RBA to follow Powell’s lead on rate hikes, bring equity, housing pain

Stress lines over falling equities and housing markets are deepening across the world as rates rise to curb inflation. Picture: Michael M Santiago/Getty Images

Batten down the hatches Australia. We are set for stormy weather which will last well into 2024.

The skipper of the global ship, Captain Jerome ‘Volcker’ Powell has decided to tell his crew the truth about his intentions.

And among the “crew” is our own Reserve Bank Governor Philip Lowe who will now be forced to follow his captain and raise Australian interest rates to a level that will almost certainly not only cause a recession, but lower share and property prices led by dwellings and office blocks.

I have attached the name ‘Volcker’ to the current chairman of the US Federal Reserve because former chair Paul Volcker was arguably the last central banker in the world to tell the truth and explain that the only way to lower embedded inflation, which now infects the US, Australia and Europe, is to be prepared to risk a recession and much higher unemployment.

Stunned share traders on Wall Street were not accustomed to hearing the truth from central bankers so after the Powell statements they found it difficult to fathom what the truth actually meant to US share prices.

US Fed chair Jerome Powell left no doubt rates will go higher. Picture: Drew Angerer/Getty Images

And so initially US shares actually rose. Then suddenly the horror that comes from a central banker telling the truth began to sink in and US shares began to decline and were down when the final bell brought relief from the fall.

So let us first look at what Powell intends to do in the US and what that will force on our local central bank and the Australian economy.

Powell estimates that ‘neutral’ interest rates in the US represent a Federal Reserve funds rate of about 2.25 per cent, which is approximately the level that existed before the latest hike.

For what it’s worth we know from US orders in China and the experience of big US transport operators that interest rates at that level are actually slowing the US economy, although it’s not yet in the official figures.

Powell plans to double his neutral rate to between 4.4 and 4.6 per cent and that will take place before the end of 2022.

Many believe that the delay in statistics will cause Powell to take the official rate to 5 per cent, but 4.6 per cent is not far off.

Moreover he intends to leave the rate at that level for all of 2023 and then slowly lower it in 2024.

While it wasn’t mentioned in comments, Powell is also withdrawing money from the US system by selling bonds or not renewing maturing securities.

This is similar to what Volcker did in the early 80s, except that he went a lot further and took interest rates up to 20 per cent.

Powell believes that 4.6 per cent will be sufficient to curb consumers spending, force companies to stop lifting prices and wages and boost unemployment.

Powell left no doubt that if 4.6 per cent is not sufficient to create that environment, then rates will go higher.

Australian property markets are bracing for the impact of escalating rates. Picture: Mick Tsikas

One of Volcker’s mistakes was to release the brakes too early and he had to reimpose them. Powell has studied the Volcker period and is determined not to make that mistake, although some of the members of the Federal Reserve board will inevitably get squeamish when the impacts of the higher rates storm begin hitting Americans.

So let us translate that to Australia.

Because of Australia’s foolish home-lending spree in 2020 and 2021, the Commonwealth Bank estimates that our ‘neutral rate’ is about one per cent below that of the US.

This means our current Reserve Bank official market rate at 2.35 per cent is already hitting the economy, but the impact is delayed by two to three months, signifying the gap between rate announcements and the hit to families with big mortgages.

If we were forced to increase our interest rates to match a US 4.6 per cent rate, it would mean another 2.25 per cent in interest rates increases, which would cause carnage in our housing market and make the predictions of a 20 to 30 per cent fall in house prices a reality.

Shares would fall sharply because of the big fall in consumer demand and much higher unemployment.

RBA governor Philip Lowe is taking his cues from Captain Powell. Picture: Lukas Coch

So Philip Lowe will try and limit the Australian interest rate rises and the inevitable carnage. But markets sense a weakness in Lowe.

In the eyes of traders, he does not have the strength of Captain Powell, so Australia is going to be “punished”.

Accordingly as US shares were falling, traders were looking at other ways to make money and began dumping the Australian dollar and our currency slipped quickly to US66.3c at the US close.

If our dollar keeps sliding, then given our dependence on imports, it will mean that our inflationary pressures will become much greater and Lowe will come under greater pressure to follow his Captain.

These are very dangerous times for Australia.

But it does mean that yields on Australian shares, property and bonds stock will rise, but those increases in many cases will be triggered by falls in capital values.