What goes up should come down

Inflation worries weigh on minds of investors as do the many questions hanging over Bitcoin

24 May 2021 | Shane Oliver, AMP Capital (Image: Sean Robertson)

The inflation scare continued to worry investors over the last week and likely has further to go yet. Our view remains though that the spike in inflation is largely transitory and reflects distortions caused by the pandemic and reopening which should fade as global production returns to normal and consumer demand shifts back to services from goods.

There are signs that some commodity prices may be starting to roll over (with lumber down) or slow and semiconductor chip prices may also be starting to fall. As such, central banks are unlikely to rush in with an early and debilitating monetary tightening that brings an end to the bull market in shares. Thanks to ongoing easy monetary policy and rising earnings we continue to see share markets being higher by year end.

However, the inflation scare is likely to linger for a while yet as the earlier surge in commodity prices and bottlenecks continues to feed through which is likely to push bond yields higher and risk a further correction in shares in the next few months.  

Investment markets

Share markets had a bit of a rough ride over the last week with inflation fears continuing to impact along with taper talk in the US and maybe some impact from the fall in crypto currencies forcing speculators in them to sell shares to help cover margin calls on their crypto losses. This left US shares down 0.4% for the week, but Eurozone shares still gained 0.3%, Japanese shares rose 0.8% and Chinese shares gained 0.5%.

Australian shares were hit hard early in the week by inflation fears and concerns about China diversifying its iron ore supply away from Australia (which is not likely in the short term as there is not much spare capacity outside of Australia with Australia accounting for 50% of global iron ore exports) but managed to claw back resulting in a 0.2% rise for the week with strong gains in IT, health and retail shares being partly offset by weakness in utilities, materials and energy shares. Bond yields actually fell, and commodity prices were soft with metal and iron ore prices down and oil prices down on reports of progress in US/Iranian talks to return to the nuclear deal and end sanctions on Iran. The $A fell despite a further fall in the $US. 

RBA in step with Federal Reserve

The minutes from the RBA’s last meeting offered little that was new – but its approach looks like similar to the Fed’s. We expect the stronger than expected recovery to see it announce in July that it will stick with the April 2024 bond for its three-year bond yield target and that it will taper its weekly bond buying from $5bn a week to $2.5bn a week in September when the current bond buying program ends.

However, the RBA wants to see wages growth “sustainably above 3%” in order to be confident of sustainably achieving the 2 to 3% inflation target. Unemployment and underemployment are falling faster than expected but at 5.5% and 7.8% respectively are likely to be a long way from full employment which is likely to be nearer 4% and 6% respectively. And so, sustained 3% plus wages growth is likely still several years away. Ergo it follows so too is the first-rate hike – albeit we expect it to come in 2023, which is a bit earlier than the RBA’s “2024 at the earliest”. 

Victorian and Federal Budget

Sticking to Australia – just as it was surprising to some to see the Federal Coalition Government deliver another stimulatory Budget with no budget repair in sight, it was also surprising to see Victoria’s Labor Government deliver a budget with $15bn of budget repair. There were some winners, but the danger is that the tax hikes and public sector cost savings weigh on the recovery at a time when Victoria has been harder hit by the pandemic than other states. The various tax increases risk further distorting the tax system, and the property tax increases risk adversely affecting affordability (particularly as those buying $2 million plus property are forced into slightly cheaper property having a cascade effect down through the market) and the windfall property developer tax risks adversely affecting property supply. 

Our Australian Economic Activity Tracker rose over the last week and remains very strong indicating that recovery remains on track. Our US and European Economic Activity Trackers also rose with our US Tracker almost back to precoronavirus levels but our European Tracker still well down. 

Bitcoin rollercoaster

The wild slide in Bitcoin and other cryptocurrencies over the past week or two reminds us of three key things. First, – while it beats me as to why Elon Musk just discovered this – it uses a massive amount of electricity so is far from environmentally friendly.

The claim by some that because it uses so much electricity it will incentivise investment in solar and other sustainables is an environmental nonsense akin to saying that the path to sustainable power is to all use more energy! Second, cryptos face massive threats from governments not wanting to give up the revenue they get from issuing their currencies – as the PBOC highlighted by reiterating that digital tokens cannot be used as a form of payment in China.

Third, they are highly speculative as indicated by their sensitivity to tweets from digital gurus and “influencers”. They may be great for a bit of noisy volatility and excitement but that’s not the same as investing. To adjust Paul Samuelson’s comment “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800…” and put it in Bitcoin. Interestingly while Bitcoin has been sliding, gold has been trending up again. 

The crypto slide may be having a negative impact on share markets in the short term (as crypto speculators sell shares to cover their crypto losses) but it looks marginal with Bitcoin having had a 50% fall since mid-April but shares remaining near record highs. The crypto plunge is unlikely to have much impact on broader economic conditions as most have no exposure to crypto currencies, any negative wealth effect will be swamped by ongoing stimulus and the banking system has little exposure to them.

Dr Shane Oliver is Head of Investment Strategy and Chief Economist, AMP Capital

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