All bets are off now. Rate hikes are a thing of the past. What the heck happened?
Take a look at this chart here. This is a story of a hundred broken promises.
Over the past six or seven years, the markets have continually over-estimated the trajectory of interest rates. They expected them to be a lot higher than they actually ended up being.
And you can understand why. Because for all that time, the RBA was saying that the next move in interest rates would be up. They were saying that they would like to ‘normalise’ interest rates from their historically low levels, and they’ll be doing that just as soon as they possibly can.
The markets took them at their word…
… and everyone was wrong.
Now, things have become interesting. Markets are actually expecting lower interest rates.
It started when the RBA gave up trying to sell the world on rate hikes and admitted that, actually, the next move in interest rates might not be up. Maybe things are about right where they are, and it’s a coin-toss as to which way the next move in rates is going to be.
That led to most market economists downgrading their expectations as well. This week, Westpac’s Bill Evans broke ranks and said he now believes the next move in rates will be down.
The curious thing here is why anyone thought interest rates would be going up in the first place. When you look at inflation (the metric that the RBA is supposed to care most about) – it’s barely making it into the RBA’s target band.
There’s hardly a case for rate hikes there.
Probably where they got the idea that rate hikes would be going up is this chart here. This is employment growth vs the RBA’s cash rate.
As you can see, historically, they’ve moved pretty closely together. When jobs growth is strong, interest rates rise, and when it’s weak, they fall.
For twenty odd years that rule of thumb served us pretty well.
But around 2013 it started to break down. Jobs growth was strong – going great guns actually – but interest rates were stuck to the floor.
And to be fair, most economists were thinking it would have to happen sooner or later. Strong jobs growth would feed into stronger wages growth, which would turn into stronger inflation numbers.
But it just didn’t happen.
And I reckon the key to understanding why that transmission mechanism broke down is this chart here. This is the part-time employment share across the anglo-sphere.
What it shows is that a lot of jobs in Australia are part-time. It’s 32% here – almost one in three. It’s just 20% in New Zealand.
So while jobs growth has been strong, we’re not adding full time jobs. More and more we’re creating part-time jobs.
And the thing about part-time work is that it tends to be a bit precarious by nature. If you’re only on a part-time contract, you’re not in a position to be hustling for higher wages.
And so the growing share of part time employment helps us understand why wages growth has been so underwhelming.
… which in turn helps us understand why inflation outcomes have been so soft.
… which in turn helps us understand why the promised rate hikes just never materialised.
I think a lot of economist in the market and at the RBA thought that this would just sort itself out.
But now, they’ve collectively given up on it.
The wages boom isn’t coming. Rate hikes are off. This is the new reality.