There’s been a sudden about-turn at the Reserve Bank.
In the space of just a few months, Governor Michele Bullock has dramatically changed her tune about the future direction of interest rates and the speed at which they’re expected to decline.
Back in February, when the RBA first cut rates after more than a year on hold, the message was all about caution and restraint. Like a surly teenager, the RBA said it was cutting, but only reluctantly.
The message between the lines was that, while the evidence pointed to it being the right decision, the increasing weight of expectations was somehow forcing its hand and, so, you should rein in your expectations about future cuts.
That attitude and the warnings that accompanied it have now completely disappeared.
There are two main reasons why.
First, Bullock has declared victory over the inflation fight after jettisoning the arguments about “the narrow path to a soft landing”. We’ve now landed. And inflation has been slayed while unemployment has remained low.
RBA Governor Michele Bullock cut the official cash rate in May to 3.85 per cent, which means mortgage rates under 6 per cent are the new norm. (AAP Image/Dean Lewins)
That’s the good news.
The second big force affecting rates — the outlook for growth — is more concerning.
Global growth and Australia’s growth have been marked down for the next two years because of the projected negative impact of Donald Trump’s tariffs.
The level of tariffs is entirely up in the air right now and won’t be finalised for another few weeks, if at all. Most countries are dialled in for 10 per cent tariffs but Mexico and Canada are facing 25 per cent, with China looking down the barrel of 30 per cent.
That could all change in a heartbeat, which is creating enormous uncertainty.
Just to reinforce the message, Bullock let slip that the RBA board’s decision to cut was unanimous and the only serious debate on Tuesday was whether it should deliver a supersized double cut.
“There was an argument [about it] and we did debate it, and you’d expect us to debate it. But quite frankly it wasn’t the strongest argument in the room,”
she said.
But the uncertain future, to which the RBA repeatedly refers, may not be confined to growth. There’s every chance the Trump Administration’s policies could switch the problems to much higher-than-expected inflation.
And that may turn the RBA’s projections on its head.
Growth v inflation
While the RBA’s concerns for global growth are entirely justified, it has chosen to overlook the worries about global inflation.
While the domestic economy seems to have stayed on the narrow path out of the inflation crisis, global uncertainty is a thorn in the RBA’s side. (Reuters: Tim Wimborne)
It’s not alone. Global investors have also focused attention on the temporary freeze on tariffs, hoping America ultimately will scale back its original threats to something that appears palatable and, somehow, we’ll sail through the storm.
But the threat to growth is matched by the potential for the tariffs to ignite another bout of inflation.
Despite the president’s protestations and denials, economists are agreed that America’s trade and tariff war against the world will raise prices for American businesses and consumers.
And it’s entirely possible that higher US inflation could permeate through the global economy.
Why?
Given it is the world’s biggest economy and the centre for pricing global money, anything that happens in the US tends to reverberate through the rest of the world.
Wall Street stocks may have recovered spectacularly, sending our stock market soaring. But bond markets remain unconvinced.
For weeks now, US interest rates have been rising on money markets as concerns grow about the inflationary impact of the tariffs .
At this point, the degree to which yields have risen isn’t concerning. But the trend is beginning to flash red.
US deficits and debt
For months, Trump has been harping on about America’s trade imbalance, that it runs a massive trade deficit with the rest of the world.
But its bigger problem has been its budget deficit and the $US36 trillion debt it has racked up after decades of deficits.
Economists are agreed that America’s trade and tariff war against the world will raise prices for American businesses and consumers. (AP: Manuel Balce Ceneta)
The interest bill on servicing that debt is now the second biggest item in America’s budget.
US bond markets now are becoming twitchy over the Trump Administration’s inability and unwillingness to tackle the problem.
The president is now pushing for Congress to ratify his “big, beautiful bill”, an omnibus piece of legislation that will incorporate, amongst other things, massive tax cuts for the wealthy and huge new spending programs.
Included will be the Golden Dome defence strategy, a space-age defence system announced this week, that could cost at least $US175 billion.
All up, the bill — including tax cuts promised during the election — could denude US government coffers by up to $US9 trillion over the next decade.
That has debt markets on edge, particularly after the last major ratings agency, Moody’s, downgraded US debt last weekend.
Already, the Trump administration has sparked a run on US assets with the greenback falling more than 9 per cent since the inauguration. Global investors no longer view America in the same benign way they once did.
The prospect of a huge lift for extra debt financing is likely to push US market interest rates higher, just as global growth slows.
And the US, with a debt to GDP ratio of 120 per cent, isn’t the only culprit.
Since financial deregulation half a century ago, governments globally have indulged in a debt-fuelled spending binge.
That trend has accelerated since the global financial crisis and the pandemic.
At some point, there will be a global reckoning that could force interest rates higher and Trump’s America may be the catalyst.