Many commentators have been predicting, for several years now, that US inflation is set to explode because of the massive monetary stimulus the US Federal Reserve Bank has undertaken since the GFC. In fact, inflation has averaged about a percentage point lower since the GFC than in the decade before it. But recently there have been some tentative signs that inflation is starting to drift up.
This has been driven more by tightening capacity than money supply. Not just capacity in plant and equipment, commonly called ‘capacity utilisation’, which has risen back towards its previous peak, but also ‘capacity’ in labour markets — the unemployment rate is heading back towards the pre-GFC lows. There’s no crisis yet, but good management means you should always be looking ahead to head off future crises. So the ‘bears’ on the Fed board will start getting twitchy, and the pressure to raise the Fed Funds rate (the US’ version of our own ‘cash rate’) will start to build.
Why does this matter for Australia and the Australian share market?
Well, first off, it’s hard for our share market to go up when Wall Street is going down, and though initially inflation tends to be good for share markets, later on it gets very bad for them, especially if the Central Bank responds by raising interest rates. So at some point the US massive bull run (rise) is going to come to a sticky end. A year from now? Six months from now? This is not to say that the fall in the US share market will be severe when it comes—it probably won’t—but even a 20% fall still hurts!
Secondly, if US interest rates are going up and ours are not, then our currency will tend downwards. Actually, this will be quite good for our economy if the decline isn’t too fast, because it will help stimulate local production. Of course, if commodity prices boom, then this effect will be offset by rising coal and iron ore prices. But commodity prices are unlikely to boom, if only because all that mining investment has increased the supply of minerals at a time when global demand growth has slowed. The good news is that a fall in our dollar will help prop up our share prices even if the US share market falls.
From an investment point of view it’s an interesting time. Australia and Europe are very out of sync with the US — Australia is in its own slowdown, having avoided the GFC, and Europe hasn’t really recovered from the GFC yet. This kind of mismatch often makes for big moves in currencies. So if you’re planning on an overseas holiday, maybe you should go sooner rather than later!
In the meantime, even though the party will eventually end in tears, our local share market is still likely to drift up over the course of the next 12 months, not spectacularly but steadily, which is the best way to get a sustainable rise.
