Economic Updates

Risk assets ended 2021 on a strong note. December saw risk assets rise strongly despite the potentially growth crimping threats from rising Delta and Omicron infection rates. For the most part 2021 and December were influenced by stronger than expected economic activity and faster than expected rise in inflation with governments and central banks barely starting to stem very easy policy settings.

We view early 2022 as a make-or-break period for the world’s major economies, including the Australian economy. Most major economies are leaving 2021 and entering 2022 with strong growth momentum built largely on the highly stimulatory policy settings of most governments and central banks. Where policy stimulus is starting to be wound back the process is modest so far and unusually modest in the case of central banks already presiding over above-target inflation.

Financial markets took in their stride the news on Friday that US annual CPI inflation had climbed to a near 40-year high 6.8% y-o-y in November. The richly valued S&P 500 rallied to a new record high, while the US bond market was unperturbed. The prevailing view in financial markets is that the high November CPI reading was no higher than expected by the markets and will not drive the Federal Reserve to accelerate reduction of its bond buying at its policy meeting this week. The markets are 100% convinced there will be no increase in the Fed’s emergency low 0-0.25% Federal Funds rate.

The Australian economy is more than a month into the rebound after the lockdowns in New South Wales, Victoria and the ACT. However, most of the official economic data releases due over the next 10 days will look backwards to Q3, reflecting the worst of the damage to economic activity from recent lockdowns. The approaching Q3 data releases culminate in the GDP report on 1^st December that is likely to show that economic growth fell at least 2% in the quarter.

There has been a shift in monetary policy over recent years from preemptively attacking the first signs of inflation to reacting to inflation once it is established in the data. The shift in policy thinking by central banks came in the latter years of the long period between the early 1990s and late 2010s when strong disinflationary pressures ruled. Some of the key factors contributing to disinflation were globalisation of production and flow of labour, technological development, demographics and through much of the period an emphasis on budget discipline by governments.

Conflicting influences on financial markets through October increased volatility, but with most risk asset markets recovering their losses from the previous month. Australian financial markets went against the improving trend, with a late month sharp lift in government bond yields caused by a higher-than-expected rise in Q3 underlying inflation. The broad-based lift in underlying inflation added fuel to views in local interest rate markets that the RBA will need to change its guidance that official interest rates will hold down at 0.10% until 2024. The market forced the 3-year bond yield above 0.70% at month end, well above the RBA’s 0.10% target rate.