As high as it gets

David Wyss, chief economist at Standard & Poor’s, places little importance on the perceived symmetry in interest rate settings around the world, pointing out that key investment regions are in vastly different stages of the investment cycle. The US is nearing the end of its tightening bias, Japan is just beginning and Europe is in the middle.

But where does that leave Australia? Well, perhaps in line for a rate cut next year, Wyss predicts.

In the US, the Federal Reserve has just completed its 17th consecutive rate rise, with speculation that another will take place this week. Wyss says that the Federal Reserve is almost guaranteed to overcompensate because the tools at its disposal have a time delay of about 12 months.

With the latest figures showing that growth has slowed from 3.5% to 2.5% in the US, Wyss says it is increasingly likely that by next year US rates will have to be cut.

Wyss also examines trends in global growth, which is expected to drop to 4.5% from 4.8% last year, the role of the consumer in higher oil prices and the commodities cycle.

The interview

Michael Pascoe: Does it look like Australia’s just put interest rates up when the Federal Reserve has stopped rising?

David Wyss: Well, I’m not sure the US has finished. My guess for now is that there may be actually be one more hike from the Federal Reserve but all the world is at different stages in the tightening process. The US Federal Reserve is near the end of the tightening process. They’ve moved at 17 consecutive meetings. Europe is about in the middle. Japan’s just getting started. There’s no reason everybody has to be in exact concert but right now; everybody’s going in the same direction.

Where do you think Australia is in that process?

I think Australia’s getting near the end, a similar position to the Federal Reserve that the Reserve Bank has had several rate hikes now. You’re up around 6%. That’s probably about as high as they need to go. Another one or two wouldn’t surprise me.

There is concern the United States is actually about to slow down. How worried are you?

Well, the US is slowing down. You raise interest rates 17 times, the economy eventually gets the idea. It’s taken it a bit longer than we expected. We’re looking for about 2.5% growth going forward compared to the 3.5% we’ve seen for the past couple of years.

You’re comfortable with 2.5% though?

I wouldn’t mind. You’re looking at 2.5% growth, 2.5% inflation, 4.5% unemployment rate. That’s not bad.

How do you weight the risks?

That’s the problem for the Fed because inflation is clearly a risk. The problem for the Fed is always that what they do today affects the economy a year to 18 months from now. So that almost guarantees you over-react but it’s hard not to over-react because you’re looking at what the economy is doing now to make policy.

How do you rate the risks? Do you see a danger of the Fed not having done enough or maybe having done too much and the economy’s going to slow down too fast?

I think the Fed has probably done too much. That’s the usual pattern and my guess is by the middle of next year they’ll be cutting rates. But at the same time if I were at the Fed I’d be voting the same way because the balance of risk, you really do need to over-react a little bit because the danger of under-reacting is too great.

One of the big mysteries in this tightening phase is that fuel prices '” petrol prices '” haven’t done more of the job for central banks.

It’s been amazing how much the economy’s been able to ignore higher fuel prices. I mean, fuel prices and oil prices more than doubled over the past two years; almost tripled. You’re looking at record high prices and yet the consumer just keeps marching along. And I think the reason for that is that energy just isn’t as big a part of the economy as it was back in the 1970s when we had the last big OPEC price increases. Back then it took about a third of a tonne of oil or the equivalent to produce $1000 worth of GDP in today’s prices. Today it only takes about two-thirds that much, so we’ve got a lot more energy-efficient than we used to be.

Well the fuel impact isn’t as great as it was previously. Isn’t it still a magnifier on monetary policy? It’s as if the Fed actually put up rates maybe 25 times.

Yes, it’s probably more like the equivalent of a big tax hike coming on top of the Fed interest rate hikes. Because fundamentally that’s what it is: it’s a tax imposed on the economy by the energy producers. And that money is leaving the economy so it is going to slow us down but as I said, it’s not slowing us down that much.

Overall international growth is in an interesting phase.

May you live in interesting times! We’re seeing a rotation in world growth. Basically the US is slowing down but on the other hand Europe and Japan have sped up a little bit. Overall, we think the world will slow down a bit from the sort of 4.8% last year and this year to around 4.5%. That’s still going to be very good growth rates by historical standards but the source is shifting. Two-thirds of world growth, measured on purchasing power parity basis, is now coming from the developing countries and I think that’s healthy in the long run, if for no other reason than that developing country is no longer a euphemism.

And that’s enough to keep the commodities boom going?

I think it’s going to keep commodity prices strong but I think commodity prices are probably going to be dropping a little bit from where they are now. They’re artificially high now because they were unusually low during the 1990s and as a result none of the commodity companies were doing any investment. Now that commodity prices are going up they’re starting to do the investment but it takes a few years to bring that production on line. So I think you’re going to see a cycle but it’s a cycle around a rising trend of commodity prices.

What are the bellwether indicators you’re watching now in these interesting times of coming off the speed a bit?

In terms of the United States, obviously the key element is the consumer. We think we’re seeing the consumer slowing down. We’ve clearly seen the housing market peak and start to come down a bit, and that’s going to slow the economy down. The offset to that is investment, which is picking up; and the trade deficit, which seems to be stabilising, so net result is a moderate slowdown but what we worry about is number one: oil prices. Probably number two and three as well. That’s the one thing that could really cause a disaster in the short run. I don’t know what’s going to happen to oil. I don’t know what’s going to happen to the Middle East but I suspect nothing good.

What is your outlook for interest rates then?

For interest rates '” I think the Fed is just about done tightening; maybe one more hike. Maybe they’re done already and by the middle of next year they’re going to be starting to cut rates.

Are you going to predict what’s happening in Australia on the same basis.

My guess is I don’t know the Australian economy as well but from what I know and the people I’ve talked to I think we probably have one or two more rate hikes from the RBA and then they’ll probably stabilise and my guess again would be to bring them down maybe a little before the next election.