Sorry Skyhooks, we are not living in the Seventies.

market analysis

Sorry Skyhooks, we are not living in the Seventies.

By

David Clark, Partner, Investment Management – Cameron Harrison


Posted 13 July 22

The similarities between the current inflation outbreak and the Seventies, a period when there was an extraneous oil price shock plus inflation and slowing economic growth, are obvious however, investors should be wary of expecting a repeat of history.

Interview with ausbiz, 11 July 2022

The near decade-long battle with inflation that ensued in the Seventies was a combination of several factors that are unlikely to be repeated. These factors included (but were not limited to):

  1. Political interference in central bank policy by the Nixon administration that suppressed interest rates in order to promote growth and improve electoral popularity.
  2. Wage controls in the early 70s, that when removed, resulted in a period of rapid wage growth as wages caught up to economic growth.
  3. Dramatic growth in workforce size due to the baby boomers and female workforce participation, which drove higher consumption demand.

Watch the interview and read the summary, below:

Taking each of these factors in turn

After keeping rates too low through the second half of 2021, Central Bankers have rapidly shifted into full-Volcker mode and can hardly be accused of not taking the inflation risk seriously.

In contrast to the 1970s, wage growth has been artificially accelerated (see factor below) and will slow as it returns to normal operation. Leading indicators of the labour market, such as the difficulty in filling jobs and the job quit rates, recently started to inflect.

Developed economies have experienced a supply shock. The restriction on the movement of people (immigration) resulted in the supply of cheaper labour drying up but this will rectify itself as borders reopen.

Job movement is elevated after being suppressed by the pandemic; higher switching of jobs is correlated to higher wage growth (why move unless you will get paid more?).

Many older workers failed to return to the labour market in 2021; given older employees typically have slower wage growth, this further elevated wage growth. Recent data suggests the unretirement rate has shifted from a pre-pandemic rate of 1.0-1.5% to over 2% as rising wages, high inflation and lower asset prices drive over 55s back to work.

Finally, and potentially most importantly, the demographic-driven inflationary forces that drove the labour force growth rate above 2.5% per annum have gone. The forecast for the coming decade is a measly 0.5% p.a. - a disinflationary force rather than inflationary.

The chart following shows long-term US labour force growth against the total population and working-age population.

Diagram showing

What about Australia?

Australia is in a very different position for monetary policy than the US and other Northern Hemisphere developed economies.

In the US, over 90% of mortgages are fixed-rate with terms of over 15 years, in Australia, it is the reverse, with nearly all mortgages either variable rates or fixed for less than 5 years. This means every rate rise by the RBA rapidly impacts the stock of existing debt, rather than just new loans!

Further, Australia has far higher household leverage, so any rate rise by the RBA has a magnified impact on household budgets. The RBA also started the tightening cycles earlier (relative to inflation forces), and wage growth is lower, as is inflation.

Despite all this, bond markets expect the RBA to lift rates above the FED! as shown in the futures pricing in the chart below.

At Cameron Harrison, our view is different. We do not see this happening without significant and enduring harm to the domestic economy.

Diagram showing