A deeper reality

Delivered on By Justin Pyvis

Good morning! Big news – we’re taking six weeks off from publishing after today’s wrap. When we return on Monday, 25 July it’ll be with a fresh look, a new publishing schedule and a completely different structure to the 300 issues we’ve churned out over the past 452 days (can you believe it’s been that long?!).

We’re also changing the name of the newsletter from Brekky Wrap to The Context. If you’d like to know more, we’ve written about the change and what it means here.

We think you’ll like it – be sure to whitelist hello@thecontext.au so you don’t miss out. In the meantime, take care and enjoy what will be our final wrap!

Reading the tea leaves

Daily % change







AU Bond



US Bond









Brent (bbl)



Gold (oz)



Iron ore (t)









Note: Brent oil, gold bullion and iron ore prices are the second futures contract. Bond yields are 10-year Treasuries.

The US S&P500 plunged -2.38% overnight, with all 11 sectors in the red ahead of tomorrow’s all-important consumer price index reading, which will go a long way to determining just how hard the US Federal Reserve lifts rates. Concerns about stagflation also grew after signs of weakness emerged in the US labour market, as “initial jobless claims spiked to their highest level since mid-January last week”.

Locally, the ASX200 fell -1.42% with only energy (+0.6%) gaining on the back of another increase in oil prices the night before. Most of the damage was done by the index’s two largest sectors, materials (-2.2%) and financials (-2.1%), which fell due to lower commodity prices and rising interest rates – Australian 10-year Treasury yields hit an eight-year high during the session – respectively.

Food for thought

Did the pandemic break the Phillips curve, or was it always "just a correlation after all, hiding a deeper reality".
Did the pandemic break the Phillips curve, or was it always "just a correlation after all, hiding a deeper reality". Source

A deeper reality: The world’s central bankers, including the hundreds of PhDs that walk the halls of Australia’s RBA, rely heavily on so-called New Keynesian models of the economy, the centrepiece of which is the Phillips curve.

According to economist John Cochrane, that worked relatively well for them between 2007 and 2019, with “large changes in unemployment correspond[ing] to very little change in inflation”. However, their models broke when the pandemic struck (with a lag, of course):

“Clearly, something is very wrong here. Maybe expectations shift. Maybe supply shocks do matter after all. Surely one should start with a serious dynamic Phillips curve, as most macro literature does. Maybe the Phillips curve is flexible up but sticky down, and the natural rate shifts around. Maybe prices are sticky until they aren’t. As Bob Lucas showed long ago, the slope of the Phillips curve depends on the volatility of inflation. Countries with volatile inflation get no output boost from additional inflation. Thousands of epicycles can be added, and this post is a bit of an invitation to do so. Or maybe the Phillips curve was just a correlation after all, hiding a deeper reality.”

Cochrane concludes that the breakdown of the Phillips curve means “This time of inflation will lead us to rewrite an awful lot of macroeconomics.”

But it should also teach us to be wary of macroeconomic ‘truths’ in general – we would all be a lot better off today if the world’s central bankers had glanced away from their macro models for a moment and used a bit of judgement and common sense; perhaps it would have allowed them to see the inflation monster that was staring them right in the face, before it was too late.

On broken models: Back in February we pondered what Australia’s Treasury Secretary and RBA board member Steven Kennedy would say “when his model really breaks from reality and inflation starts rising a lot faster than wages..?” Now we have the answer:

“Treasury Secretary Steven Kennedy has urged the Albanese government to control ‘significant spending pressures’ on disabilities and aged care, while suggesting a crackdown on tax breaks worth billions of dollars to the wealthy and companies.

Dr Kennedy issued a frank warning that the federal budget must be repaired to manage inflation risks and rebuild fiscal buffers for future economic downturns. He said that solely relying on economic growth to reduce the $1 trillion debt, as both sides of politics flagged during the election, was no longer the ‘prudent’ course.”

What a difference a few months can make – Dr Kennedy has managed to rapidly transform himself from chief proponent of debt-financed expansionary fiscal policy (monetised by the RBA) to economic reformer who wants to move Australia to “closer to the global frontier” of productivity growth. 🙄

Credibility in tatters: Former RBA economist and AMP CEO Andrew Mohl was the latest to lash the RBA:

“The RBA’s credibility is in tatters. So much for cash rates not rising until at least 2024. So much for its commitment to hold medium-term bond rates at 0.1 per cent. So much for its forecast that inflation would remain below 3%.

In hindsight, the warning bells were ringing loudly in late 2020. Broad money supply then was growing at an annual rate of almost 13% after the RBA had resumed money financing of budget deficits – a practice that had been abandoned more than 30 years earlier because it was so inflationary.

Incredibly, there was barely a murmur of commentary about this rapid growth in money supply.”

Mohl is clearly not a subscriber. We repeatedly warned the RBA of its mistakes e.g. in June, July, multiple times in October, November, more forcefully in December and then seemingly every week in 2022, starting with this special report.

But that’s all in the past – what no one seems to be prepared for are the billion-dollar trading losses the RBA’s about to start realising this coming financial year, after its unelected bureaucrats recklessly speculated on government bonds.

Chewing the fat

Bits and bytes

🏡 Economists at ANZ, AMP Capital and CBA expect house prices to fall more rapidly – up to 18% in Sydney and Melbourne by the end of 2023 – as a result of the RBA’s decision to bump up the cash rate faster than they anticipated.

🛂 The Northern Territory government will scrap its strict vaccine mandate from 16 June. With quarantine no longer required, the Howard Springs facility – Australia’s largest – will also be shut down.

📊 Australia’s death rate in 2020 – the first year of the pandemic – was the lowest ever recorded but the “death toll in 2022 is already more than double that of the previous two years combined”.

🔐 Freedom didn’t last long: “Shanghai will lock down a district of 2.7 million people on Saturday to conduct mass coronavirus testing, city authorities.”

🌾 The OECD’s latest Economic Outlook warned that “the global economy [is] on a course of slower growth and rising inflation - a situation not seen since the 1970s… raising serious food security risks in the world’s poorest economies”.

📈 At its latest meeting the European Central Bank “said it would raise its key interest rates by 0.25% in July, with further increases planned for later in the year… [as] inflationary pressures had ‘broadened and intensified, with prices for many goods and services increasing strongly’.”

🤏 “Shrinkflation” is accelerating worldwide because it “appeals to manufacturers because they know customers will notice price increases but won’t keep track of net weights or small details, like the number of sheets on a roll of toilet paper”.

✈️ To counteract fake passport usage, Ryanair required “South African travellers to take an Afrikaans test to prove their nationality before boarding flights… [but Afrikaans] is only used by an estimated 12% of the population”.

📉 Nobel laureate economist Robert Shiller estimated the chances of a US recession sometime over the next couple of years is 50%, a level “much higher than normal”.

🍎 Apple is shifting iPad production out of China for the first time ever, making it “the second major line of Apple products made in [Vietnam], following the AirPods earbud series”.

🚢 China’s exports jumped 16.9% in May from a year earlier, well above the 7.3% expected despite “the latest coronavirus outbreaks and resulting lockdowns, [with] Shanghai only ending its two-month shutdown last week”.

📺 The “Direct Line with Vladimir Putin” annual TV show, on air since 2004, was “abruptly cancelled… due to potential backlash in the form of questions about Ukraine”.

⚔️ Russia’s President Vladimir Putin spoke on Peter the Great’s 350th birthday anniversary, saying “Peter the Great returned territories and fortified them. This destiny has also fallen to us.”

⛳ The PGA tour suspended 17 golfers – ten of whom had already resigned – for playing in the rebel Saudi-backed LIV Golf league.