For most of this year, I’ve been suspicious of a hike in interest rates in Australia. There were five reasons for this.
First, the Australian labor market is still struggling to deliver wage benefits in line with ever-increasing inflation. In the latest figures, only a fifth of the labor market segments surveyed are providing wage benefits above the RBA’s 3% limit.
Second, the RBA knows it has included a large and automated rate-hiking sequence in 2023. Come next year, the $500 billion fixed-rate mortgage that offset the pandemic’s boom in home prices will roll over to much higher floating rates. The housing market is already witnessing a fall in prices due to the removal of cheap fixed rates.
Third, I expected supply-side bottlenecks to ease as demand for DM goods passed the post-COVID by increasing services activity. It is happening, even as it has been slowed by a series of setbacks that include the Ukraine war, energy prices and the Omicran outbreak in China. Especially the car supply chain is starting to clean up. Goldman:
This will lead to deflation in the global supply chain and the further it will go.
Fourth, the Chinese manufacturing economy is very weak as its assets continue to decline and, I argued, will lead to a fall in the prices of wholesale goods and energy in due course. It is still much weaker than anyone expected and productive deflation was well underway.
However, as the Ukraine war and Russian sanctions dealt a new blow to supplies and instead increased commodities, that argument was turned on its head. Still, the markets are yet to understand that this commodity boom will not deliver many benefits to most Australians due to the lack of follow-on investment.
This brings me to the fifth and most important argument why interest rates may not rise in 2022. Here it is, TS Lombard:
As every investor knows, interest rates have been low for 40 years and whenever central banks have tried to break out of this megacycle, something has gone wrong with the financial markets and/or the real economy. Most pundits blame rising debt levels. Lower interest rates encourage households, businesses and governments to borrow more, which, in turn, makes the economy more vulnerable to the cost of borrowing. In fact, you don’t need to be an enthusiastic goldbug to realize that the post-Bretton Woods financial system appears to be stuck in a “bad balance,” as high levels of leverage also tend to include systemic weaknesses, which In turn, demand for safe assets increases, putting further downward pressure on interest rates. So, given the 40-year trend of “lower lows” and “lower highs” in interest rates, it is perhaps not surprising that most investors are skeptical about whether the world’s central bankers will be in this period. How much will you be able to increase? Well. The prospect of a reversal in the bond markets only reinforces this suspicion.
We had seen quite a bit of a crisis in the global junk debt spread even once before the FOMC hiked, so my view was that it wouldn’t need to tighten up any more to trigger a new crash.
Where can it come? For most DMs, the main risk is corporate debt:
Not so in Australia, where families bear the burden of debt:
Australians coming in second in the world in terms of taking advantage of hostages says it all.
It is the case that given the positive terms of the trade shock, the balance of risk has shifted to a post-Ukraine rate hike. But there’s still a lot of doubt.
We can say with certainty that there is a mighty tug-of-war between the economic shocks in stable conditions versus Europe (war and energy), China (assets and COVID) and the US (a very fast Fed). Currently prevailing in the Australian economy which will eventually give way to a tightening of the RBA.
It may seem a strange argument, that many Australian families should pray for a global economic shock to save them.
But this is the world we live in.