Via the AFR:
Donald Trump appears on track to blow out the US budget deficit and debt, in a Reagan-like fiscal loosening that could drive up global interest rates higher than anticipated.
Not that stock investors seem to care. The Dow Jones Industrial Average burst through a record 21,000 points Wednesday in New York (Thursday AEDT) following Trump’s toned down speech to Congress.
Yet unless fiscal conservatives in Congress act on their concerns about Trump’s unfunded big spending and tax cut plans, Australian home borrowers will be among those to feel the reverberations.
Economist Warwick McKibbin, a former Reserve Bank of Australia board member, is visiting Washington and reckons Trump is about to unleash a big fiscal stimulus that will propel the US dollar, inflation and global interest rates.
“Rising global long-term interest rates will inevitably be reflected in rising mortgage costs in Australia,” says McKibbin.
When president George W. Bush pushed a second round of tax cuts in 2003, former vice president Dick Cheney famously said: “Reagan proved that deficits don’t matter.”
That’s my base case too for the US. However, the detail is very important for everywhere else:
- if our Donald goes for his border tax proposal then the US dollar will rise so fast that any inflation issue will be extinguished. The Fed will slow right down;
- if he simply deficit funds “massive” corporate and middle class tax cuts, and relies upon bilateral trade negotiations to fix trade, then, yes, the world will see more inflation and the Fed will hit the gas. The USD will still rise but not so fast.
Whether the RBA is forced to respond is a different question. It is clear that it would rather cut than hike rates right now:
“We’d like the economy to grow a bit more quickly and we’d like the unemployment rate to come down a bit more quickly than is currently forecast.
“But if we were to try and achieve that through monetary policy it would encourage people to borrow more money and it probably would put more upward pressure on housing prices and, at the moment, I don’t think either of those two things are really in the national interest.”
It is trapped by specufestors. The question is who will step into the breach? APRA has been hopelessly slow but the RBNZ is showing it the way with more targeted macroprudential policies. Really, all APRA needs to do is drop its investor loan speed limit to 5% and given it is so heavily weighted towards Sydney and Melbourne it’ll do the targeted job anyway. The silence around the question as house price rocket past last year’s growth highs is not encouraging.
Then we need to consider how fast the terms of trade boom will come off. Coking coal has already halved. Thermal coal is down one third. But iron ore is up another 20% at the same time. This balances out to roughly flat quarter on quarter for the terms of trade. Given it is iron ore that matters most and $60 is a fair average price for H2, then we will see big falls in the ToT in the second half. The RBA is not going to want to hike into that. Once we reach year end, Chinese reform looms as possible again with more falls ahead.
There is also clearly spiking political risk that the desperate Do-nothing Malcolm government does something crazy in the Budget, either tax cuts, first home buyer stimulus or, even more perversely, does some thing sane like negative gearing curbs, hinted at today by the Property Council. If it is the former and APRA remains asleep then the RBA may well be forced to hike into a weak economy. If it is the latter then the pressure could come off and enable the RBA to cut. Perhaps it will be a combination.
Whichever way you cut it, the headwinds for the economy are unchanged. For now conditions are moderate as the east coast dwelling construction boom persists. But once it rolls later this year, the car industry shutters and the terms of trade resume falling the headwinds mount for domestic demand even with some government investment and a slowing but persistent mining capex cliff.
So, at this stage my base case remains that the RBA doesn’t lift rates at all in the foreseeable future no matter what Donald Trump does even if there are some tail risk combinations of variables that could force it. Cuts are less probable today but still more likely than hikes.
There is the obvious second likelihood that the banks hike anyway. Their spreads have been falling but rising global interest rates will drive up borrowing costs.
