Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 412

A tale of the inflation genie, the Fed and the RBA

Inflation is the topic du jour in global financial markets.

The parameters of the debate appear to be focussed on the likelihood of some persistent inflation, and potential financial stability concerns, in the absence of a timely withdrawal of the historically high levels of monetary accommodation currently being applied by central banks.

In the US the most recent May inflation report showed annual ‘core’ inflation at its highest level since 1992. In the past three months US inflation was running at an annual rate of 8.3%, the highest since 1982.

Plenty of inflation evidence

Moreover, the inflation pulse continues to beat rapidly. Purchasing managers report suppliers struggling to meet demand. Order backlogs are at their highest in 40 years, and commodity prices are surging.

In Warren Buffet's annual address to Berkshire Hathaway investors, he stated that he was seeing “very substantial inflation”.

Obama-era Treasury Secretary Larry Summers, former Pimco Head and Allianz adviser Mohamed El-Erian and BlackRock CEO Larry Fink, have all expressed concerns regarding inflation as well as some of the latent financial stability dangers.

They cite inflationary pressures mounting from:

  1. The boost in demand created by the $US2 trillion-plus in savings that Americans have accumulated during the pandemic
  2. Historically high levels of monetary accommodation including large-scale US Federal Reserve debt purchases and Fed forecasts of essentially zero interest rates into 2024
  3. $US3 trillion in fiscal stimulus passed by the US Congress
  4. Soaring stock and real estate prices.

Further, inflation may yet accelerate due to demand growth outstripping supply growth, rising materials costs and diminished inventories and the impact of inflation expectations on purchasing behaviour.

The Biden agenda, including higher minimum wages, strengthened unions, increased employee benefits and strengthened regulation - while replete with laudable intent - all push up business costs and prices.

The main argument - is it transitory?

However, US Federal Reserve Chair, Jerome Powell, continues to assert that any inflation will be “transitory” and reflect short-term supply imbalances as the economy recovers from the dislocation wrought by the COVID pandemic. Neither does the Fed Chair display any overt concern regarding financial market imbalances. 

However, on occasion, unless addressed, 'transitory' inflation can take on an air of permanence. In the words of former Australian Prime Minister Keating “the inflation genie gets out of the bottle,” and once that occurs, it is a difficult process getting that genie back.

That is precisely what happened with the oil price shocks of the 1970s when policy generally ‘accommodated’ the increase in oil prices. Not that the current circumstance is entirely redolent of what took place back then.

For the time being the bond market has given the Fed the benefit of the doubt and has bought the ‘transitory’ narrative. Nevertheless, the time is fast approaching when the Fed needs to articulate an exit strategy from the historically high levels of monetary accommodation.

Were the Fed to indicate that it is 'thinking about thinking about' the retreat from current levels of monetary stimulus, that would be timely for the RBA.

Inflation less evident in Australia

Inflationary pressures are present but less visible in Australia. The fiscal boost was way less than that applied in the US and the prospective regulatory agenda less ambitious.

While base effects will see June quarter annual ‘headline’ inflation likely get close to 4%, the RBA’s preferred trimmed mean measure is forecast to be around 1.5%, still well south of the RBA’s 2-3% target. Indeed, the RBA forecasts only have inflation reaching the bottom of the 2-3% inflation target band in June 2023, and even then, wages are forecast to be running at a paltry 2.25%.

The RBA has achieved its stated objective in pursuing yield curve control and QE of “keeping the AUD lower than it otherwise would have been”. In my view, it will not wish to unwind those achievements by prematurely foreshadowing a significant retreat from the currently historically high levels of monetary accommodation.

Were the Fed to signal that it is reviewing or about to review its level of stimulus, the capacity for the RBA to signal its own (ever so slight) retreat is enhanced without exerting unwanted upward pressure on the AUD.

Given the RBA’s unequivocal commitment to full employment, and given that despite progress on the unemployment front, it is still some way north of the 4% or even “3 point something” previously cited by the Governor as getting close to capacity, the RBA is likely to implement only marginal adjustments to its QE programme. Changes will be implemented flexibly and with caution, perhaps by signalling a likely weekly run-rate of purchases of bonds say between $2.5-$4 billion a week, which would follow the expiration of the current six-monthly $100 billion programme in September.

Such measures are at this stage rather small in the scheme of things given the prevailing expectation of the RBA Board that a policy rate increase is “unlikely to be until 2024 at the earliest.” 

It remains the case that while the economy’s performance has certainly exceeded expectations, recent price and wage growth remains at levels that are still uncomfortably low for the RBA and its inflation and employment objectives, and the economy is still some way from a level consistent with full capacity.

Whilever that remains, and while ever the Fed persists with current settings, and while ever there is no ‘lived experience’ of adequate wage and price inflation, we should expect the maintenance of the historically high accommodatory tack from the RBA.

A Fed retreat would give the RBA sufficient cover to commence a calibrated and marginal retreat.

But keep an eye out for that genie. If you see it, then it really might get interesting!

 

Stephen Miller is an Investment Strategist with GSFM, a sponsor of Firstlinks. He has previously worked in The Treasury and in the office of the then Treasurer, Paul Keating, from 1983-88. The views expressed are his own and do not consider the circumstances of any investor.

For more papers and articles from GSFM and partners, click here.

 

 

RELATED ARTICLES

It's not all about interest rates: give me a 1980s petshop galah!

US rate rises would challenge multi-asset diversified portfolios

Yikes! Three critical factors acting on inflation and rates

banner

Most viewed in recent weeks

The nuts and bolts of family trusts

There are well over 800,000 family trusts in Australia, controlling more than $3 trillion of assets. Here's a guide on whether a family trust may have a place in your individual investment strategy.

Welcome to Firstlinks Edition 581 with weekend update

A recent industry event made me realise that a 30 year old investing trend could still have serious legs. Could it eventually pose a threat to two of Australia's biggest companies?

  • 10 October 2024

Welcome to Firstlinks Edition 583 with weekend update

Investing guru Howard Marks says he had two epiphanies while visiting Australia recently: the two major asset classes aren’t what you think they are, and one key decision matters above all else when building portfolios.

  • 24 October 2024

Preserving wealth through generations is hard

How have so many wealthy families through history managed to squander their fortunes? This looks at the lessons from these families and offers several solutions to making and keeping money over the long-term.

A big win for bank customers against scammers

A recent ruling from The Australian Financial Complaints Authority may herald a new era for financial scams. For the first time, a bank is being forced to reimburse a customer for the amount they were scammed.

The quirks of retirement planning with an age gap

A big age gap can make it harder to find a solution that works for both partners – financially and otherwise. Having a frank conversation about the future, and having it as early as possible, is essential.

Latest Updates

Investment strategies

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

Economy

US election implications for investors and Australia

The return of Donald Trump to the US presidency brings the prospect of more US tax cuts and deregulation, but also more tariff hikes, trade wars and policy uncertainty. Here's what it means for markets going forward.

Retirement

The rising tension between housing debt and retirement balances

Australians are taking more mortgage debt into their 60s than ever before. Retirement planning assumptions haven’t adapted and could result in future income projections that ultimately disappoint retirees.

Investment strategies

Why megatrends can deliver big upside (and downside)

The magnitude and duration of society's most important trends are often underestimated. While these trends are usually touted as a tailwind, one in particular could have dark consequences for many assets.

Property

Fixing the construction industry house of cards

Australia needs to build new homes like never before but construction firms keep going belly up. Unless regulators act now, consumers will continue to carry the can.

Investment strategies

How investor portfolios have become riskier versus history

Risk in portfolios has dramatically increased as time horizons have shortened and investors have piled into equities. It's resulted in a growing disconnect between what investors need and what the financial industry is delivering.

Shares

The abacus, big data and a brief history of indexing

Equity indices have evolved over time, led by step-changes in our ability to manipulate data. Despite the rise of passive investing, they weren't initially meant to be investment tools.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.