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10 Oct 2022 - Inflation will test Fed's patience, but RBA has cards up its sleeve

By: Pendal

Inflation will test Fed's patience,

but RBA has cards up its sleeve


September 2022

ALONG with many other observers, we expected US inflation to moderate more than it did in August.

Headline CPI came in overnight at 0.1% (8.3% annual) and underlying at 0.6% (6.3% annual).

A new group of unrelated components (including vehicle repair, dental charges and tobacco) showed fresh signs of inflation, pushing the rate positive for the month.

We still expect goods deflation in the months ahead. Oil prices and most other commodities are weak.

But US wage growth is spreading inflation wider into services. Services inflation is now the battleground and labour supply lines are normalising far slower than goods.

What little patience the US Federal Reserve may have had is running out.

Fed funds now seem destined for 4% or higher. As little as six weeks ago the market was expecting terminal rates closer to 3%.

RBA may be more patient

As always, Australian bonds will follow the US. But the RBA seems prepared to show a bit more patience. 

This is due to a number of factors — but the two main ones are wages and our floating rate mortgage market.

The NAB business survey showed that rate hikes are yet to have any impact.

This is not surprising as the economy is now almost fully open, many have pent-up savings to spend and fixed rates are protecting 40 per cent of mortgage holders.

The RBA remain on course for 3% cash rates by year end (either 2.85% or 3.1%).

It will likely rely on the fixed rate mortgage cliff and immigration to do the heavy lifting to combat inflation in 2023.

Bond markets are caught in the loop of pushing rates up with the Fed but also with one eye on increasing recession risks.

Flatter curves seems to be the favoured way of reconciling these two outcomes.

Credit and equity markets were hit by the high inflation numbers, but for now look to be range-trading rather than breaking down.

The only certainty for now is volatility is here for a while yet.

Author: Tim Hext, Portfolio Manager and Head of Government Bond Strategies

Funds operated by this manager:

Pendal Focus Australian Share FundPendal Global Select Fund - Class RPendal Horizon Sustainable Australian Share FundPendal MicroCap Opportunities FundPendal Sustainable Australian Fixed Interest Fund - Class RRegnan Global Equity Impact Solutions Fund - Class RRegnan Credit Impact Trust Fund

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