The RBA may have lost its patience, but the Australian economy is not in the same place as the US. Interest rate normalisation will be much slower, longer, and lower than Mr. Market believes.

The US rate tightening cycle has begun in earnest with markets pencilling in at least another half-dozen rate rises in 2022. With wages growth in the US running at 5.8% year-on-year, we think that this may be a plausible, albeit slightly hawkish, forecast from Mr. Market.

This hawkishness has seeped into Australian bond market mindsets, and we caution against extrapolating the economic conditions in the US to Australia for 3 key reasons:

1. Australia does not yet have an issue with wages growth. The most recent data pointed to a 2.4% year-on year increase.

2. The slight uptick in wages that has occurred, and any increase that will follow, has been driven by the reduction in labour supply, with negative net migration over 2020 and 2021.

3. Net migration levels are certain to rise in the next few years, resolving the labour supply constraints that have marginally pushed up wages.

Watch the interview and read a 1-minute summary, below:

State and Federal government debt has exploded due to covid-related stimulus payments and, given an unwillingness to reduce spending post-pandemic, governments need to rely on economic growth to meet funding needs.

Equally, since the GFC, economic growth has been underpinned by population growth, with productivity improvements (outside of digging up more resources) missing in action.

So, there is an alignment of interests at all levels of government in Australia – state, federal, and council – to run higher levels of migration. This increases aggregate tax receipts and GST for the states. While this helps GDP, it comes at the expense of GDP per capita and also wage growth.

Post-WWII to pre-GFC, Australia had an average net migration of circa 90,000-100,000 per annum and wage growth that was regularly in the high 3% to 4% range. Post-GFC / Rudd Election, net migration has more than doubled, coinciding with a trend decline in wages growth to 2%.

As illustrated in the chart below, we expect there will be a jump in wages in the short term as employers deal with labour supply shortages. However, unless migration is returned to the 100,000 per year level, then wage growth will not return to the mid to high 3% range.

Wage growth is key for inflation, as the relationship in the graph below illustrates. Unless wage growth is 3-3.75%, it will be difficult for the RBA to keep inflation in the 2-3% range.

In summary, while higher immigration places stress on infrastructure such as public transport, or hospitals, it does deliver headline economic growth. This increases government receipts and lowers wage growth and interest rates, which further reduces the cost of debt. It also protects the value of residential housing.