In August 2020, the US 10-year government bond yield sat at just 0.5 per cent. That was arguably peak cheap money – the apogee of the “low-rates-for-long” paradigm. Fast-forward a few years, and the US 10-year yield pierced a staggering 4.
Back in December 2021, investors thought that the maximum Fed policy rate in the coming rate-increase cycle would be only circa 1 per cent. Yet today the Fed is already at 5.25 per cent to 5.50 per cent and threatening to move towards 6 per cent.In May, this year, markets were complacently pricing in more than 100 basis points of rate cuts from the Fed in 2023, which this column argued was absurd.
Yet in Australia and New Zealand, unit labour costs are running at 7 per cent-8 per cent. In Europe, they are expanding at a 6 per cent- per cent clip. The one hope is the US, where unit wage growth has recently decelerated from 5 per cent to 6 per cent to 3 per cent to 4 per cent.To its credit, the Fed has been more aggressive and forceful than most peers, quickly lifting its cash rate to double its 2.6 per cent estimate of the “neutral” rate.
One argument in favour of the RBA taking a softer approach to combating inflation – despite Australia’s inflation problem being just as bad as that evidenced overseas – has been the fact that mortgage rates have risen much further here than in peer nations because of the preponderance of variable-rate loans locally.
For example, a 100 basis point increase in the cash rate reduces inflation by about 0.1 per cent a year in Australia, Europe and the US according to the central banks’ macroeconometric models and by 0.3 per cent a year based on their DSGE models. One can then apply these estimates to figure out the likely impact of the recent policy changes since 2022.
“Unless inflation has suddenly become more responsive to higher interest rates, the estimates also indicate that central banks are implicitly assuming that most of the recent surge in inflation reflects temporary supply factors that are now being unwound, with much less of a role for the demand-driven inflation that is sensitive to high interest rates,” Davies says.