Market Update
“Some people dream of success, while other people get up every morning and make it happen.” Wayne Huizenga
Last week RBA (Reserve Bank of Australia) Governor Phillip Lowe reiterated his view that cash rates are unlikely to change before 2024 – “I find it difficult to understand why rate rises are being priced in next year or early 2023” – referring to market pricing. He restated his own view that “Our judgement is that this condition for a lift in the cash rate will not be met before 2024.” He strengthened the statement by raising the stakes in terms of his inflation guideline: “It won’t be enough for inflation to just sneak across the 2% line for a quarter or two. We want to see inflation around the middle of the target range and have reasonable confidence that inflation will not fall below the 2–3 per cent band again.” The well-known Phillips Curve below illustrates the relationship between inflation and unemployment and indirectly, interest rates.
In terms of employment numbers, Westpac expects that the unemployment rate will start 2022 at around 5.4%. Strong demand growth, constrained by supply restrictions, including slow population growth, are likely to see the unemployment rate fall to 3.8% by year-end. It’s incredible to think that Australia has not experienced a national unemployment rate below 4% since the early 1970s. This will, in theory, place some upward pressure on wages growth. The expected lift in wages growth will give the key boost to inflation through 2022 which should see the RBA reach its 2.5% inflation target in the December quarter 2022.
The first steps towards policy normalisation were also front of mind in the US this week as the FOMC held their September meeting. There was no formal taper announcement, but Chair Powell and the Committee guided that the conditions for this decision were “all but met”. Depending on the strength of the September and October employment reports, their decision to taper could come at either the November or December meeting. At present, risks related to the US’ delta wave of COVID–19 and developments in China seem to be having little bearing on US monetary policy.
China has also remained in the headlines this week, not because of monetary policy, but instead because of the plight of Evergrande and the impact of broader reforms to the residential construction sector which, together, have materially reduced momentum. The Evergrande situation is immensely complex and so will take time to work through. But there is a way forward, at least for the construction projects being undertaken by the firm. These projects are diversified by region and, even with the Evergrande holding company in a precarious financial position, still in demand. To protect both the purchasers of these apartments and the workers, they could be sold or handed over to other developers for completion. Notably, Evergrande’s spread across tier 2 and 3 locations is important to authorities as it fits with their intention to make wealth and quality of life more equitable across the population. This means the projects should also be valuable to other developers.
It is interesting to note, as per the chart below, that Evergrande’s bonds were trading at a significant discount to par back in July/August demonstrating just how efficient the fixed income market is at reflecting a company’s underlying financial health, something the Bond Exchange is incredibly diligent with.
The key takeaway this week is that central banks remain focused on 3 main factors. Monetary policy, inflation, and unemployment/wages growth. The stars must line up on all 3 for there to be a shift in interest rates. For now, it is about watching and waiting to see how economies around the world come out of what has been a horrid 2 years.
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