Stock markets fell sharply again over the past week in response to another round of hawkish rate hikes that pushed bond yields higher and added to recession fears. A threat of escalating war in Ukraine added to concerns.
Reflecting the weak global lead, Australian stocks fell around 2.7%, with declines led by interest-rate-sensitive stocks in IT, real estate, utilities and retail. Prices for oil, metals and iron ore fell on lingering fears of recession. The AUD fell as the USD rose.
Warmongering central banks remain the main driver of the decline in equities. While inflation is showing signs of peaking in the US, it’s not enough for the Fed, which rose another 0.75% and remains very hawkish. High inflation has also prompted rate hikes from many central banks over the past week – with another 0.5% hike from the Bank of England also remaining hawkish, a 1% hike from the Swedish central bank and a 0.75% hike by the Swiss central bank (although both were catch-up) and rate hikes in South Africa, Norway, the Philippines, Indonesia and in Taiwan.
While the Fed’s 0.75% hike to 3-3.25% was expected, its post-meeting statement and comments were very hawkish. Fed officials’ so-called dot plot of interest rate expectations has been revised up 1% for this year to 4.25-4.5%, its inflation forecast has been revised to upwards, its growth forecast has been revised down and its unemployment forecast has been revised up to 4.4% next year. Although the Fed does not yet foresee a recession, its projected rise in unemployment would normally be consistent with a recession and it seems willing to tolerate one, as its “overriding objective” is to bring inflation down to 2%.
Channeling Paul Volcker, Fed Chairman Powell said “we will continue until the job is done.” To slow the pace of tightening, Powell wants to see a slowing labor market and more evidence that inflation is slowing. Another 0.75% increase seems likely in November.
The commitment of central banks to lower inflation is good news, because a sustained return to high 1970s-style inflation would be very bad for economies, living standards, jobs and markets. investment.
The danger, however, is that the Fed and other central banks have become locked into oversized hikes based on historical inflation and employment data and a loss of confidence in their ability to predict inflation at some point. where they should pay more attention to monetary policy. delays. This increases the risk of excessive tightening leading to a deep recession. (Just like in hindsight, they were too slow to start the hike.)
Fed tightening and hawkish policy saw the US 10-year and 2-year yield curve invert further, reinforcing its recession warning, with the more reliable 10-year fed funds yield curve yet to been reversed but approaching.
The bottom line is that even if near-term inflation remains elevated, these considerations are consistent with the fact that the United States has peaked in inflation and signals a sharp decline in inflation ahead, which should allow central banks to slow the pace of the rise by the end of the year, hopefully in time. to avoid a severe recession (except perhaps in Europe). If this applies to the United States, Australia should follow its lag of the United States by about six months when it comes to inflation. For this reason, while equities are likely to decline further in the near term, we remain bullish on equities over the 12 month horizon.
Five reasons why the RBA should be less hawkish than the Fed
The increased hawkishness on the part of the Fed has led many to conclude that the RBA will also have to become more hawkish and therefore adjust to further Fed rate hikes. However, there are five reasons why the RBA should be less hawkish than the Fed and other central banks:
- The household debt-to-income ratio in Australia is almost double US levels – at 187% in Australia compared to 102% in the US.
- Household debt interest costs in Australia are much more sensitive to rising interest rates – as most borrowers are on floating rates linked to the RBA cash rate and the rest are on terms relatively short fixed terms with many maturing next year unlike in the US where most mortgages are 30 year fixed so only new borrowers are affected by rising rates. Combined with the first point, this means that a given size rate hike in Australia will be more effective in dampening consumer demand than in the US.
- Inflation is lower in Australia, at least for now.
- Wage growth – the main driver of business costs – is about half of what it is in the United States.
- The Fed risks over-tightening and causing a severe recession in the US and there is no logical reason for the RBA to do the same. But raising the cash rate to 4.15% by the middle of next year, as the money market assumes, would take house prices down 30% and plunge the economy into a recession that we don’t have. don’t have to know.
In short, the combination of Australian households being far more vulnerable and therefore reactive to rising rates than US households, lower inflationary pressures in Australia and a desire to avoid excessive tightening means the RBA is unlikely to increase rates as aggressively as the Fed.
The main argument for following the Fed is that if the RBA doesn’t, the AUD could crash, but the whole point of floating the dollar was to get an independent monetary policy. And we’ve seen that lately with the RBA hikes in 2009-10 (but no action from the Fed) and the Fed hikes in 2015-18 (but the RBA continues to cut rates).
Of course, if the AUD crashes to $0.50 and brings Australian inflation back to US levels, it could be more difficult for the RBA – but it’s also worth noting that high commodity prices are offsetting it a bit. AUD negative. impact of the Fed hike more than the RBA. If the AUD crashes it will likely be in a period of immense global stress and falling commodity prices where it would make more sense for the RBA to let it go as it did in the GFC and the start of the pandemic when it fell to $US0.60 or lower.
Overall, we think the RBA should be back to 0.25% at its October meeting, but it’s starting to feel that another 0.5% is on the way. A 0.4% increase could be a good compromise!
The monthly CPI ABS indicator will show a further rise in Australian inflation
The ABS decided to advance the publication of its monthly CPI indicator to September 29 with data for July and August. In June, it had already increased to 6.8% over one year.
Based in part on the Melbourne Institute’s previously released inflation gauge, which shows a sharp rise in July and some decline in August, we expect it to show monthly inflation rising to 7 .8% YoY in July and fell back to around 7.1% YoY in August. It should be noted that this volatility is partly due to the base effect of a sharp rise last August.
Caution should be exercised in interpreting it at least initially as; it updates only about two-thirds of the elements of the CPI and will be subject to revisions; it will be very volatile from month to month; and there will be no mean or truncated median, which initially makes it difficult to assess underlying pressures.
The RBA has indicated that it may take time to discern reliable trends and reflecting this, Deputy Governor Bullock noted that it is “unlikely” to have much impact on the rate decision. october. But a big move in either direction can be hard to ignore and could impact market volatility.
Monitoring of economic activity
Our Australian, US and European economic activity trackers have changed little over the past week. Overall, they continue to suggest that while some momentum has been lost following the post-pandemic recovery, economic activity is holding up reasonably well so far – but this likely reflects the usual lags of monetary tightening.