I described the August decision by the Reserve Bank of Australia (RBA) Monetary Policy Board (MPB) to leave the policy rate unchanged as “defensible but contestable”.
In essence, the Board at the August meeting ceded the argument that increases in the policy rate so far this year are working to contain inflation, and with activity growth tepid, the balance of risks pointed to no need to increase the policy rate at the August meeting.
That the decision was not without risk was exemplified by the reality that inflation pressures in Australia are among the highest in the developed world. That reflects the uncomfortable circumstance of a homegrown structural inflation proclivity.
That some Board members were cognisant of those homegrown inflation risks seemed to be made clear in the minutes of the August meeting, which canvassed the potential requirement to increase the policy rate should upside inflation risks materialise.
This week’s monthly July consumer price index (CPI) report brought those upside risks into stark relief.
Indeed, the July report makes it hard to construct a narrative around declining inflation. The annual rate of increase is stuck at 3.6 per cent. Perhaps even more worrying, the annualised 6-monthly rate of increase is at 3.9 per cent. That is the highest in the (admittedly short history) of the published monthly series.
What is more, “sticky” inflation must cast some doubt on the prevailing RBA (and financial market consensus) narrative that monetary policy is restrictive. A “real” policy rate of somewhere around ½ – ¾ per cent does not strike me as particularly restrictive, at least in terms of an inflation containment challenge compounded by policy missteps at the governmental level.
I have noted in the past that Australia’s poor relative inflation performance stems from abject productivity growth, which makes the task of inflation containment all the harder, necessitating higher policy rates. That abject productivity growth reflects, inter alia, the interplay of regulatory creep in labour and goods markets. Regulatory creep also imposes costs on businesses, part of which are passed on to consumers, giving further impetus to price pressures.
In the absence of a meaningful (and at this stage somewhat unlikely) deterioration in the labour market, I strongly suspect that the RBA will be required to raise the policy rate again and certainly the September meeting is a “live” one in that respect.
Even in the event of some labour market weakness, the RBA may still need to contemplate a policy rate increase. Too great a delay in tightening policy runs the risk of too “sticky” an inflation rate and, as a consequence, a more substantial dislocation in economic activity and in the labour market down the track.
Warsh at Jackson Hole: inflation, the bond market and the “Bessent put”
Fed Chair Warsh has been roundly criticized for some perceived communication shortcomings.
He has an opportunity to address those perceived shortcomings when he addresses the Kansas City Fed’s Jackson Hole symposium on Friday night (AEST).
Warsh has articulated a strong antipathy to forward guidance.
In essence, Warsh appears to doubt that such guidance (exemplified by the Fed’s quarterly “dot plot”) is additive to the information set of the Fed or markets. Indeed, he implies that, in some instances, the exercise is beset by a certain disutility, insofar as such projections are inherently ephemeral and create a damaging façade of an anchoring mechanism that bears no relation to unfolding reality.
At the same time, it might be said that Warsh has unnecessarily let his (perhaps justified) antipathy toward forward guidance manifest itself in a reticence to communicate a rationale for the Fed’s current stance, failing to communicate any detail regarding Fed members’ assessments of current inflation pressures, and indeed on the economy more broadly.
Warsh could have simply shared elements of the Fed’s current economic assessments without crossing the line into forward guidance
By choosing to communicate nothing by way of a rationale for the FOMC decision, the Fed Chair has created an information vacuum. In part reflecting that void, the bond market took the path of least resistance and arrived at a collective view that Warsh lacked resolve on inflation.
It probably didn’t help that President Trump opined that Warsh was doing a “fantastic job” and “would love to lower interest rates”.
Nor does it seem that Treasury Secretary Bessent’s somewhat clumsy intervention in the bond market has helped matters.
For one thing, it complicates Warsh’s narrative around signals from the bond market. Financial repression of the sort pursued by Bessent – if it is successful – smothers any meaningful signal from the bond market, a point made by Bessent’s former mentor at Soros, Stanley Druckenmiller, in a Wall Street Journal Op-Ed (with, apparently, some assistance from AI).
In any case, it is arguable whether such intervention will achieve its desired end. I have my doubts about the durability of the “Bessent put”.
But it is clear that the unsettled US bond market is worrying about more than just the inflation outlook. Bessent’s intervention, amid headlines about a $US40trn national debt and a budget deficit of a magnitude unprecedented at virtual full employment in peacetime, is testament to that.
Nevertheless, there is a credible (but contestable) case to be made that inflation is perhaps benign enough for the Fed to eschew a policy rate increase, at least for the time being.
This week’s private consumption expenditures (PCE) price index report provided some evidence that inflation continues to be less than feared, particularly in the wake of the Trump Administration’s tariff policies and the potentially deleterious effect on inflation and inflation expectations from the surge in oil prices in the wake of the Iranian conflict.
The traditional Fed inflation focus – the core private consumption expenditures (PCE) price index – is, at 3.3 per cent, well north of the Fed target of 2 per cent. However, Warsh prefers the Dallas Fed trimmed-mean measure, which is currently running at 2.3 per cent – not that far from the Fed target. That gives the Warsh Fed at least some temporary cover in eschewing a policy rate increase.
Of course, the vagaries of oil prices and tariffs might upset that positive emergent US inflation narrative.
Warsh has articulated a desire to reframe the Fed’s strategic direction via the establishment of a series of taskforces covering communication, Fed balance sheet management, a review of data sources, productivity and jobs, and inflation drivers and measurement.
By giving some indication of progress on these taskforces at Jackson Hole, Warsh might be able to better articulate a rationale for an unchanged policy rate. The areas pursued by the taskforces give Warsh some scope to expand on his previously expressed view that disinflation in the US will follow from tremendous (largely AI-motivated) investment. In Warsh’s view, that investment has wrought a productivity dividend that (other things equal) has raised the US economy’s “speed limit”. In other words, the US economy can grow at a faster rate before igniting inflationary pressures.
The notion that AI-driven productivity growth can constrain inflation is a credible – if debateable – position. Some worry that the huge capex requirements associated with AI might, in the short term, put demand pressure on inflation.
Bond markets still have a bit to worry about, particularly the huge US Budget deficit, and despite some glimmers of hope, inflation is still a concern, but some communication around progress on the taskforces might be helpful for markets in gaining an understanding of the drivers of monetary policy under the Warsh regime at the Fed.
Stephen Miller is an Investment Strategist with GSFM. The views expressed are his own and do not consider the circumstances of any investor.
