More good stuff from from Chris Joye this afternoon:
The exuberance in shares and housing will continue for as long as central banks deny savers decent rates of return in safer investments.
So how will one know when the worm turns? Look to bond market bandits rationally punting billions on the direction of future rate movements. After falling to as low as 2.5 per cent in August, the three-year Australian government bond yield jumped to 3.25 per cent in November, or 75 basis points over the RBA’s current cash rate. Rate hikes are coming – it is just a matter of when.
…If we are passing through the eye of the storm, what lies on the other side?
…Trend growth coupled with price stability means…equities, property, cash and floating-rate notes should all offer decent real returns in this favourable scenario.
The most probable local inflation trigger is a sharp fall in the Aussie dollar on the back of a sustained US recovery…That would be bad for housing, equities, and bonds, but good for cash and floating-rate notes.
…A third future to contend with is deflation…We could still get deflation [by] financial markets independently signalling that capital allocation has been massively distorted by cheap money (for example over-investment in housing and unproductive financial services) and requires radical adjustments. This is, in fact, what asset prices were telling us back in 2008.
Finally something to get our teeth into today!
First, if Chris is right and the Australian dollar falls even as housing recovers then we will indeed see rate hikes as tradable inflation pours into the economy.
But I see this as a contradiction in terms. If housing continues to boom then the threat and even reality of rate hikes will prevent the dollar falling very far. That will keep pressure upon tradable sectors and that disinflationary force will prevent anything untoward transpiring in the CPI. I see this happening even if there is a US taper which will not, of itself, lower the dollar far enough to get a proper recovery going as we head off the capex cliff. Such would also at least cap the share market if not cause outright falls.
If Chris is right that rate rises are coming anyway, driven by asset inflation not consumer price inflation, then our future is deflationary. As I’ve explained many times, this is the “RBA recession” scenario in which capping asset prices exposes the mining capex cliff and Australia finds itself without any domestic growth driver.
The third possible scenario is that asset prices slow by themselves on a weakening economy or via RBA/APRA macroprudential activity. In that event, interest rates fall further and there is an inflationary surge as the dollar falls but no rate rises as the RBA “looks through” tradable price spikes. This is actually the most sensible suggestion for rebalancing, so long as it is accompanied with wage restraint.
I still see outcomes two and three as vying for most likely at this stage.
