Interest rate pain probably won't get too bad despite tough talk
Written and accurate as at: Sep 01, 2022 Current Stats & Facts
Central banks have primarily abandoned forward-looking monetary policy since Covid. One wonders why they need big teams of economists if they merely respond to the latest prints of often-lagging indicators such as inflation. Last week, this was highlighted at the Jackson Hole central bankers conference in Wyoming.
One cannot blame them for hawkish comments on inflation, including talk of bringing on the pain. After all, their lack of forward-looking policy failed to pick up inflation soon enough in 2021. In the US, there is a risk they will get it wrong again — but in the opposite direction, failing to pick up an imminent fall in inflation led by goods inflation, which forward indicators are showing. Or maybe they are aware of it and want to take the credit for falling inflation when it's already baked in as supply chains and business margins normalise.
Market reaction
Markets this week reacted to the rhetoric by selling off bonds and equities. July's rally in hopes of a soft landing is a distant memory. But there are signs the rally, although premature, had the right idea. This comes down to the notion that inflation will fall and then stabilise at around 4% in the next year. That's still too high, meaning rate cuts would be unlikely. But hikes would stop around neutral and central banks would feel they had time on their side.
Australia is a bit behind the US. Due to our CPI's composition, the moves up and down will be less dramatic. We also face a mortgage fixed-rate cliff next year, which US 30-year mortgages don't have. If the RBA exhibits patience, it will likely sit at 3% cash rates in 2023.
Falling global inflation should allow our central bankers more confidence that we are not in some 1970s-style spiral.
Wages are key
Wages will be critical in the medium term. We believe that goods inflation will fall before stabilising at about 2%. Services inflation will remain at around 5%, leading to a 4% CPI. This assumes wage growth of close to 4% next year.
Prime Minister Albanese's jobs summit this week will bring that all into focus. Awards now cover a little more than 20% of workers — the main one being the minimum wage set by the Fair Work Commission. Another 40% of us have individual agreements.
The jobs summit will focus on the remaining 40% covered by collective agreements or enterprise bargaining. This is where the major battleground over wages will be fought, especially if agreements try to keep pace with the recent 4.6-5.2% minimum wage increase.
Bonds outlook
For now, bonds have once again entered the buy zone. I will avoid predictions on equities. But I observe that the landing in the US may not be as hard as many predict.
Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team. Tim has extensive experience in banking, financial markets and funding, including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.