inflation market update 23 jan 2012 1227 1[1]

8/3/2019 Inflation Market Update 23 Jan 2012 1227 1[1]

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Fixed Income: Inflation Market Update23 January 2012

Philip Brown Quantitative Strategist T. +612 9118 1090 E. [email protected]

Important Disclosures and analyst certifications regarding subject companies are in the Disclosure and Disclaimer Appendix of this document and atww.research.commbank.com.au. This report is published, approved and distributed by Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945.

Internal data suggests a low Q4 CPI

Key Views on Linker Markets .............................................................................................. 2

Using CBA credit card data to forecast Q4 CPI: +0.45% ............. .............. .............. ............ 3

A Strategists perspective: .................................................................................................. 5

Tenders and Issuance ......................................................................................................... 5

Long-term Charts ................................................................................................................ 6

Economists Preview: the QIV 2011 CPI .............................................................................. 7

Appendix 1: Significant (courtesy xkcd) ............ .............. ............... .............. .............. ........ 9

Australian Q4-2011 CPI data is scheduled to be released on Wednesday25 January. Currently, the economic consensus is for a print of +0.2%,though a significant number of economists are looking for negativeprints.

Last November we explained how substitution bias could lead to adistinct fall in CPI readings when the basket was rebalanced. This effectcan be as large as 0.5% per year. The change is a measurementchange only, there is no change in the real economy, but the newweightings change the result. At the time we suspected that the Q4-11CPI would be very low because of the new methodology.

This month, we delve into the CBA credit card data to try to build a

simple model for quarterly headline CPI. Our supposition is thatchanges in prices in the economy should show up as higher averagespending per transaction on credit cards. We found that the behaviourof some of larger sub-categories (like Apparel) have predictive power forthe CPI.

By testing the various subcategories of card spending, we created animplied forecast for Q4 CPI of +0.58%. However, this doesnt take intoaccount the change in the new CPI weightings. If we subtract 0.125%(5% divided by four) from that estimate we get a Q4 CPI forecast closerto 0.45%. We must caveat that this is the first time we have tried thisprocedure and there isnt enough history to properly backtest it.However, we are heartened that our forecast is quite close to theeconomics team who expect an increase of +0.2%. (See Pages 3 and

7.) The economics team uses a completely different methodology.

In general, linker yields have been falling steadily for the last twomonths. The 2015 bond yield fell below 0.90% for a time and is startingto show real signs of rally fatigue. (See Figure 2.). This is in line withour expectation (see 22 August 2011 Inflation Monthly), though it hastaken a little longer for this dynamic to exert itself than we hadanticipated. Because the 2015 linker is finding it difficult to rally, anyfurther rally in the 3Y bond is likely to force BEI very tight very quickly.

Also this month we include our Chief Economist Michael Blythes CPIpreview on page 7. They highlight that the ABS new, concurrentseasonal adjustment process complicates the outlook for thecommonly-watched underlying CPI measures.

Figure 1: Current Bond Yields

ACGB Yield Semi Maturity Yield

Aug-15 0.93 NSWTC Nov-20 2.07

Aug-20 1.11 NSWTC Nov-25 2.37

Sep-25 1.31 NSWTC Nov-35 2.70

Sep-30 1.49 QTC Aug-30 2.88

ACT Jun-30 2.74

Source: CBA (20 January)

Figure 2: Yields on Aussie Government linkers

Source: CBA, Bloomberg

Figure 3: Current BEI and ZCS curves


0.00

0.50

1.00

1.50

2.00

2.50

3.00

Feb-11Apr-11 Jun-11 Aug-11 Oct-11Dec-11

Aug-15 Aug-20 Sep-25

Sep-30 10Y BEI

2.00

2.25

2.50

2.75

3.00

2013 2017 2021 2025 2029 2033 2038

ZCS Curve Bond BEI%


2/12

Global Markets Research

Fixed Income: Inflation Market Update

2

Key Views on Linker Markets

Our two recommended trades are both doing well and both have continued upside in our core view. We do not wish tochange our trades.

The indications are that the Q4-11 CPI print (scheduled 25 Jan) should be very low, assisting our 1Y ZCS trade.

The 5Y ZCS vs BEI trade also benefits from a continued rally. We expect the RBA to cut rates and for bonds to rally in thenext few months. This should see the nominals outperform the linkers and the basis between ZCS and BEI should widenfurther.

Key Trades

Trade Entry Curent Profit Target Stop Comment

Pay 5Y ZCS against receivingBEI on the Aug-15 bond

+14bp

(22 Aug 2011)

+28bp +14bp +70bp -5bp Hold: An insurance trade, if the marketkeeps rallying, the spread should widen. Itis currently mid-range

Receive 1Y ZCS 2.84%

(10-Nov-2011)

2.66 +18bp 2.40 3.00 Hold: The combination of substitutionbias and the falls in fruit prices should seeZCS fall.


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4

At this point, we should acknowledge that there is a good chance of some of the significant resultsoccurring through pure chance. We ran 41 models and have found six which are significant at the95% confidence level (the ones above the line in Figure 4). A random assortment would find twowhich are significant at the 95% confidence level (5% of 41). See Appendix 1 for one of myfavourite cartoons on this topic.

Knowing which results are real and which are random is a matter of judgement (until we canget more data!). However, we suspect that the strong performance of Association/Membershipcosts is probably purely random. The Association/Membership category has a negative correlationwith CPI. There seems little reason to believe that the price of jointing Associations should varyinversely with CPI for a structural reason. However, most of the other top rankings are broadcategories that noticeably overlap with consumer spending as measured by the CPI.Apparel/Clothing and Home Improvement seem more likely to represent real relationships whilethe Liquor category appears to be driven by two strong single results which is characteristic ofliquor in the CPI too. This is entirely a judgement call, but does seem reasonable.

Figure 5 shows the relationship between theresiduals from the Home and Office furnishingssectors and the CPI. This is particularly

important because the home and officefurnishings spending has been very low in Q4.In both October and November the actualaverage spend was $9 less than predicted. Ifrepeated in December, that would be $27 lessthan expected and would imply a very lowquarterly CPI (see Figures 4 and 5).

However, the result from the Apparel andClothing category presents a stronger result.The Q4 results in clothing are much better, withaverage transaction volumes only just underexpected results. (See Figures 4 and 6.)

So which do we believe?

An actual forecast for CPI in Q4

We have six models for Q4 CPI that seemworthy of consideration. (See Figure 4.)However, we choose to discount theAssociation / Membership category. Using thewisdom of crowds, the average prediction forQ4 CPI from the remaining five models is a CPIresult of 0.58%.

However, our models are implicitly assuming

that the Q4 CPI is produced using the sameprocedure as was used in 2009-2011. Its notgoing to be though. The new methodology forCPI has created a systematic change in theCPI, known as substitution bias (see the 11November Inflation Market Update ). The newbasket could lower CPI by as much as 0.5%per annum. Our estimate of +0.58% for Q4 isbefore that change in methodology is taken intoaccount. As such, the CBA credit card data issuggesting a Q4 CPI print closer to 0.45%.

Our economists, using a completely differentmethod, come up with an estimate of 0.2% q/q.

(See page 7) No matter which way you look atit, Q4 CPI should be low.

Figure 5: Relationship between Home and

Office furnishings and the CPI

Source: CBA, ABS

Figure 6: Relationship between Apparel and

Clothing card spending and the CPI

Source: CBA, ABS

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

-40 -20 0 20 40

QuarterlyCPIChange

Residual from CBA credit card data

(Home and office furnishings)

Qrtly CPI Change

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

-4 -2 0 2 4

QuarterlyCPIChange

Residual from CBA credit card data

(Apparel and clothing)

Qrtly CPI Chan ge

When testing somany hypotheses,you need to wary ofrandom chancecausing significantresults

Our models suggestCPI of 0.58%, butthats before thesubstitution bias isincluded

Our model suggestsa print of 0.45%, notfar from theeconomists at 0.2%


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5

A Strategists perspective:

As just explained, for multiple reasons we arelooking for a very low CPI print in Q4-11. InNovember we recommended receiving the 1YZCS to implement this trade. To be honest,little has changed.

The 1Y ZCS has rallied a little but still sitsaround 2.70%. Thats pretty high if the firstprint of four is going to be around 0.2% or0.4%. We would like to hold our ZCS positionover the CPI print and well reassess the tradethen.

The Outlook for BEI

Breakeven inflation has actually been trending

up in the last few weeks as nominal bond yieldshave increased. Real bond yields haventchanged though, leading to a small widening inBEIs. (See Figures 7 and 8.)

However, this small recent widening is againstthe larger trend of tightening BEIs. (See Figure8.)

We have previously recommended receiving theBEI against paying the ZCS at the 5Y / 2015point. This trade continues to perform well andwe wish to maintain it. The real driver of thistrade has been the fact the 2015 linker bondhas struggled to keep pace with the rally inother bonds in late 2011 (Figure 7). We expectthat dynamic to continue if bonds rally further.

The NZ CPI release

We are not huge believers in the NZ CPIpredicts Australian CPI as a general rule, butthe most recent NZ release has got as thinking.The NZ CPI fell -0.3% in Q4, againstexpectations of +0.4%. Thats a huge negativesurprise of -0.7%.

We tend to think that the NZ surprise is moreimportant than the absolute level of NZ CPI.This time, of course, both the NZ CPI print andthe surprise were negative, so its a mootpoint. Either way, the NZ CPI print suggeststhat the Australian CPI print should be low.

Tenders and Issuance

We are not aware of any imminent plannedissuance in linkers. The AOFM is planning toissue a new line of linkers (with a maturity lessthan the 2025). However, this will not be until21 February at the earliest.

Figure 7: Real Yields and 10Y BEI

Source: Bloomberg, CBA

Figure 8: BEIs of 3 bonds

Source: Bloomberg, CBA

0.00

0.50

1.00

1.50

2.00

2.50

3.00


Aug-15 Aug-20 Sep-25

Sep-30 10Y BEI

2.00

2.20

2.40

2.60

2.80

3.00

3.20


2015 BEI 2020 BEI

2025 BEI (vs 22)

Happy to stayreceived 1Y ZCS

NZ CPI was very lowtoo.


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6

Long-term Charts

Figure 9: Long term AUD bond yield and BEI

Source: CBA, Bloomberg, RBA

Figure 10: Long term global Breakevens

Source: CBA, Bloomberg, RBA

Figure 11: Drivers of main CPI moves since 1990


0

3

6

9

12

95 97 99 01 03 05 07 09 11

BEI

Nominal

10yr

%

Real yield

Asian crisis

(onset of global'savings glut')

Suspension

of C'wealthissuance

New

issuance

0

1

2

3

4

5

6

95 97 99 01 03 05 07 09 11

UKAustralia

%

United States

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Year Ended

AUD Headline CPI year-on-year AUD Underlying Inflation year-on-year%

The recession

we had to have

GSTIntroduced

GST rollsout of Y/Y

Cyclone Larry

banana spike

Cyclone Larry

banana trough

Commodity boom and utility

prices trigger widespreadinflation response

The GFC

%

Cyclone Yasi

Rising cash

rates triggerrising CPI *

Falling cash rates trigger a fall in CPI*

* The CPI used to include a measure of mortgage interest rate costs in outright terms. As such, change s in

the RBA cash rate were immediately reflected in CPI and tended to create feedback loops.

Introduction

of RBA2-3%inflation

target

Long-term moves inCPI


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7

Economists Preview: the QIV 2011 CPI

We expect the headline CPI to rise by 0.2% in QIV (3.3%pa). The underlying CPI on our forecasts will print at 0.7% (2.6%pa). The focus on European woes has reduced the importance of CPI readings in the rates debate.

The price data to round out 2011 is comingthrough in a series of QIV releases over the nextfew days. The focus as always will be the CPIreadings (due 25 January).

The inflation story shifted dramatically in 2011.What looked like a clear acceleration in HI hadthe RBA debating rate rises up until August.But a new estimation methodology that revisedaway some of the acceleration and a

surprisingly low QIII CPI outcome allowed theRBA to revise down its inflation forecasts. Thislower trajectory opened the door to rate cuts byyear end. And the RBA quickly steppedthrough that door, delivering 50bpts of rate cutsover November and December.

The CPI would normally shape views on whatthe RBA will do next. But the focus onEuropean woes means that the status of theQIV data has been reduced. Those woes meanmarkets have effectively fully priced a rate cutfor February. And economic commentators,

including ourselves, agree.On current figuring, the QIV price readingswould not stand in the way of a rate moveanyway.

Data on international trade prices, for example,was released today. That data suggests thatthe terms-of-trade declined at the end of 2011for the first time since 2009. The terms-of-traderemains close to 140-year highs. But thestimulus from a risingterms-of-trade has eased.

Looking ahead, we expect the QIV PPI (due 23

January) to rise by 0.6% in QIV. Annual growthwould stand at 3.2%. But the overallimpression should be one of upstream pricepressures remaining relatively contained.

The headlineCPI (nsa) should look benign. Weare expecting an increase of only 0.2% in QIV.The annual growth will remain uncomfortablyhigh, at 3.3%, but should slow quickly in HI2012.

The QIV outcome is favoured by the seasonalpattern of price moves and assisted by a largedrop in fruit & veg prices. So the new ABS

seasonally-adjusted CPI should print higher (weexpect a rise of 0.6%) and the underlyingmeasures should also exceed the headlineresult.

Releasedate

CBA(f)

Marketconsensus

Marketrange

PPI 23 Jan0.6%

(3.2%pa)na na

CPI 25 Jan0.2%

(3.3%pa)na na

UnderlyingCPI 25 Jan

0.7%(2.6%pa) na na

As at 20 Jan

-1

0

1

2

3

4

5

-1

0

1

2

3

4

5

Sep-01 Sep-03 Sep-05 Sep-07 Sep-09 Sep-11

CONSUMER PRICES(% change)% %

Annual

QuarterlyCBA(f)

0

2

4

0

2

4

Sep-98 Sep-01 Sep-04 Sep-07 Sep-10

CONSUMER PRICES(annual % change)% %

Headlineinflation

(exc GST)

Underlyinginflation

CBA(f)

QIV price data iscoming up.

Price readings arelikely to have littleimpact on the RBArate trajectory giventhe dominance ofEuropean woes.

The PPI.

The CPI.

Trade prices.


8/12



8

We expect the average of the RBAs trimmedmeanand weighted medianCPI measures torise by 0.7% in QIV. Annual growth would printat 2.6%. An alternative measure also favouredby the RBA, the CPI excluding volatile items,

should rise by 0.5% (or 2.7%pa) on our figuring.

On a six-month-ended basis that smooths outquarterly volatility:

a QIV CPI of 0.6% would keep underlyinginflation at the middle of the band.

it would take a QIV CPI of 0.9% or more toget inflation up to the top end of the band.

The new ABS seasonal-adjustmentmethodology complicates the analysis.Seasonal factors are re-estimated each quarter

and recent quarters can undergo significantrevision. The QIII underlying CPI rise averagedout at 0.3%. This outcome was the smallestrise in the ten years for which the new measuresare available. It pays to be suspicious ofextreme readings (in either direction). So part ofour thinking on the QIV outcome reflects thelikelihood of a bounce back (or revision to QIII).

A top-down modelling approach shows the QIVCPI outcome driven by a lift in unit labour costspartly offset by lower import prices and a smalloutput gap. The importance of unit labourcosts in driving core inflation outcomes

highlights the need to lift productivity growth.

The key price move in QIV is the unwinding ofthe weather-induced spike in fruit & veg pricesearlier in 2011. The infamous banana effecthas reversed (and the run down now actuallyexceeds the preceding run up). Lower fruit &veg prices should reduce CPI growth by0.32ppts. The other traditional volatile item,petrol prices, should have little impact in QIV.

Seasonal influences will be quite important indriving the QIV outcome. Seasonally lowincreases in property rates & charges, utilities,education, clothing, household appliances,utensils & tools and pharmaceuticals will helphold down the headline CPI.

Categories set to record above-averageoutcomes include dwelling rent, new dwellingpurchase, alcohol & tobacco, some transportcomponents, holiday travel & accommodation,some recreation and culture items, somehousehold services and insurance services.

Fluctuations in the degree of discounting at theretail level are the key source of risk to the

forecasts. The New Zealand CPI outcome (-0.3%in QIV) also suggests some downsiderisks.

Table: CPI Components (nsa) QIV 2011

% change Contrib (ppts)

Food & non alc bev -1.5 -0.25

Alcohol & tobacco 0.6 0.04

Clothing & footwear 0.1 0.00

Housing 0.6 0.14

Furnishings, h/h equip etc 0.4 0.04

Health -0.5 -0.03

Transport 0.4 0.05

Communication 0.1 0.00

Recreation & culture 0.9 0.11

Education 0.0 0.00

Insurance & financial serv 0.7 0.03

Michael Blythe Chief Economist T. +612 9118 1101 E. [email protected]

1

2

3

4

5

1

2

3

4

5

Sep-02 Sep-04 Sep-06 Sep-08 Sep-10 Sep-12

UNDERLYING CPI(annual % change)% %

RBAtarget

QIVscenarios

0.9%

0.6%

100

150

200

250

300

100

150

200

250

300

Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11

SELECTED FRUIT & VEG PRICES(Oct'01=100)Index Index

Cyclone Larry"banana effect"

Source: CBA/Ausmarket

Dec'11

Qld floods &Cyclone Yasi

"banana effect"

Therisks.

Sensitivity.

Seasonal issues.

Model results.

Thedetail.


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9

Appendix 1: Significant (courtesy xkcd)


10/12



10

Source: This cartoon is from the webcomic xkcd.com. See http://xkcd.com/882/


11/12



11

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12/12



Research

Commodities Telephone Email Address

Luke Mathews

Lachlan Shaw

Paul Hodsman, CFA

Agri Commodities

Mining & Energy Commodities

Mining & Energy Commodities

+612 9118 1098

+613 9675 8618

+613 9675 8532

[email protected]

[email protected]

[email protected]

Economics Telephone Email Address

Michael Blythe

Michael Workman

John Peters

James McIntyre

Diana Mousina

Chief Economist

Senior Economist

Senior Economist

Economist

Associate Economist

+612 9118 1101

+612 9118 1019

+612 9117 0112

+612 9118 1100

+612 9118 6394

[email protected]

[email protected]

[email protected]

[email protected]

[email protected]

Fixed Income Telephone Email Address

Adam Donaldson

Philip Brown

Alex Stanley

Steve Shoobert

Winnie Chee

Tally Dewan

Kevin Ward

Head of Debt Research

Fixed Income Quantitative Strategist

Associate Analyst, Fixed Income

Credit Research Analyst

Securitised Product

Quantitative Analyst

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+612 9118 1095

+612 9118 1090

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+612 9118 1096

+612 9118 1104

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+612 9118 1960

[email protected]

[email protected]

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Currency Strategist

FX Economist

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Delivery Channels & Publications Telephone Email Address

Monica Eley

Ai-Quynh Mac

Internet/Intranet

Information Services

+612 9118 1097

+612 9118 1102

[email protected]

[email protected]

New Zealand Telephone Email Address

Nick Tuffley

Jane Turner

Christina Leung

Daniel Smith

ASB Chief Economist

Economist

Economist

Economist

+649 301 5659

+649 301 5660

+649 301 5661

+649 301 5853

[email protected]

[email protected]

[email protected]

[email protected]

Sales

Institutional Telephone Equities Telephone

Syd FX

Credit

Japan Desk

Melb

Lon FX

Debt & Derivatives

Corporate

HK

Sing

NY

+612 9117 0190

+612 9117 0341

+612 9117 0020

+612 9117 0025

+613 9675 6815

+613 9675 7495

+613 9675 6618

+613 9675 7757

+44 20 7329 6266

+44 20 7329 6444

+44 20 7710 3905

+852 2844 7538

+65 6349 7077

+1212 336 7739

Syd

Asia

Lon/Eu

NY

+612 9118 1446

+613 9675 6967

+44 20 7710 3573

+1212 336 7749

Corporate Telephone

NSW

VIC

SA

WA

QLD

NZ

Metals Desk

Agri Desk (Corp)

Agri Desk

+612 9117 0377

+612 9675 7737

+618 8206 4155

+618 9482 6044

+617 3015 4525

+64 9375 5738

+612 9117 0069

+612 9117 0157

+612 9117 0145

inflation market update 23 jan 2012 1227 1[1]

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