, the rise of populism globally, the withdrawal by the Trump administration of support for the liberal order that has supported the rise in living standards globally and China’s attempt to rein in shadow financing were the major influences Lowe cited.

The accumulation of downside risks, he said, had become evident in business and consumer surveys and in the recent volatility in financial markets.

In Australia, again off a solid base of economic growth that the RBA expects to continue, albeit at a marginally lower rate than it had previously (and quite recently) forecast, the key influences over the near term future for the economy relate to income growth and housing prices.

House prices have, of course, been falling quite dramatically – but still remain way above (more than 70 per cent in Sydney and Melbourne) their levels a decade ago. Wages growth, which had been stagnating, appears to be finally picking up. In NSW and Victoria unemployment rates are at levels last seen in the 1970s, job vacancies are at record highs and hiring intentions remain strong.

If global conditions were to deteriorate further, the floating exchange rate and the fact that, unlike most developed economies, there is some scope to deploy conventional monetary and fiscal policies in response to a downturn, provides some insulation.

In the domestic economy, the threat to the RBA’s soft landing scenario is whether the fall in housing prices (which Lowe regards as a “manageable’’ adjustment) continues and has an impact on household spending.

There’s a partly-related uncertainty about the availability of credit generated by the combination of the macro-prudential measures the regulators imposed on banks to slow the growth in the riskier segments of the housing market and the financial services royal commission’s focus on responsible lending.

The RBA has some concerns that what began as a necessary tightening of credit standards might have gone too far, particularly in its impact on the supply of credit to small business. A full-blown credit crunch would be quite destructive.

Lowe said there were scenarios where the next move in the cash rate is up, and others where it is down.

 If Australians are finding jobs and wages are rising more quickly, inflation could be expected to rise and the cash rate would rise “at some point.’’

If income and consumption growth disappoint, or there is a sustained increase in unemployment and no rise in inflation, lower rates are more likely.

While the RBA appears slightly less confident than it was late last year that the rosier scenario will prevail, the fact that Lowe is willing to assign it a rough 50 per cent probability – and, as he says, that the bank and government have some ability to respond if the gloomier scenario were to develop – leaves us in a more optimistic and more flexible position than most developed economies.

The margins for error – and the difference between a continuation of a recession-free era now nearing three decades and something quite unpleasant – are, however, quite narrow and somewhat narrower than they were.

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