Signal or noise? Three macro experts on what matters for your portfolio

Patrick Ian Polk (0:13)

Good morning, everyone. Thank you for coming along today.

There is a lot going on in the world right now, and all of it seems capable of moving markets. When I was coming up, admittedly, many moons ago in markets, there was only three things that you needed to pay attention to have a handle on the macro, and that was inflation, interest rates, and growth. Now, we have to worry about policy mistakes, housing, AI, deglobalization, and US exceptionalism, to name but a few. That was the reason why we put the question up on the screen earlier, and if we can get the poll results up, please.

We'll see what the audience says. Same game, more moving parts, 40 percent, genuinely more complex, we're over-complicating it, it's always been this complex. Interesting suite of results there. Helping to answer the question and cut through the noise and find some more signal, of course, Diana, Damien and Roy, and throughout, we'll keep bringing the conversation back to what really matters for investors and for your portfolios. We're going to start with a nice easy topic, and that is the RBA, front and center. These, what you're seeing on screen here are some real headlines that I pulled from websites and from newspapers over the last few weeks in preparation for the event. And the RBA, as we know, has a genuine problem. Inflation remains uncomfortably high, but there are signs that it's already starting to bite. Damien, you've argued that the RBA is getting closer to over tightening. What tells you it's at risk of going too far?

Damien Boey (1:42)

So the way the RBA usually sets interest rates is it says, look, here is the amount of spare capacity that we have in the economy, and here is the amount, here is the rate that we think is necessary to keep the economy stable inflation on an even kill over the longer term. And you kind of take into account both of those. What the bank is currently arguing is that there isn't much spare capacity. What the economists call the output gap, the deviation of actual economic level of activity versus the potential, is positive and that's inflationary.

My issue with all of this is that currently the AI narrative is quite pervasive. I think it's almost a coordinated message actually that you're getting from central banks, that AI right now is an inflationary phenomenon and therefore an impetus to raise rates. The problem is, if you think that AI really is going to be productivity enhancing, then the maximum rate that the economy can grow out without causing inflation is a lot higher than what the RBA believes. It's much higher than 2%.

What this also means is that there's more spare capacity in the economy than the bank believes. But yet if you're operating on an old model, you're actually slowing the economy way too much relative to that baseline. So to that end, I actually think that the RBA is over tightening. Our framework actually suggests right now that the equilibrium cash rate is 4%. It's already below where the RBA currently is.

Patrick Ian Polk (3:04)

Diana, I'll throw to you, what do you think matters more from here? Is it persistent inflation or some of what's going on underneath the headlines?

Diana Mousina (3:12)

Yeah, I guess in my mind, the policy mistake risk is not tightening enough. And when we were going through the period of the initial rate rises, we thought that the consumer would prove to be much more fragile. We'd see more slowing in home prices. We'd see much softer economic growth. But that didn't eventuate. And I think that the consumer proved to be a lot more resilient because they had all these additional savings that they drew down on all this additional wealth because the average household wealth situation has improved phenomenally in recent years.

And one of the main reasons has been because home prices have gone up by on about 50% since 2020 and share markets have been so strong.

And I think in this current period, yes, we're going through a dip. We're going through a slowing. But I think it's necessary to really make an impact on inflation. The chart that I have for the session is here and I know there are a lot of squiggly lines of different colors, but the rest of the world is going through a downtrend in inflation and Australia is that blue line there. We're going the opposite way. I think we have a genuine inflation problem here, which comes down to the fact that we have very high wages growth. We have government spending that's too elevated and other countries that we compare ourselves to are just not in the same situation. So unless we want to have inflation running at 3 or 4% for the next few years, I think that the RBA will probably have to raise rates a few more times. And that does mean that we are going to see a slowing in growth and further decline in home prices. But it's probably necessary because as most of the other countries experience by the US, you probably do need to get more of an adjustment in the labour market than we've had. And we've been very lucky that the unemployment rate is still so low, close to a 50 year low actually. And unfortunately, I think we do need more pain in that sector to actually get inflation down to a sustainable manner.