Markets are getting ready for rate hikes. I’m not so sure.
So markets find themselves in a bit of a tizz this week. Are rate hikes coming?
This is a tricky one. No one is really sure, and it doesn’t look like even the RBA knows what it’s doing.
On Friday, they let bond markets walk all over them. They have been running a yield rate target on government bonds of 0.1%. And they’ve been pretty much nailing it up until recently.
But then on Friday, they just seemed to abandon it all together, and yields blew out to 0.7% before settling down again.
So just what is the RBA doing? Is it starting to walk back the super-easy monetary policy we’ve had since Covid?
No one knows.
The other piece of the puzzle was the inflation data that came out last week.
This surprised a little to the upside.
The headline rate came in more or less as expected, at 0.8% in the quarter and 3.0% over the year.
However the trimmed mean – which is closer to the ‘core’ inflation that the RBA is interested in – that came in higher than expected, at 0.7% in the quarter and 2.1% over the year.
The real key is in that last number. Remember the RBA has a target band of 2-3% that they’re trying to land core inflation in.
So Wednesday’s number puts core inflation back in the target band – for the first time since 2015!
So this rattled markets. The RBA now has a trigger it can point to if it actually wanted to raise rates. Inflation is back in the target band.
And so we know have this weird situation where the RBA is publicly saying that they’re not going to be raising rates until 2024 at the earliest, but the markets don’t believe them.
The general consensus in markets is that we’ll see rates start to lift in late 2022.
Like AMP’s Shane Oliver:
“We are now pencilling in a small increase in the cash rate from 0.1 per cent to 0.25 per cent in November next year and a 0.25 per cent hike in December 2022, taking the cash rate to 0.5 per cent by the end of next year.”
So who is right? Markets or the RBA?
Personally, I’m still leaning towards the RBA.
Remember Phil Lowe has said recently that the labour market is key, and that he needs to see wages growing at 3-4%. Wages are currently growing at 1.7% so we’re a long way off that one.
Secondly, when you break down prices in the latest quarter, price pressures are pretty thin. It’s almost exclusively in petrol prices and housing construction (due to material shortages).
Neither of those are likely to be permanent.
And lastly, when you look at what’s happening around the world, Aussie inflation still looks very tame.
Core inflation in the US is running at 3.6%, in the UK it’s 2.9% and in New Zealand it’s 4.9%!
So 2.1% is hardly cause for panic.
Especially when you’ve just spent six years undershooting the target!
So look, pressure is building. Markets are skittish.
But markets have been wrong before.
And I think any normalisation of rates is more likely to happen on the RBA’s schedule than not.