The Point

TIM HEXT: This week’s modest wages data won’t last

The latest wage data shows surprisingly modest growth in some sectors.

But wages are the ultimate lagging indicator and that will soon change, says Pendal’s Tim Hext.

The latest WPI data shows the price of labour grew a modest 0.7% in the March quarter and 2.4% for the year.

Those numbers may be surprising especially in industries such as construction and retail which face worker shortages.

But the data will change, since we’ve only fully opened up this year, says Tim.

“The RBA expect the WPI to hit 3% by year end and 3.5% by the end of 2023. Chances are we hit these levels sooner.

“This adds to the narrative that inflation will struggle to fall back to target anytime in the next few years. Investors should still be looking to inflation bonds ahead of nominal bonds.

“Inflation will moderate next year but levels above 3% look like being more entrenched over the next two to three years, helped by wages eventually nearing 4% growth”.

Tim Hext: RBA in final preparation for take off

The RBA’s “loss of patience” was widely noted this week.

Investors will now be watching Q1 CPI data on April 27 (“likely around 1.7% and 1.2% underlying”, says Pendal’s Tim Hext) and Q1 Wages Price Index on May 18 (“less spectacular but won’t stop a June tightening”).

There’s also a good chance one of the next unemployment numbers will be below 4%, says Tim.

“The RBA will therefore be able to say in May that inflation is sustainably within its band in the medium term and can tighten in June.” (A May hike ahead of an election is less likely.)

“The short end of the bond market is now predicting cash rates to peak around 3.5% in early 2024. If mortgage holders were aware of this impending doom house prices would be off 10% tomorrow.

“Mortgage brokers I’ve spoken to are telling clients rates shouldn’t go up by more than 1% to 1.5%. The average size of a new mortgage is now well over $600,000 – so an extra $20,000 a year in interest is coming borrowers’ way if markets are correct.”

Tim expects rates to finish 2022 around 1.25% and 2023 around 2.5%.

Tim Hext: Is March the month for hawkish hikes?

Our head of government bond strategies Tim Hext turned a few heads recently when he spoke of a “hawkish hike”.

Aren’t all hikes by definition hawkish, a few readers asked.

“They are,” says Tim. “But the accompanying statement is a chance to influence expectations of future hikes. This is especially so in countries where longer-term fixed rate home loans are predominant – no point hiking and seeing them go nowhere.

“We expect the US Fed to do this in their March hike, possibly pushing up the terminal level of rates as well. This will not be bond friendly.”

In Australia the RBA would be “extremely happy if by the end of 2022 inflation is at 3.25%, unemployment sub 4%, wages 3.5%, equities 10% lower, 10-year bonds 2.75% and cash rates 1%”, says Tim.

“It is not the RBA’s job to make sure superannuation balances have positive performance in any given year. Or to protect house prices. Given the massive rises in 2021 a negative year for assets is not a major setback. A year where labour outperforms capital is long overdue.

“Of course the Ukraine disaster will have an impact. But prospects of higher inflation will mean the Fed will need to get on with its hiking path, even if near-term risk markets are unsettled.”

Inflation: nowhere to run, nowhere to hide

What impact will this week’s extremely strong inflation numbers have on next Tuesday’s RBA meeting?

New dwellings, food and fuel were the main drivers of the spike, but the real surprise came from a wider range of goods that normally see little if any inflation, says Pendal’s Tim Hext.

“Clothing, footwear, furnishings and a wide range of everyday items are going up by around 3% to 5% annually. Some of that is supply related and might come down if things normalise later in the year. But for now that is all speculation.

“The RBA once again has been railroaded on its forecasts and will need to address this number in next week’s meeting.”

Four rate hikes are priced for 2022 with the first in May. The RBA would have thought that too aggressive, but now may be forced to admit the market has been better at reading the economy, says Tim.

“Although the numbers support inflation concerns, we still don’t expect an unhinging of inflation from the medium-term 2% to 3% band.

“That’s still considered low — and business investment and the economy in general can easily handle that.”