Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 77

Policy pincers in Australia and the US

In the US, the two big policy imperatives – unemployment and inflation – have been going in the right direction (down) since 2011. Ultra-loose fiscal policy (four years of trillion dollar budget deficits) and ultra-loose monetary policy (near- zero interest rates and unprecedented money printing) have borne fruit, albeit slowly:- the economy is growing, the unemployment rate is falling, the budget deficit is contracting, deflation has been avoided, inflation has been low, and asset prices are rising (including shares, bonds, housing and commercial property). The ‘QE’ money printing program is coming to an end without rattling asset markets or investor confidence.

Falling unemployment plus very low inflation, despite the strong dollar and tightening budget, mean the Fed can start tightening monetary policy by raising interest rates. The big risk is that the Fed continues to dismiss rising inflation as ‘noise’, and keeps interest rates too low for too long. The likely outcome is that the Fed will wait too long and have to hit hard with unexpected interest rate hikes, rattling investment markets, as in 1994.

Standing behind Fed Chair Janet Yellen now is the new Fed Vice Chairman Stan Fischer who, as head of Israel’s central bank from 2005 to 2013, used aggressive money printing to over-stimulate the Israeli economy, resulting in high inflation and a roaring housing bubble.

Investors want to see the Fed keep interest rates low for longer, but not for so long that it will be forced to act suddenly and unexpectedly to tackle inflation. All eyes and ears are on Yellen and how she views inflation and unemployment. In July she indicated that the rising inflation was merely “noise”; that monetary policy (rate hikes) should not be used to address asset bubbles; and that her main focus is now on ‘under-employment’, which is running at twice the rate of unemployment. In her Jackson Hole address at the end of August she hinted at possible rate rises early in 2015, rather than mid-year. But she also made it clear that she would be very careful and responsive to any adverse effects of rate rises on growth or employment.

It is the reverse in Australia. Here we have rising unemployment rates and rising inflation. In addition we still have very loose, and now politically chaotic, fiscal policy (big budget deficits and a hostile, volatile Senate). Inflation is already at the top end of the RBA’s target range but the RBA cannot raise interest rates to kill inflation and cool the housing market for fear of causing the dollar and unemployment to rise even further.

August saw the unemployment rate rise to 6.4%, up from a pre-GFC boom-time low of 3.9% in February 2008 at the peak of the commodities boom. Inflation is now up to 3%, the top of the RBA’s target range, and up from just 1.2% two years ago. Even ‘core’ inflation is now 2.9%. July also marked the start of the new Senate, with Palmer and other micro parties making fiscal policy and genuine economic reforms more challenging. This is dampening business confidence and investment and may necessitate the RBA providing monetary support for longer – ie keep interest rates low for longer.

As a result, the RBA, like the Fed in the US, will also probably act too late and too harshly with rate hikes. Indeed the RBA may even try another rate cut first to try to bring down the dollar. This would probably further inflame prices in the property and share markets, as well as accelerate consumer price inflation. That would mean it would need to come down even harder and harsher with rate hikes later on.

 

Ashley Owen is Joint CEO of Philo Capital Advisers and a director and adviser to the Third Link Growth Fund.

 

1 Comments
Jerome Lander
September 05, 2014

Great article Ashley. For anyone left wondering why the markets are rising they need look no further than this. Excessively easy monetary policy has helped drive markets up and may well continue to do so for the time being, or at least until it becomes clearer that rates can rise as well as fall.

Investor portfolios are largely speaking completely dependent on this - sharemarkets, housing, infrastructure, property, bonds - you name it.

There are few real alternatives and they can't compete on price performance in this environment. Nonetheless prudent investors need to consider how much monetary policy risk they are willing to own, which is almost the same in this environment as saying how much risk they are willing to take. As markets continue to rise, and we get closer to the time to expectations of an interest rate rise, this risk will just become more and more acute.

This is a potentially very profitable but very risky environment for investors. Market timers will be nervously monitoring expectations as timing becomes more critical than ever. Those who reduce their risk exposures before the markets more broadly know interest rates rises are coming will be the ones who get to keep their (impressive) gains from their risky long only portfolios. Investors do not know yet when that time will be - it may be a while off yet or 2015 may indeed be an interesting year.

 

Leave a Comment:

RELATED ARTICLES

Brace, brace, brace: The real issue behind the banking turmoil

Is it all falling apart for central banks?

Reserve Bank has both a date and data dilemma

banner

Most viewed in recent weeks

Retirement is a risky business for most people

While encouraging people to draw down on their accumulated wealth in retirement might be good public policy, several million retirees disagree because they are purposefully conserving that capital. It’s time for a different approach.

The perfect portfolio for the next decade

This examines the performance of key asset classes and sub-sectors in 2024 and over longer timeframes, and the lessons that can be drawn for constructing an investment portfolio for the next decade.

UniSuper’s boss flags a potential correction ahead

The CIO of Australia’s fourth largest super fund by assets, John Pearce, suggests the odds favour a flat year for markets, with the possibility of a correction of 10% or more. However, he’ll use any dip as a buying opportunity.

The challenges with building a dividend portfolio

Getting regular, growing income from stocks is tougher with the dividend yield on the ASX nearing 25-year lows. Here are some conventional and not-so-conventional ideas for investors wanting to build a dividend portfolio.

How much do you need to retire?

Australians are used to hearing dire warnings that they don't have enough saved for a comfortable retirement. Yet most people need to save a lot less than you might think — as long as they meet an important condition.

Welcome to Firstlinks Edition 594 with weekend update

It’s well documented that many retirees draw down the minimum amount required and die with much of their super balances untouched. This explores the reasons why and some potential solutions to address the issue.

  • 16 January 2025

Latest Updates

Investment strategies

UniSuper’s boss flags a potential correction ahead

The CIO of Australia’s fourth largest super fund by assets, John Pearce, suggests the odds favour a flat year for markets, with the possibility of a correction of 10% or more. However, he’ll use any dip as a buying opportunity.

9 ways to fix Australia's housing crisis

Decades of policy failure have induced a fall in housing affordability. Unless painful changes are made, an underclass will emerge in a society that is supposed to boast the one of the world's highest standards of living.

Shares

Australia: why the chase for even higher dividend yields?

Australia boasts one of the world's highest dividend yielding sharemarkets, providing substantial benefits to investors and retirees. Despite this, individuals often stretch for even more yield, to their detriment.

Shares

MIGA – Make Income Great Again

The Australian sharemarket seems to be rewarding a number of unprofitable companies on the promise of future riches. Yet profits and cashflows still matter, as a recent case study of Domino's Pizza shows.

Shares

Mapping future US market returns

Exceptional returns from the US sharemarket over the past decade have driven by sales growth, margin expansion, rising valuations, and dividends. Predicting future returns requires careful consideration of these factors.

Shares

Read this before you go all in on US equities

US equities rule global markets, but history is littered with examples of markets that seemed invincible — until they weren’t. Diversification will be key for investor portfolios going forwards.

Property

What impact would scrapping stamp duty have on housing?

Increasing house prices pose challenges for housing affordability. This investigates the impact of stamp duty on the property market, and how removing the tax could help address several key issues.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.