There’s almost no chance, at this stage at least, that rates will remain on hold in May. In fact, money markets appear to have priced in a series of back to back rate cuts for the next three meetings.
A little more than a month off but, already, the calls are being made.
Will the Reserve Bank of Australia deliver a single cut or, given the mayhem on global markets, opt for a double rate cuts? Much will depend upon the March quarter inflation statistics due on April 30. Happily, consumer prices have decelerated at a better than expected pace with underlying inflation back in the RBA’s target band in recent months. This gives the RBA some wriggle room.
The biggest challenge, however, emanates from the erratic behaviour of recently installed US President Donald Trump.
Corpulent he may be, but he’s become something of gymnast, at least when it comes to policy decision-making.
Financial markets have descended into a state of almost constant turmoil. The upheaval briefly interrupted by occasional presidential backflips on previously declared rock solid policy.
At some stage, that is likely to spill-over into household spending given superannuation balances have dropped. Investors have racked up losses, which will be key to how the RBA reacts.
Is a liquidity crisis brewing and involving rate cuts?
It would appear those closest to the president have little idea of what is coming next. This is what last weekend’s events indicated.
On Friday, the White House posted a list of industries and products that would be granted exemptions. This included electronic devices such as smartphones and laptops, in the ever changing US tariff landscape. Over the weekend, the president decreed via social media channels that there would be no exemptions. Those products would incur the 20 per cent tariff that had been previously announced rather than the bloated 140 per cent.
The RBA has consistently noted that it is maintaining a vigilant eye on global affairs. The odds have risen that the global economy is headed for serious trouble.
If Trump continues, the best-case scenario is that we endure a sharp drop in growth and possibly another inflation outbreak.
The worst? A liquidity crisis that undermines and permanently damages the US financial system. Let’s hope it doesn’t get to that.
Still, the RBA is unlikely to be rash. The impact of the tariff war, its effect on the global economy and particularly China, has yet to be felt.
There is a solid argument that double rate cuts may provide some insurance. At the same time, a super-sized reduction could be counterproductive. This if it spooks households and business rather than providing relief.
Plus, the RBA might consider it more prudent to keep some fire retardant in store.
More about rate cuts
It is difficult to understate the level of danger into which global finance has descended.
The world’s biggest economy has self-inflicted the kind of wound that its enemies could never have imagined possible. Trump has correctly identified America’s unsustainable internal budget deficit as a problem. It needs urgent attention. But engaging in a reckless trade war has created stock market panic. This has spilled over into bond and currency markets.
The capricious decision-making process has forced a rethink of America’s role in the global economy.
Until a fortnight ago, the US was the global safe haven for investors. Any sign of trouble, and global cash would flee to the safety of US government bonds. It was a system that allowed Americans to live well beyond their means. All that cash — from investment institutions to sovereign wealth funds and governments — washing through the US financial system kept interest rates low and consumption high.
Not anymore. In his ham-fisted attempt to punish the foreign countries that supply America with goods, investors from those very same countries have decided to rethink their US lending strategy.
Trump administration
What the Trump administration has failed to consider is that it now will cost America far more to service its already gargantuan debt, after US bond markets last week were hammered.
Bond investors didn’t get “queasy” or “yippie” as Trump described them. They went into full-scale revolt. Market interest rates went from under 4 per cent to almost 4.5 per cent and Trump was forced to buckle.
That mightn’t sound like much, but bear this in mind: Interest payments on America’s $US36 trillion ($56.9 trillion) debt — which is growing at around $US2 trillion ($3.1 trillion) a year — is the country’s second biggest budget expense after social security. It spends more on its interest bill than on defence.This year, America is due to refinance around $US7 trillion ($11 trillion) of existing debt, as well as issue a further $US2 trillion in new debt.
That’s about to become a lot more expensive than a fortnight ago, before Liberation Day blew the global trade system to smithereens.
On top of that, the increasing likelihood of a US recession this year will see a further deterioration in the US budget as social security costs rise and income from personal and corporate tax falls.
That will lay waste to any fiscal benefits from Elon Musk’s heavy handed cost-cutting program.
Critical banks and political minerals
Perhaps the most concerning thing about last week’s bond market insurrection is that it wasn’t a transitory event, a quick storming of the White House before a hasty retreat.
US bond market yields have remained stubbornly high ever since. To make matters worse, the US dollar continues to be smacked as global investors liquidate their US debt holdings and shift elsewhere, mainly Europe.
The word unprecedented is used a lot these days. But this loss of investor confidence on such a scale during a time of crisis is exactly that.America has suddenly been relegated from the world’s most trusted financial destination to somewhere down the pecking order. Faith has been broken and “America First” is no more.
How this plays out is anyone’s guess.
The enormous losses on global stock markets have left institutions and investors licking their wounds, but debt markets are an entirely different beast. They’re far more complex, with more at stake and often involve trades on debt using debt.
Banks and official lending institutions were bolstered after the Global Financial Crisis. But there are limits as to how much you can sandbag a financial system.
The fragilities in the system almost always come from some unexpected quarter. And the reversal on US debt markets last week, while certainly causing enormous losses, could also trigger liquidity issues elsewhere, either in the banking system, insurance system or between large institutions such as hedge funds.
With everything else that’s occurred in the past few days, it may have gone unnoticed that China has imposed blanket bans on exports of rare earths the United States.
Just as America has wielded enormous power — until now — through the might of its financial system, China has slowly built a monopoly position in many of the world’s critical minerals and rare earths.
