1 October 2019
What happens when your local Central Bank declares war on Unemployment?
The Reserve Bank of Australia has shifted its focus from supporting an improving labour market, presumably one with gradually falling unemployment rates, to targeting a labour market at full employment. In official ‘Central Bank language’ there is nothing subtle here.
Full employment is thought to be about 1% lower than current rates. Why is the RBA targeting full employment? Because only then do they forecast wages to rise faster than inflation, boosting consumption and importantly, core inflation back towards their 2-3% target zone.
Now the RBA has called in reinforcements – literally begging Governments to accelerate infrastructure spend – but so far those calls are falling on deaf ears. The promise of a Surplus is taking priority. There are really only three levers the authorities can pull to influence macroeconomic activity.
Monetary policy (interest rates); Fiscal policy (Government tax and spend); and the exchange rate. The RBA sets short interest rates directly, and indirectly influences long term rates, and are doing all they can to get them down and keep them there. Low rates usually promote a lower Australian dollar – this has been happening, helping our traded goods sector.
There is no sign of significant Fiscal ease. At current employment growth rates, it will take well over a year to reach full employment. That means rates are low, staying low and potentially going lower. Remember, at around 1.2/1.5% for a term deposit at the bank your savings are just about keeping pace with inflation. Investors will continue to look for better returns.
Those returns may be available in volatile financial assets like shares, corporate hybrids, property trusts or their foreign equivalents. However, by most historical standards these assets are expensive and exposed to an increasingly risky global economic environment – Trade Wars, Middle Eastern conflicts, Hong Kong protests, China slowdown and debt bubble, and US isolationism.
Couple this picture of diminishing policy support for growth with a slowing China and the outlook for growth in Australia at a high enough rate to get to full employment is challenged. In that environment investors will begin to focus more on real, rather than expensive financial assets. Some have controversially suggested that low rates have led to stretched valuations in traditional assets. Things investors can see, touch, feel, and even smell are, by comparison, reassuringly tangible.
Real property will rise in value, although at 2.5% or so yield in Sydney and Melbourne versus a 5% or so Investor borrowing cost, it may struggle.