Stephen Miller
2022 may have been an annus horribilis for RBA Governor, Philip Lowe. And so far 2023 doesn’t seem to be much better.
In the last week he has been pilloried for his communication “difficulties”.
Much of that stems from briefing given to clients of an investment bank, something which RBA Governors have been doing for decades. This writer recalls attending various such briefings dating back to the period when Bernie Fraser was the RBA Governor, and his term commenced in 1989. Indeed, the (faux?) indignation surrounding such briefings has all the elements of a media sponsored pile-on. Some of that appears to stem from the Governor’s decision to decline a National Press club speaking invitation. That is inconsequential as it hardly signals the Governor’s withdrawal public commentary altogether.
Of more importance is that the substance of the recent criticism misses the point. It is not the various fora through which the Governor chooses to communicate that is the problem, but the flawed substance of the message.
The missteps in RBA communication through 2022, including the “no increase in the policy rate before 2024” have been well documented. However, it is more important to recognise that the substantive error that led to that flawed policy communication was the underappreciation of persistence, magnitude, and momentum in inflation.
Even after the abandonment of the “no increase in the policy rate before 2024” mantra, that underappreciation continued. It is reflected not only in the RBA’s comparative caution in raising the policy rate but in communication which implied a reluctance on the part of the central bank to get out in front of the inflation challenge.
This was exemplified by the revelation in the minutes of the December RBA Board meeting that a “pause” in increasing the policy rate was on the table. This indicated that the policy optionality pendulum has swung too far from the specificity of “no increase in the policy rate before 2024” to one that is so wide that it becomes meaningless. Moreover, to openly contemplate a pause when all indications were that inflation momentum continued unabated was highly questionable.
In my view, the decision last October to reduce the magnitude of the policy rate increment from 50bps to 25bps was also an error but I would admit that is a more contestable point. That said, it appeared to indicate a reluctance to commit firmly enough to inflation containment.
Sure, the RBA continued to “talk the talk” on inflation but it did so with the walk of the lame.
Certainly, over the course of the summer the RBA has appeared to shore-up its resolve to aggressively tackle inflation. This was reaffirmed at Lowe’s Parliamentary testimony yesterday.
In my view this new-found hawkishness is a welcome development.
This week’s NAB monthly business survey continue to indicate considerable wage and price momentum into 2023. Indeed, the three-month annualised measures derived from the NAB survey suggest that wage and price growth in the double-digit zone. While I don’t believe those sorts sort of magnitudes to be reflected in official readings, these sorts of numbers do indicate that in the absence of concerted anti-inflationary monetary measures, any inflation “peak” may well be illusory.
The attached chart shows the 3-month annualised rate of increase in the NAB Monthly Business Survey measures of labour costs and retail prices. While those measures appear to have peaked, they remain well above the quarterly annualised increase in trimmed-mean CPI. That may mean that the latter remains “sticky”, admitting the possibility that the RBA’s favoured inflation measure may yet exceed upwardly revised February Statement on Monetary Policy (SoMP) forecasts. Rather than “peak”, inflation may just “plateau”. In this context a policy rate with a “4 handle” seems highly likely and there must be some upside risk that the current peak policy rate of circa 4.15% reflected in market pricing is exceeded.
In this context, criticisms surrounding “private” briefings of market participants are a distraction, as are the mostly myopic grumblings of some politicians.
Indeed, the RBA has not had a lot of help from other arms of policy. State governments have shown little disposition to adequately rein in pandemic-era spending. And well-intentioned but, in certain instances, flawed changes to the regulatory environment, particularly (but not solely) in relation to the wage-setting framework, run the risk of entrenching higher inflation in Australia..
The pandemic saw monetary policy assume unprecedented levels of accommodation. Viewed through that lens, policy adjustments through 2022 may have represented a partial return to some version of normality and perhaps significantly tighter conditions are yet required to meet the inflation challenge.
Drawing on the ‘70s experience the least costly path in containing inflation in terms of potential dislocations in activity and employment, is to be aggressive early in the piece. It was this recognition that drove the Fed and the Bank of Canada to aggressively hike their policy rates in 2022. It is no coincidence that those economies are on the verge of some respite from inflation. A more acute dislocation of activity and employment comes from central banks exhibiting excessive caution in in containing inflation and then having to slam the monetary brakes later in the piece. The path between containing inflation and recession becomes narrower the longer central banks delay aggressive action against inflation. The RBA’s prevarication through 2022 meant that path got much narrower than necessary.
That means 2023 will be a year of slow growth – perhaps even recession. That is true of most economies and was “baked in the cake” some time ago when nearly every developed country central bank was late in recognising the persistence, magnitude, and momentum in inflation and that the attendant fallout from the pandemic was not as bad as initially feared.
Some central banks such as the Fed and the Bank of Canada have taken aggressive remedial action and there is some with some prospect that they may have minimised the fallout in terms of growth and employment. Others, such as the RBNZ, have admittedly fared less well, possibly reflecting regulatory frustrations.
Those central banks who prevaricated on assuming a more aggressive role in inflation containment, including the RBA, face potentially bigger challenges. That prevarication has raised the probability of a more extended period of slower growth culminating in a more substantial dislocation to employment and activity.
And even if the path between inflation containment and recession has grown even more narrow through 2022, that the RBA and its Governor appears more focussed on inflation means that it might still yet be navigable but early aggressive action is the key.
That hitherto complacent markets unambiguously comprehend the RBA Governor’s message only helps. Even if it is delivered via a “private” briefing
US January core CPI slightly higher than expected but still vindicates Fed’s aggressive approach
January’s slightly higher than expected US core CPI result represents a vindication the aggressive approach exhibited by the US Federal Reserve to the containment of inflation, and its recent messaging around the policy rate getting to above 5% and staying there for an extended period.
Last night’s retail sales simply reaffirms that hawkish messaging. January retail sales jumped by the most in 2 years possibly reflecting some bounce-back from weather-related weakness in December.
And while Federal Reserve officials continue convey a (mostly) hawkish message the reality is that the most recent “dot plot” indicates that by and large FOMC members do not believe there is much more left to do.
In essence the difference between markets and the Fed has been the first easing point. By and large Fed officials think that a policy rate above 5% would endure until the end of 2023 even with a projected slowdown in activity. Up until the period prior to the release of the January employment report, markets had been implicitly less sanguine on activity, expecting faster declines in inflation and had seen the policy rate closer to 4.5% or lower by year-end. Last night’s January retail sales release following the January CPI and the blockbuster January employment report, has significantly tempered (though not erased) those expectations to the extent that markets now expect a “5 handle” by year end.
Measures of the ‘inflation pulse’ are down from their peak even if newly updated seasonal factors have seen the extent of that decline to be less significant than it had appeared. The 3-month annualised core CPI was 4.6% in January, up from 4.3% in December but well down from a peak of 7.1% in June. Similarly, the Cleveland Fed trimmed-mean measure was at a still elevated 5.8% in January, up from 5.2% in December but well down from a peak of 7.8% in June.
The big question regarding future inflation is over the trajectory of services inflation. On that front the jury may still be out as 3-month annualised services inflation rose to 7.2% in January from 6.4% in December but down from a peak above 11% in May. The closely watched services ex-shelter rose back above 4% in January after plunging to under 1% in December.
Probably reflecting some “stickiness” in services inflation, Federal Reserve officials continue to adopt a hawkish stance and at this stage I’d conjecture at least two more 25bp increases from the Fed in 2023 taking the upper limit of the policy rate target to 5.25%. Further my expectation is closer to the Fed’s “higher for longer” outlook compared with market pricing which admits some probability of easing from that 5.25% level by year-end.
Having said that, a US 10-year bond yield is probably range-bound around a mid-point close to 4%. On that basis it is not a stretch to posit that bonds (government and corporate) offer investors a modestly attractive enough yield without the prospect of significant capital losses, even if the 10-year government bond yield today a little south of that 4% level. In other words, it may be time to “dip a toe in the water” on bond exposure.
A proximate stabilisation in bond yields may be good news for US equity markets, representing as it does the abatement of what has been a significant valuation headwind. However, while equities benefit from stabilizing bond yields, the question remains whether earnings estimates have appropriately priced the cyclical downside. Depending on the extent of cyclical downside, equities seem likely to offer at least single digit returns and perhaps more if any recession is shallow and short-lived. Markets are now flirting with this ‘Goldilocks-lite’ scenario.
Of course, recession remains the big question. In terms of commentary, recession talk was around for much of 2022, particularly in the second half of that year when the Fed embarked on four successive 75bp policy rate increments. Thus far, the data has not validated that recession view, particularly given the labour market’s extraordinary resilience and even the latest Atlanta Fed GDP ‘nowcast” has first quarter GDP growing at a respectable 2.2% after 2.9% in Q4 2022 and 3.2% in Q3 2022.
Understandably the forgoing has raised expectations that the Fed may “thread the needle” and engineer smooth disinflation without an excessive dislocation in activity and employment.
That narrative seems plausible but is a highly US centric one. The challenges loom larger in the Eurozone, in the UK (even after a better January inflation report) and in Australia.
UK core inflation surprises on the downside
UK January inflation surprised sharply on the downside with core inflation coming in at 5.8% compared to 6.2% expected and 6.3% in January.
That will certainly ease the pressure on the Bank of England whose Governor had on occasions through 2022 appeared to resile from assuming an aggressive frontline role in inflation containment even if the Bank of England adopted a more aggressive tack in the second half of the year increasing the policy rate from 1.25% to 4% from August through to February.
The decline in inflation probably gives the BoE scope to reduce the policy increment to 25bps when it next meets in March.
By Stephen Miller, investment strategist
