Inflation – Why worry?

• Tuesday 7th February, the Reserve Bank of Australia (RBA) raised borrowing and lending rates by a quarter of one per cent
• Overheating inflation raises the probability of larger rate hikes in the future
• The strength in exports is serving to defend the Aussie dollar from the steeper cost of imports

From the US

President Joe Biden made his State of the Union speech on Tuesday evening. He emphasised the current strength of the US economy and the subsequent high employment levels, adding an appeal that the current debt ceiling be raised.

A higher debt ceiling and increased money supply will pressure the US dollar if inflation keeps ahead of the Fed’s rate-hike pathway.

Earlier in the day, the Federal Reserve Chairman Jerome Powell was busy talking down inflation and repeated the Fed’s 2% target. He focussed on the tight service sector labour market as a source of inflation that is proving stubborn.

The situation offers US companies the carrot of stabilised interest rates, provided hiring slows or layoffs are increased. The stick is the threat of higher rates in a tight labour market. Such an outcome would be most damaging to growth and technology company market valuations.

Impact on markets

The more dovish political and monetary policy voices coming out of Washington DC sent the US dollar slightly lower. The US Dollar index (DXY) retreated from the highs of 104 set earlier in the day.

The Australian dollar, already buoyed by a strong trade balance print, was trending higher and returned to the 70 US cents handle.

All in all, the talk of rate-hike off-ramps, a strong economy, and low unemployment has served to prop up international stock markets, in particular interest rate-sensitive technology stocks.

The S&P/ASX 200 is up 7% on the year, with the tech-heavy US NASDAQ being up 16% over the same period.

The solid Australian trade balance keeps the Aussie dollar from sliding too far in the face of climbing inflation. Record raw material exports prevent a flood of dollars from leaving the country as the cost of imported goods and services increases.

The Australian dollar is up around 2% in the calendar year.

The wrap

The Australian and US economies power ahead in the face of multi-decade high inflation. The high employment levels and the post-COVID money supply still sloshing around in the system provide ample fuel to get over the hump of high prices.

Australian technology stocks are taking the lead from the US technology sector, providing an added boost to the raw materials engine room, supporting the Aussie dollar and sending the Australian stock market higher.