By Cameron Bagrie
Economist Bagrie Economics
CP Wealth Exclusive
We are pleased to welcome Cameron Bagrie as our guest Economist presenting an exclusive article for our CP Wealth investors. He explores the future of the US economy and discusses the delicate balance of monetary policy and financial markets, providing insights into the challenges and opportunities ahead.
The United States (US) economy and financial markets, including the bond market, set the tone for the rest of the world. New Zealand bonds take their lead from the US Treasury market. Currencies are two-sided coins; the US side has been shinier in recent months.
In the third quarter of 2024, there were widespread expectations interest rates could be falling in most countries with signs the inflation thief was headed back to jail.
Now, markets are not so sure in the US.
Inflation is “sticky”
Core inflation has cooled to 3.3%, but it’s been flatlining at that level in recent months, and the word “sticky” is being thrown around a lot to describe it.
The last few yards in any disinflation battle are always the most difficult.
It may seem blasphemy, but could the US Federal Reserve have to do a U-turn and hike rates?
The strength of the economy, combined with the potential for lower taxes, higher tariffs, and restrictions on immigration, puts that scenario on the table. With service sector inflation in excess of 4%, the disinflation crusade has come via goods deflation. What if we see a geopolitical or geo-tech shock or oil prices lift, with globalisation progressively replaced by fragmentation?
The good side of that story is that strength in growth and productivity is a sign of vibrancy and resilience, which is a favourable backdrop for earnings/equities in the US. US markets have been stellar. The New Zealand equity market is not so despite a late 2024 interest rate-driven lift.
The most recent outlook from the International Fund had a broadly unchanged assessment for the world economy with an upgrade to the United States offsetting downward revisions in other major economies.
Monetary policy is a delicate balancing act.
You have targets (typically 2% inflation and full employment) and a blunt instrument in the form of an interest lever, that when changed can take time to diffuse through the economy. At the same time, there are many things beyond central banks’ control, including oil prices, shipping costs and government policy. The currency, credit, banking sector, and asset prices can make financial conditions different from monetary conditions.
Any central bank needs to be credible. This is where inflation expectations measures are key; they show whether society believes a central bank will achieve its objective. Politicians need to respect the central bank’s independence. There is tension in the US.
The outlook for US financial markets
US financial markets are still anticipating the US Federal Reserve will lower rates in 2025, though by one or two 25 basis point cuts, and not a succession. According to their most recent meeting minutes, there appears to be growing tension within the US Federal Reserve. With the neutral Fed Funds rate thought to be around 3%, monetary policy would still be considered restrictive even if they cut again. The performance of the US equity market does not say that US financial conditions are excessively restrictive at present, though, which begs the question: Is the neutral rate really 3%?
Many are now saying we could see a very long and potentially uncomfortable pause as opposed to a hike.
Bonds, such as the US 10-year Treasury, have been volatile, but they have lifted considerably from their September lows as inflation has proved to be more stubborn and growth has exceeded expectations. What the US Federal Reserve has delivered in interest rate cuts, the 10-year bond has somewhat taken back.
There is more discussion about fiscal positions and debt issuance. Term premiums – that additional yield that you need to hold a long-term bond over a short-term one, are back.
A lot of uncertainty remains over the trajectory for inflation.
Central banks had some massive disinflationary support up to Covid. Globalisation – that process of outsourcing – was disinflationary. Wage inflation was contained. Fiscal policy (government spending) was contained. The world had a savings glut. That meant low interest rates.
What if the world is now fundamentally different? The potential from AI is huge, and new clean energy, too. Onshoring is replacing offshoring though. Security is now a factor influencing trade and usurping the economics of trade. Populations are ageing, meaning worker shortages. Climate change and tariffs add to costs. Governments are now responding to populism and division is rampant.
Buckle up. Challenges and opportunities ahead.
31 January 2025
Cameron is the Managing Director of Bagrie Economics and formerly chief economist of ANZ. He is also a business owner and sits on a couple of boards. To relax he sits on an erg for an hour.
The Future of the US Economy: Inflation, Growth, and Policy Implications
By Cameron Bagrie
Economist Bagrie Economics
CP Wealth Exclusive
We are pleased to welcome Cameron Bagrie as our guest Economist presenting an exclusive article for our CP Wealth investors. He explores the future of the US economy and discusses the delicate balance of monetary policy and financial markets, providing insights into the challenges and opportunities ahead.
The United States (US) economy and financial markets, including the bond market, set the tone for the rest of the world. New Zealand bonds take their lead from the US Treasury market. Currencies are two-sided coins; the US side has been shinier in recent months.
In the third quarter of 2024, there were widespread expectations interest rates could be falling in most countries with signs the inflation thief was headed back to jail.
Now, markets are not so sure in the US.
Inflation is “sticky”
Core inflation has cooled to 3.3%, but it’s been flatlining at that level in recent months, and the word “sticky” is being thrown around a lot to describe it.
The last few yards in any disinflation battle are always the most difficult.
It may seem blasphemy, but could the US Federal Reserve have to do a U-turn and hike rates?
The strength of the economy, combined with the potential for lower taxes, higher tariffs, and restrictions on immigration, puts that scenario on the table. With service sector inflation in excess of 4%, the disinflation crusade has come via goods deflation. What if we see a geopolitical or geo-tech shock or oil prices lift, with globalisation progressively replaced by fragmentation?
The good side of that story is that strength in growth and productivity is a sign of vibrancy and resilience, which is a favourable backdrop for earnings/equities in the US. US markets have been stellar. The New Zealand equity market is not so despite a late 2024 interest rate-driven lift.
The most recent outlook from the International Fund had a broadly unchanged assessment for the world economy with an upgrade to the United States offsetting downward revisions in other major economies.
Monetary policy is a delicate balancing act.
You have targets (typically 2% inflation and full employment) and a blunt instrument in the form of an interest lever, that when changed can take time to diffuse through the economy. At the same time, there are many things beyond central banks’ control, including oil prices, shipping costs and government policy. The currency, credit, banking sector, and asset prices can make financial conditions different from monetary conditions.
Any central bank needs to be credible. This is where inflation expectations measures are key; they show whether society believes a central bank will achieve its objective. Politicians need to respect the central bank’s independence. There is tension in the US.
The outlook for US financial markets
US financial markets are still anticipating the US Federal Reserve will lower rates in 2025, though by one or two 25 basis point cuts, and not a succession. According to their most recent meeting minutes, there appears to be growing tension within the US Federal Reserve. With the neutral Fed Funds rate thought to be around 3%, monetary policy would still be considered restrictive even if they cut again. The performance of the US equity market does not say that US financial conditions are excessively restrictive at present, though, which begs the question: Is the neutral rate really 3%?
Many are now saying we could see a very long and potentially uncomfortable pause as opposed to a hike.
Bonds, such as the US 10-year Treasury, have been volatile, but they have lifted considerably from their September lows as inflation has proved to be more stubborn and growth has exceeded expectations. What the US Federal Reserve has delivered in interest rate cuts, the 10-year bond has somewhat taken back.
There is more discussion about fiscal positions and debt issuance. Term premiums – that additional yield that you need to hold a long-term bond over a short-term one, are back.
A lot of uncertainty remains over the trajectory for inflation.
Central banks had some massive disinflationary support up to Covid. Globalisation – that process of outsourcing – was disinflationary. Wage inflation was contained. Fiscal policy (government spending) was contained. The world had a savings glut. That meant low interest rates.
What if the world is now fundamentally different? The potential from AI is huge, and new clean energy, too. Onshoring is replacing offshoring though. Security is now a factor influencing trade and usurping the economics of trade. Populations are ageing, meaning worker shortages. Climate change and tariffs add to costs. Governments are now responding to populism and division is rampant.
Buckle up. Challenges and opportunities ahead.
31 January 2025
Cameron is the Managing Director of Bagrie Economics and formerly chief economist of ANZ. He is also a business owner and sits on a couple of boards. To relax he sits on an erg for an hour.