Boomers are the landlords...nobody likes either it seems
Boomers are busting hopes of rate cuts
JONATHAN SHAPIRO
The wealth effect is an elusive concept that policymakers and forecasters have struggled to quantify. But in the opinion of macro commentator James Aitken, of Aitken Advisors, it may be the swing factor that will prevent US Federal Reserve chairman Jerome Powell from cutting interest rates any time soon, and could lift US 10-year bond rates towards 6 per cent.
And in Australia, where higher interest rates are a source of pleasure for savers and pain for borrowers, the wealth effect – the theory that people spend more as the value of their assets rise – may be more powerful than we appreciate. It, too, may propel the cash rate above 5 per cent.
In his latest dispatch to clients, Aitken referenced a fascinating 2023 study from payments giant Visa.
It concluded that the wealth effect is far more powerful. Most studies imply consumers spend between 4¢ and 15¢ of each dollar increase in wealth via housing and the sharemarket. It found that figure has tripled from 9¢ in 2017 to an estimated 34¢ in 2023.
One of the central reasons behind a more powerful wealth effect, Visa argued, is the fact that much of this wealth is in the hands of retirees who are cashed up and keen to spend.
Aitken says official data in June is likely to show that US household wealth to disposable income will be close to eight times, well north of the six and 6.5 times reached during the 2000 tech bubble and 2006 housing bubble.
‘‘I understand and admire all the effort that goes into estimating the next basis point or 10 basis points of core inflation, but I wonder whether all that effort is missing the point,’’ he told clients.
With an economy at full employment and a budget deficit of 6.5 per cent of GDP, the added fuel of historically high wealth will likely ensure that aggregate demand grows too fast to allow the Fed to hit its 2 per cent inflation target.
US equities and credit markets, Aitken says, appreciated this fact and, until now, bond markets have resisted it.
‘‘If, like me, you think US nominal GDP is going to continue to chug along at 5, 6 per cent, perhaps more, then the 10-year note should be somewhere between 5, 6 per cent,’’ he said.
Aitken, who has shared his views with The Australian Financial Review every so often, runs a consultancy firm advising major policymakers, institutional investors and hedge funds.
He closely tracks the machinations of markets and their plumbing, and tries to make sense of central bank speak. But his takeaway of late is to block out the noise.
Central banks seem as confused as any of us about the direction of their respective economies and the appropriate policy settings.
One client, a macro trader, told him that for the past 25 years, he’s tuned out the rate-setters. ‘‘He’s not read, listened to nor watched a single central bank paper, speech nor presser respectively,’’ Aitken says.
‘‘He concluded a long time ago that all that was less important than paying close attention to data, and to price action.’’
Aitken’s advice is to do likewise. Another client, he says, has described central bank communications as ‘‘performative exactitude peddled as transparency’’.
Most Australians and Americans would have seen little through their own eyes over the past six months to back up the market’s conclusion that interest rate cuts were coming to save us.
Aitken says his experience on a trip to Australia is that the wealth effect is in full throttle from Sydney’s exclusive Vaucluse to Penrith, where $240 tomahawk steaks are flying off the grills of high-end pubs in the western suburbs.
The Reserve Bank of Australia has done its own studies on the wealth effect phenomenon, concluding that rising house prices fuel spending on new cars and furniture. But its last detailed missive was in 2019, and it may not be capturing an acceleration in Baby Boomer spending alluded to in the Visa report.
There is no denying the extraordinary wealth accumulated by Australians that is growing larger by the day. It is mainly tied up in property. Households sit on $10.7 trillion of real estate, dwarfing their equities holdings of $1.4 trillion – a record high.
Rich in assets, high in income and short on time, there’s every reason for retirees to spend big on steaks, travel and anything else they desire.
What is apparent – and business leaders have spoken about this – is that wealth, consumption and confidence is graded by age group.
While Boomers are YOLO-ing, middle-aged, middle-income families are caught in the squeeze. They are being crushed by higher rents, mortgage payments and grocery bills. Higher interest rates will hurt them more, but arguably do little to slow the spending of retirees.
What has become apparent – both in the US and Australia – is that those interest rate cuts that strained borrowers had been hoping for, and which financial markets had banked on, aren’t likely to eventuate.
Last week’s quarterly inflation data surprised to the upside, and money market traders reacted by pricing out the prospect of rate cuts. By the end of the week, the outside odds were that the RBA may have to hike again.
There are more reasons that the market’s shift to price out the prospect of rate cuts is justified.
Aitken says the inflation data may force the RBA to go further and revisit its assessment that the current 4.35 per cent cash rate setting is sufficiently restrictive.
‘‘Let us, therefore, think conservatively, that sufficiently restrictive – as opposed to ‘sufficiently hopeful’ or ‘politically opportunistic’ – monetary policy in Australia requires a 5.25 per cent cash rate,’’ he says.
Then there are the stage three tax cuts, which by some disputed estimates could be the equivalent of 50 to 75 basis points of rate cuts. Perhaps that’s too much, Aitken reckons, but it’s certainly not going to restrict demand.
He further points out that over the past 30 years, the RBA cash rate has, on average, sat 1.6 percentage points above the US Fed funds rate. So, if history is any guide, the cash rate should peak about 7 per cent, well north of today’s setting.
Of course, this time is different. The US economy is at full employment and there is a ‘‘colossal’’ amount of US government spending, so US rates should be higher relative to Australian rates.
‘‘If historical analogues hold, then the RBA’s cash rate should be 75 to 100 basis points above the Fed funds rate. But it should probably not be 100 basis points below Fed funds, as it is today.’’
As central banks are forced to re-engage in the fight against inflation, this could lead to further bifurcation in wealth, fortune and confidence. The market is only just starting to adjust to this reality.
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