Australian Bond Exchange Weekly Update
Friday 18th August 2023
Key Points
- RBA minutes signal a turning point in the fight against inflation
- The Aussie dollar tumbles to a nine-month low
- Despite a need for instant gratification, monetary policy offers no shortcuts
- New ABS data shows Australia has likely dodged a wage-price spiral bullet
- England may have won a world cup battle, but they risk losing a wage-price war
- In times of economic uncertainty, invest in defensive assets.
Global Cash Rates & Inflation
- The Reserve Bank of Australia (RBA) Cash Rate sits at 4.1%pa, as inflation eased in the year to the June quarter to 6%.
- The UK cash rate sits at 5.25%pa, to fight an inflation rate of 6.8% in the year to July.
- The US cash rate (policy rate) is currently between 5.25-5.5%pa, and the annual inflation rate in the year to August is 3.2%.
- The ECB Cash Rate (deposit facility) is 4.25%pa, to fight an annual inflation rate of 5.5% in the year to June.
Monetary policy offers no shortcuts
This week, the Reserve Bank of Australia (RBA) released the minutes from the August meeting, which confirmed that despite sticky services inflation, rising rents, a lack of supply and a tight labour market, “inflation [is] heading in the right direction.”
In minutes that seemed more dovish than usual, many analysts gathered that the RBA is now confident in achieving the ‘narrow path’ toward returning inflation to its 2-3% target range.
One of the most important things to note in the minutes was RBA Governor Philip Lowe’s reminder that “the full effects of the earlier tightening [are] yet to be recorded in the data.”
Though tempting to get caught up in the speed and instant gratification provided by social media, an “always on” news cycle, and a constant flow of economic data, it’s crucial to remember that monetary policy works at a lag.
Backward-looking statistics and year-on-year comparisons provide key insights for economists, central banks and governments into how markets have been operating, and must be considered as such. The impacts of tightening monetary policy (raising official cash rates to make credit less available) are not seen until after the fact.
In 2010, the chairman of the Federal Reserve Board, Ben S. Bernanke that “using forecast inflation is a more useful benchmark” than using the current rate of inflation. This is seen in Bernanke’s graph below, where the green dotted line (representing inflation forecasts) more closely follows the target rate than the red dotted line (the current inflation rate at the time), clearly showing the lagging impact of the target rate changes.
Source: Federal Reserve Board
As unemployment rises, the dollar takes a dive
The delayed effect of monetary policy tightening must be considered when reviewing the recent releases from the Australian Bureau of Statistics (ABS), and will likely play a part in the upcoming Reserve Bank of Australia (RBA) cash rate decision set for the 5th of September.
ABS Labour force data released Thursday showed that the aggressive rate hiking cycle started last May is starting to “do its job” in terms of softening the labour market (increasing unemployment) as the unemployment rate rose to 3.7% in July in seasonally adjusted terms.
Sticking at 3.5% in May and June, there was speculation that a tight labour market could cause another uptick in inflation but as mentioned above, monetary policy is delayed in its impact and the effects of those rises are now starting to appear.
Retail spending is on a downward trend, big banks are reporting historically low consumer sentiment levels (coined by many as deeply pessimistic) and an increase in arrears on owner occupier mortgages suggests Australia may have reached a “turning point.”
In fact, attention is now shifting toward the risks of a slowing economy on the Australian dollar (AUD) with CBA expressing concern that the AUD might drop below 60c, after falling to its lowest level in nine months on Thursday.
They won a world cup battle, but will they lose the wage price war?
In the ABS’ other key data release this week, the Wage Price Index (showing the rising cost of labour across private and public sector markets in Australia) supported the RBA’s cause for pause.
Rising 0.8% in the three months to June (lower than the RBA’s forecast of 0.9%) and 3.6% annually, it seems Australia has avoided the dreaded wage price spiral. The positive dataset further backed the rising unemployment figure and dovish tone from the RBA in their minutes, to see markets shift bets from an 85% chance of another cash rate pause, to an overwhelming consensus of 91%.
This is in stark contrast to the UK, which this week saw wages rise 7.8% in the June quarter (compared to last year’s reading), and that’s excluding bonuses. This was well above economists forecasts of 7.4%, and the potential for a damaging wage price spiral is now a central concern for the Bank of England.
Though UK inflation dropped from 7.9% to 6.8% and unemployment ticked up to 4.2% (a promising sign that the UK cash rate hikes are starting to take effect), the significant jump in pay rises could make returning inflation to the Bank of England’s 2% target much more difficult.
England may have won the World Cup battle against Australia this week, but it seems they’re at risk of losing the wage price war.
In times of economic uncertainty, invest in defensive assets
Despite the falling AUD, a drop in consumer spending, China’s deflation and “deeply pessimistic” consumer sentiment, many fixed income investors are breathing a sigh of relief.
The lag of monetary policy and the economic uncertainty surrounding the outlook for global financial markets is favouring those with a patient and forward-looking approach to investing.
As unemployment rises and the Australian dollar faces a potential downward trend, investments exposed to market volatility are becoming increasingly risky.
Fixed income investments are known as defensive assets as they offer stability and predictable income streams. Unlike equities, bonds and fixed income investments offer a level of resilience against market fluctuations as the full effects of monetary policy tightening materialise.
If you’re looking to generate reliable returns yielding close to double digit yields, speak to an investment adviser at the Australian Bond Exchange. For as little as $10,000 investment, retail investors can gain access to market-linked products and fixed income securities to diversify your investment portfolio in an increasingly volatile market.
What’s coming up?
- Next Thursday, the Treasurer Jim Chalmers will address the National Press Club, and present the 2023 Intergenerational Report, revealing the “long-term economic outlook” for Australia. Read the 2021 report here.
- The Jackson Hole Symposium 2023, one of the longest standing central banking conferences in the world, will be held in the U.S. next Thursday to Saturday. Aptly named “Structural Shifts in the Global Economy,” there are talks that this meeting will focus on the “R-star” (the real neutral rate of interest – adjusted for inflation).
*Data accurate as at 17.08.2023
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