Wishful and delusional thinking

Delivered on By Justin Pyvis

Good morning! If the latest weekly ANZ-Roy Morgan survey is anything to go by then Australian consumers are not confident at all. Last week:

  • confidence plunged 4.8% to its lowest level since early September 2020 when Victoria was in lockdown;
  • just 23% of Australians say their families are “better off” financially than a year ago;
  • just 33% expect their finances to improve in a year, with 26% expecting to be worse off; and
  • only 9% expect “good times” for the economy over the next year.

Ooof. And this comes during a period of record-low unemployment, with consumers now very concerned about inflation – expectations are up to 6.0% (the highest in a decade), reflecting “pressure on household budgets as nominal wage growth lags the jump in inflation”.

Introductory image.

Reading the tea leaves

Daily % change

AUD/USD

74.7

+0.9%

AUD/CNY

4.75

+1.1%

AU Bond

2.78

+3.3%

US Bond

2.37

+2.5%

ASX200

7,341

+0.9%

S&P500

4,512

+1.1%

Brent (bbl)

115.3

-0.3%

Gold (oz)

1,922

-0.3%

Iron ore (t)

145.7

-3.0%

Bitcoin

42,398

+3.2%

Ethereum

2,993

+3.3%

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

The US S&P500 added 1.13% despite rising bond yields and expectations of further rate hikes by the US Fed, potentially by as much as 50 basis points at its next meeting in early May. A notable mover was Nike (+2.36%), which at one point was up over 5% after reporting stronger than expected earnings and sales.

Locally, the ASX200 rose 0.86% to a two-month high thanks largely to the usual suspects of materials (+3.3%) and energy (+1.7%), with higher oil and commodity prices due to the conflict in Ukraine and concerns about inflation helping both sectors.


Food for thought

A re-enactment of fiscal and monetary policy since the onset of the pandemic.
A re-enactment of fiscal and monetary policy since the onset of the pandemic. Source

Larry Summers – President Emeritus at Harvard University, former Secretary of the Treasury for Clinton and Director of the National Economic Council for Obama – pulled no punches in his response to the US Federal Reserve’s decision to hike interest rates by just 25 basis points last week, asserting that “the economic projections of the Federal Open Market Committee (FOMC) represent a continuation of its wishful and delusional thinking of the recent past”.

Ouch. 🔥

In all seriousness, Summers has been correct throughout the pandemic. He pushed back strongly against “Team Transitory” last year and has consistently warned that unprecedented fiscal stimulus in response to the pandemic (a supply shock), if not offset by tighter monetary policy, would lead to rapid inflation.

And here we are, with 7.9% inflation in the US as of February. We actually wrote about Summers' early warnings back in our very first issue in March 2021, with updates in August and November.

But let’s get back to the latest shot, which shares some similarities with the situation in Australia. The “central absurdity in the Fed forecast”, writes Summers, is:

“…the idea that a super-tight labor market will somehow coincide with rapidly slowing inflation. Even on the Fed’s optimistic accounting, a balanced economy requires 4 percent unemployment, meaning that it expects the labor market will remain abnormally tight over the next few years.”

That’s not forecasting problem unique to the US Fed. The Reserve Bank of Australia (RBA) forecasts unemployment falling to 3.5% over the next two years at the same time as it expects inflation to soften from its current 3.5% to just 2.75%, at the same time as wages growth rises from 2.25% to 3.25%.

Spot the problem? Summers does, noting that:

“…such conditions are inflationary, not disinflationary. Wages represent by far the largest component of costs. When they are rising so fast, what basis is there for supposing that inflation will slow to the 2 percent rang?

…under what reasonable economic model does rapidly declining inflation occur alongside negative real interest rates and record-low unemployment?”

The Fed, like the RBA which is also holding interest rates negative during a period of record-low unemployment, may still be pinning its hopes on inflation being “transitory”, in the sense that “it will evaporate as supply chains are restored”. As RBA governor Philip Lowe wrote in November last year:

“This is one basis for thinking that the current elevated rates of inflation are temporary: a period of strong demand saw prices rise, which was recorded as higher inflation, but prices aren’t likely to keep rising at current rates as conditions normalise, and some prices may even decline.”

Summers warns that such thinking:

“…has never seemed plausible, given accelerating residential and wage inflation and room for acceleration in the costs of health care, airfare and lodging. It seems even less plausible today, with war in Ukraine and covid lockdowns in Asia.”

Australia is likely to follow the US into an inflationary mess when the data catch up to reality. Governor Lowe will need to quickly become a hawk if he wants to avoid a similar crisis caused in part by the “wishful and delusional thinking of the recent past”.


Chewing the fat


Bits and bytes

🕵️‍♂️ “Treasury is well advanced in planning” a review of the RBA after the election, with support from “both Treasurer Josh Frydenberg and Labor’s treasury spokesman Jim Chalmers”.

📈 IGA’s chief executive Fred Harrison said he has seen the price of “cabbages, potatoes and broccoli in particular jump 75% compared to a couple of weeks ago”, while “Frozen vegetables have not recovered from the pandemic… I’ve got no doubt those suppliers are going to put price increases through the system.”

🚀 According to UK Intelligence, Russia’s claim that it is now using “hypersonic” missiles in Ukraine are in fact missiles it has been using “heavily” since day one, with the statement “intended to detract from a lack of progress in Russia’s ground campaign”.

📜 Presumably just a different allocation of rorts and waste: If elected a federal Australian Labor government would release a second Budget in 2022 to “start dealing with… nearly a decade of rorts and waste”.

🤔 “NSW Planning Minister Anthony Roberts scrapped a requirement to consider the risks of floods and fires before building new homes only two weeks after it came into effect.”

🛰️ Next week’s federal budget will include $A750 million to allow “120,000 additional premises to access fixed wireless services”. That’s $A6,250 per household. A Starlink satellite can be had for $A809

⛈️ The BOM warned people “not to be fatigued”, with another 100mm of rain expected to hit Sydney over the next few days.

⚔️ US President Biden cautioned: “Putin’s back is against the wall… And the more his back is against the wall, the greater the severity of the tactics he may employ.”

💱 Your 2c: The Australian government is seeking feedback on how “to support minimum standards of conduct by crypto asset secondary service providers and safeguards for consumers”.

👩‍💻 UK Intelligence reported that Russia’s forces “endured a yet another day of limited progress with most forces largely stalled in place”.

🗾 Japan’s Prime Minister Fumio Kishida said Russia’s decision to suspend negotiations on a post-WW2 peace treaty was “extremely unreasonable and totally unacceptable”.

📉 The RBNZ has so far lost $NZ5.1 billion on the $NZ53 billion worth of bonds it purchased during its foray into quantitative easing during the pandemic. Presumably the RBA has lost at least as much.

🚢 Shipping giant Maersk will “completely leave Russia and sell its Russian assets”.

🤝 “Italian prime minister Mario Draghi publicly endorsed Ukraine’s bid for EU membership on Tuesday.”