THEY’RE ALL HEDGING NOW
EDU DDA Feb. 18, 2025
Summary: A busy day in Oceana. RBA cut rates for the first time since 2020, making the last of the rate cutting cycles to kick off - or, the tail end of the rate cut cycle, singular. Globally synchronized is apparent in what RBA did as much as next door in New Zealand where far clearer yet similar degradation convinced the central bank there to cut by another fifty. There is as much political pressure in all places driving the sudden hedging on rates from central bankers everywhere - including, now, Australia.
WE KNOW. POLITICIANS AND CENTRAL BANKERS ARE NOW STARTING TO FIGURE THIS OUT.
Australia’s central bank takes up its place at the rear of the cycle. For the first time since 2020, the Reserve Bank of Australia reduced its benchmark rates. The reason officials gave is the same one as everywhere else; progress on “inflation.” The thinking goes, if price pressures are indeed tamed for good, then why risk upsetting the rest of the real economy, especially the labor market, with “restrictive” interest rates?
If this seems an odd argument to make for an economy simultaneously declared to be strong and resilient, it really is. After all, strong economies aren’t at risk of a few basis points or even percentage points of short-term rates. Those only have some bearing on long-term rates, which are what really matter in any real economy.
Then again, interest rate sensitive sectors in most aren’t what they used to be (assuming they ever were anything more than an academic curiosity). Basically, then, what’s the rush? Why not wait to cut rates until “inflation” has dissipated in every last measure, leaving zero doubt?
For the RBA, officials there can actually stake the best case for such patience from among any others around the world. Given how it is already February 2025 and they are nearly a year behind the start of the wave which began last March (with the Swiss followed by Mexico), already there’s little outward reason to change anything. Traditionally, Australia’s economy has largely been unbothered by recessions.
Moreover, the point of rate policies is about getting them above, below, or equal to the neutral rate. This is the theorized interest rate which neither restrains economic activity nor encourages it. Any honest central banker will tell you they have no idea where it is at any time. Instead, they’re all working backward from macroeconomic outcomes combined with questionable theory.
Authorities in Australia like those at the Federal Reserve or ECB seeking to slow an economy in order to restrain inflationary pressures (never mind this isn’t how economies work) raise their benchmark rates above what they think the neutral rate might be. This comes after millions of Monte Carlo simulations are run after ignoring all the previous runs which failed to offer any useful descriptions of economic conditions let alone forecasting future ones.
Everything is basically an eyeball test.
If ST policy rates are held above the assumed neutral rate and consumer price gains slow, or just the economy, central bankers will immediately conclude that rates must have been “restrictive” regardless of every other possible combination of factors. They claim credit for the result out of nothing more than correlation.
And it doesn’t have to be near-term, either. More often than officials care to admit, they have to wait an exceptionally long time for the correlation to make itself evident. Employing the “long and variable lags” philosophy, a rate hiking program from two years ago will be counted as “restrictive” if consumer prices slow materially even when there are clearly other reasons for it.
Besides, when Milton Friedman first made the connection, it was between monetary changes not interest rates. The former is something central banks no longer do.
The 2008 cycle was a perfect example of this inconsistency. To begin with, Alan Greenspan’s Fed began raising the fed funds target (before the introduction of interest on reserves in October 2008, the fed merely “targeted” a specific fed funds rate promising to conduct temporary open market operations to temporarily raise or lower the level of bank reserves to meet the target on an average basis over fixed “maintenance periods”; TOMOs were almost never needed since the money market/dealers took care of the fed funds market without need for bank reserves) in the middle of 2004 claiming the belated arrival of recovery (after a more-than-yearlong “jobless recovery” which materialized despite “ultra-low” rate policy of the time which saw Greenspan pull the fed funds target down to 1%) raised inflation risks based on Economics’ Phillips Curve view of consumer prices.
And while the fed funds target was raised by a quarter-point for seventeen consecutive meetings, bringing the policy target up from 1% to 5.25% by mid-2006, consumer prices began to accelerate significantly in 2007 then soared into the first half of 2008. By then, the Fed was already cutting rates given the erupting bank crisis all over the world’s eurodollar system.
In short, there was zero correlation between consumer prices and any interest rates, let alone the Fed’s, even at long and variable lags.
We can see the same unfolding here in the 2020s. Consumer price rates worldwide had uniformly peaked in the middle of 2022, before any rate hike programs even had the chance to really get going. This globally synchronized inflection for prices strongly implied global factors rather than nascent individual central bank interest rate policy changes.
Disinflation continued to develop anyway even as one official institution after another moved from hiking to cutting, as if the two were once again uncorrelated. Even so, that same disinflation is being used as evidence rate policies have held ST rates in “restrictive” territory anyway given the enormous uncertainty surrounding the neutral rate.
While this explains the reasoning for rate cutting, it doesn’t account for any urgency or timing. If an economy is really strong at the same time the slimmest question remains as to the possibility of any additional “inflation”, there is no reason whatsoever to lower rates especially when factoring so many specious correlations. The high margins for uncertainty in every direction argues against doing anything.
Whether officials wish to come out and say it, because of so much uncertainty, rate cuts are actually them hedging against the “strong” economy, instead playing probabilities that are made very difficult to assess by so few direct relationships.
In Australia, consumer price rates are still above the central bank target. Not only that, RBA doesn’t model that they’ll return to the mid-point of their range until maybe next year; yet, a rate cut anyway.
Some might argue that the Bank is yielding to political pressures, and there may indeed be some truth to the assertion. That simply adds another layer of confirmation. Political pressure is applied when – and where – economic circumstances have been “sub-optimal”, to use another Economics term.
And that means labor. While the chief complaint from the voting public focuses on price changes and rates, those would not be a primary and motivating issue had labor market conditions matched recovery rhetoric. If pay and job strength increased incomes – systemically – by 20%, then few would complain prices rose 10%.
When incomes rise 5% for 10% prices, that’s a major problem due to jobs – especially when the 5% income applies to far fewer than is required (see: US Establishment Survey).
While central banks are nominally “independent”, plain common sense dictates some degree of coordination between central bankers and political officials. Who can forget the clearly uncomfortable, almost-certainly involuntary meeting between then-President Biden and Jay Powell during 2022 urging the Fed Chair to “do something” about “inflation”; or the rate cuts in 2019, those which at least corresponded with President Trump’s public pressure campaign of his own.
Political dissatisfaction has increased markedly in Australia same as other places around the world – including America – where incumbent governments have suffered the wrath of a voting public that refuses to accept the idea that anything is strong or resilient. Even Bloomberg is seeing the connection:
Not surprisingly, the issue has electoral potency: The ruling Australian Labor Party is trailing in polls, and an election must be called in coming months. A stream of Labor legislators called for an easing. While monetary authorities stress they make decisions independently, they are attentive to political currents.
“Monetary” authorities also consistently stress everything is fine and right on track. For those in Canberra, they need only look next door to New Zealand to see the results both politically and for the economy.
Understanding first that the latter economy is quite different from the Aussies, still the more obvious recession and labor market degradation in New Zealand provides a cautionary example. On top of that, the country voted heavily in October 2023 against the administration of Jacinda Arden after giving it a landslide in just three years before.
Having taken over under those terms, the current government in Wellington hasn’t acquitted itself any better.
New Zealand’s National-led coalition government is losing support among voters, new polling shows, amid frustrations over the economy and deepening concern the country is heading in the wrong direction.
Meanwhile, the parliamentary left bloc has taken a narrow lead for the third poll in a row, enough that the opposition would be able to form a government were an election held today.
Prime minister Christopher Luxon’s favourability has also dipped to a record low.
Mere minutes ago, New Zealand’s central bank cut rates again, by another 50 bps, becoming the latest to claim it’s all good and great, but a fifty anyway, you know, just in case.
I keep pointing out this isn’t a partisan matter. Administrations on “both” sides of national aisles have been alternately praised and voted in by wide margins only to be unceremoniously dumped not too much later on once it becomes clear they couldn’t deliver on the economy – by far, the biggest issue for voters all over the world.
The latest iteration to fall is this coming Sunday in Germany where the alleged center has splintered and collapsed in the least surprising political development in recent history. A quick glance at the German economy leaves little doubt as to why.
This degree of political instability is a direct result of economies which are not strong nor resilient. All the attempts to, yes, gaslight the voting public otherwise have been met with even stronger resistance then electoral action. Following last year’s US Presidential election, there has been a quiet shift in some sections of the Democratic Party to come to terms with Jay Powell – not his rate policy, instead the lack of forthright interpretation on the economy, or, at the very least, some help clarifying why in the world so many across the world are so obviously unhappy.
He has persistently claimed “strong and resilient” whereas voters voted decisively otherwise. As one article in left-leaning Politico admitted only last week:
Before the presidential election, many Democrats were puzzled by the seeming disconnect between “economic reality” as reflected in various government statistics and the public’s perceptions of the economy on the ground. Many in Washington bristled at the public’s failure to register how strong the economy really was. They charged that right-wing echo chambers were conning voters into believing entirely preposterous narratives about America’s decline.
What they rarely considered was whether something else might be responsible for the disconnect — whether, for instance, government statistics were fundamentally flawed. What if the numbers supporting the case for broad-based prosperity were themselves misrepresentations? What if, in fact, darker assessments of the economy were more authentically tethered to reality?
Those who answered “no” to those questions should be given some – not a lot - slack. To begin with, they were following the data as it seemed on its face – GDP was resilient, payrolls never fell, even the unemployment rate which did rise never went very far, remaining, as Powell loves to point out still to this day, historically low. These all appeared to make a compelling case for a decent economy.
While a decent place to start, it is never enough. Context always matter, especially in the gargantuan gray areas that dominate economics (especially for Economics). In 2008, the CPI’s sharp acceleration taken in isolation seemed to point to out of control inflation in defiance of the previous rate hikes and presumed “restrictive” rates of the mid-2000s. In the context of everything else in 2008, there was no inflation, oil prices (and some commodities) were being pressured by a massive supply squeeze, one was doomed to reverse from the get-go and only required the deflationary background to destroy global demand, as it would.
Here in the 2020s, decent GDP or positive payrolls miss way too much. Just because real GDP was higher this quarter than last one, or that payrolls increased this month from last month, those are not necessarily evidence of “strong” growth. They could be, but require corroboration, a lesson the world should have learned from the 2010s.
While it’s good payrolls are higher this month, better than the alternative, if they’re still millions short of a full recovery then the economy cannot possibly be strong.
This same context applies all over the world in basically every statistic you examine. This bimodal assumption that if the data isn’t crashing then it’s all good needs to be voted out with the political classes supporting it. In spite of this, politicians, central bankers and Economists continue to make the same mistakes anyway – and while they are paying for it with their positions, we are paying for it with even more lost economic ground; the latter neatly explaining the former.
For all the confidence and assurances from the RBA about wanting interest rates to be “less restrictive”, the truth is officials there are hedging. Consumer price rates aren’t assured (their guidelines) by any stretch of the imagination, Australia has an enviable history of legit strength, certainly when it comes to avoiding recessions, yet RBA made its move anyway.
If Australia is now hedging…
More than anything, it’s another example of globally synchronized at its extremities. There is a reason governments are going down all over the world with seeming regularity; and why, at the same time, the tide of central bank pivots and now rate cuts has developed alongside.
Australia isn’t some isolated gigantic island, it’s merely at the one end of the same spectrum. And, given the history of Economics, would they really bet heavily on their theories and models of “inflation” or, conversely, perceived economic strengths knowing the speciousness of those theories and models?
From the central bank perspective, the perceived safest course is to put rates at or close to “neutral” then hope for the best. This one sentence explains every central bank right now, from the Swiss to the Fed to Down Under.
