Back in our March 2021 newsletter we commented on the $1.9 trillion US stimulus package and a decline in bond prices. Central banks around the world kept interest rates at near zero in spite of rising inflation telling everyone to keep calm there is nothing to see here.
Then we went on a wild ride, with Aussie bonds leading the charge having their worst financial year since 1973, recording a negative 10.5%.
What went so wrong, how did the RBA go from saying they wouldn’t raise rates until 2024 to raising rates 1.75% in just three months in the middle of 2022? On top of this only as recently as June the bond market was pricing in the RBA to have rates at 4.4% by May 2023!
This time last year I was in agreement with the central banks believing they had things under control. The message that Covid was driving up inflation temporarily with-it distorting demand and supply. People not travelling nor spending on eating out or entertaining, instead increasing their spend on durable goods like cars, renovations and white goods. While the manufacture and delivery of these very goods slumped due to lockdowns and sickness.
The Covid haze seemed to be gradually lifting in 2021 with the world learning to live with the disease. This was until around December 2021 when the Omicron variant emerged. This much more transmissible variant does not agree well with China’s zero covid approach causing ongoing supply disruptions.
Making things worse Russia invaded the Ukraine in February 2022 causing a massive disruption of oil, gas and wheat supplies for the world. This was like a one two hit to central banks in their fight on inflation leaving them “behind the curve” and scrambling to raise rates and tame inflation before it got out of hand.
On a positive note, for the bond market since around 20 June we have seen a dramatic rebound. Perversely this is due to a less resilient economy than originally thought. We now have falling house prices and a drop off in consumer sentiment telling us interest rate rises to date should temper inflation somewhat and the RBA may not need to raise rates as high as previously thought.
Where we go from here is largely in our government’s hands. One part of Australia’s inflation story is to do with gas prices. Ironically, we have one of the largest gas reserves in the world yet domestically we pay the same war induced high prices as countries in Europe. Which if not fixed through government policy of taxation or gas reservation we could see inflation go higher on the back of a doubling or tripling of electricity prices within the national grid (excludes WA who aren’t in the national grid and funnily enough reserve gas for domestic use). This would not bode well for house prices and therefore the Australian economy.
Sam Martin CFP®
Authorised Representative (No 252676)