As global rates start to rise, Australia may follow in the short-term, but structural issues will prevent the RBA from hiking rates far, explains Chris Watling, CEO of Longview Economics. Any rate-hikes from the RBA will be short-lived, he says, and those structural issues will force Australian rates to zero.
The big picture
The global reflation trade has been a rapid ride over the past 18-months as confidence has returned in Europe and equities have performed well. However, China looms large as a major risk. China began tightening liquidity earlier this year as can be seen in rising inter-bank lending rates (CHIBOR). Though this has been well documented, Watling believes this will cause Chinese growth and the Chinese housing market to roll over in coming months. As China rolls over, he sees Europe following and attention will turn again to the US as risk appetites drop.
As the housing market and Chinese growth slow more broadly, this could have a big impact on commodities. Watling identifies copper as a great example:
“It’s time to short copper. There’s a lot of speculation out of China that's forced up the price. Copper is highly correlated to the Chinese housing market. If you look at China, housing starts are close to contracting and completions are already contracting.”
In his view, speculation is the major force supporting the copper price currently.
The Australian Dollar
The Australian economy has benefitted greatly from the reflation trade over the last 18-months. As China’s economy has picked up, commodity prices have followed, and the Aussie Dollar wasn’t far behind. Watling believes that as China’s housing market rolls over, it will drag the Australian Dollar down with it.
Australian interest rates
Australia’s economy faces structural issues that mean it’s unlikely to be able to raise rates as much as the United States, further compounding the bearish story for the AUD. Watling expects to see Australia raise rates modestly in the short-term in response to other advanced economies, but in the medium-term, it’s all downhill.
“The Australian economy can’t take much tightening from here. In the long-term, I think the inherent structural problems that have been around for several years will push your interest rates to zero.”
The worst recovery on record
Watling is “bullish on equity markets, but bearish on the structural state of the global economy.” How do these two apparently conflicting view resolve themselves? It’s all about liquidity:
“When there's a lot of liquidity around equity markets go higher. Once money starts to get tight, which I suspect will come over the next 12 - 18 months, structural problems will start to surface in the global economy.”
He called this recovery “the worst quality global recovery on record,” citing high debt levels, zombie companies, a lack of productivity growth, and high asset prices.
The United States
Though Watling believes the market has lost confidence in the current US administration, he doesn’t think it’s the biggest influence on the US Dollar and markets right now. He thinks that the main reason the US Dollar is lower is a shift in positioning and sentiment. At the beginning of the year, long-USD was a crowded trade, so as attention turned to the European recovery, this crowded trade began to reverse.
The Fed has been dialing back rate-hike expectations this year in light of some disappointing macro data, but Watling thinks the US economy is stronger than it looks. Though car sales remain weak, the broader consumer trends are fine – even housing equity withdrawals are beginning to return.
On the back of all this, Watling says that the US Dollar is “an attractive opportunity here.”
Time to rethink the international monetary system
So, with all these challenges, how do we get the global economy back on track? Watling suggests some fairly severe measures:
“I think we need a new international monetary system. We need to change the way central banks work. We need to change the unanchored liquidity that we've had post Bretton Woods (since 1971). In fact, if you look at the history of international monetary systems, on average they last 40 years, and then they sort of expire because they've just run out of road, and this one's 46 years old. So, we're due a refit.”