Time to put US inflation in an Aussie context

While traders now expect the RBA to raise the official cash rate (OCR) five times before the year’s end, panic merchants should remember that the US and Australia are travelling on two diametrically different journeys when it comes to inflation.

For starters, while US inflation hit 7.5% in January, up from 1.4% in January 2021, headline inflation in Australia, courtesy of supply issues, construction costs and high fuel costs is running at around half the US rate at 3.5%.

Where we differ

It’s equally important to note that US wage increases are abnormally high for the first time in years.

Much of this is due to sustained increases in hourly earnings, up 4.7% in December alone, and record low unemployment of 4%, due to a 2.4% fall in the [unemployment] rate over the last year.

Here in Australia, overall wage growth has fallen into a hole.

By comparison with the US, Australia’s wage price index (WPI) was up an anaemic 0.6% in the June to September quarter last year, up 2.2% on the previous period.

Admittedly, wages are inching higher in Australia, but at the aggregate level, growth appears back to the low rates experienced pre-covid.

Bottom-line is if you’re looking for evidence of a replay of a 1970s-style wage/price spiral, good luck – there isn’t one.

Are futures traders simply the biggest bed-wetters?

While the biggest surprise of 2021 was the surge in inflation globally, it’s a mistake to lump Australia in with the major inflation movers like the US, NZ and UK.

For example, an unexpectedly large jump in US consumer prices has fuelled the base-case for 'big-bang' Fed rate hike in March by as much as 0.5%.

The US market is also factoring in up to four additional increases over the course of 2022.

But despite what futures traders may think, no such pressure is evident here in Australia.

By comparison to the US, Australia’s central bank governor Philip Lowe has been forecasting low wages growth for a long time, and even today reiterated the central bank's view to "not increase the cash rate until inflation is sustainably in the 2-3% range."

Lowe said the Board is prepared to be patient, recognising that "there is a risk to waiting but there is also a risk to moving too early."

Implications for Australian investors

Admittedly, reading the inflation tea-leaves can be hard.

But what's gone largely unnoticed is that while the US and Australia are travelling on different tectonic plates when it comes to inflation, year-to-date, falls in Australia’s share market broadly reflect those experienced by the S&P500.

The rotation in the US from growth to value stocks may well be justified.

However, underlying sentiment from governor Lowe today only reinforces doubts that any rotation from growth into value stocks locally - on the notion that the inflation Jeanie is out of the bottle - could be hard to swallow.

It is entirely possible, added Lowe today, “that countries with higher inflation rates will need a bigger adjustment in interest rates than currently anticipated. If so, this could result in an abrupt adjustment in financial conditions."

No S!#@ Sherlock!!!