Risk assets gave up ground in November after a strong start to the month. Ample evidence in data reports and surveys of continuing global economic recovery was tempered by concern that resurgent delta variant infection rates in the US and Europe in particular might force renewed imposition of recovery-crimping restrictions. Another concern was the emergence towards month end of the omicron variant known to be more infectious than previous variants but too soon to know where it is a more serious illness. In addition, inflation and the risk of higher interest rates dampened investors’ appetite for risk assets.

Central banks’ attitudes are shifting to reflect the bigger-than-expected lift in inflation that has occurred during in 2021. Earlier in the year most central banks saw higher inflation as a temporary problem caused mostly by supply chain disruption meeting higher demand for manufactured goods. The view was that inflation would subside relatively quickly as supply problems resolved. There was no cause to reduce monetary accommodation including emergency low interest rate settings aimed at assisting government policies lifting economies out of pandemic restriction created recession.

The persistence of supply chain problems plus increasing evidence of labour shortages and inflation tracking noticeably higher than forecast in many countries has forced a shift in central banks’ policy response to inflation. Some, such as the Reserve Bank of New Zealand and the Bank of Korea have started to lift official interest rates and are indicating more rate hikes soon.

Others have less aggressively shifted position. The European Central Bank and the US Federal Reserve have both admitted recently that higher inflation can no longer be considered temporary but are still likely to take time to hike interest rates because of the degree of uncertainty surrounding economic recovery. The RBA at the most dovish extreme on monetary policy has also shifted ground slightly conceding that depending upon how the economy performs the cash rate might need to lift in 2023 rather than its earlier guidance of 2024 at earliest.

Pandemic concerns plus the risk of higher interest rates caused previously high- flying share markets to stumble in November. Among major share markets falls in November ranged from 0.8% for the US S&P 500 to 3.8% for Germany’s DAX.

Australia’s ASX 200 fell by 0.8%.

The shifting position of central banks also caused Australian credit to soften during November. However, most factors affecting Australian credit remain favourable. The housing market remains resilient. The economy is in post-lockdown rebound with a strong lift in employment likely over the next few months and the RBA is still likely to be slow to hike the cash rate.

While central banks were shifting position on inflation and potential monetary policy change during November, government bonds enjoyed safe-haven buying as investors turned away from risk assets amid heightened uncertainty about the global growth outlook caused by pandemic developments. In November, the US 10-year bond yield fell by 11 basis points (bps) to 1.44% while the 30-year Treasury yield fell by 14bps to 1.79%. The fall in Australia’s government bond yield was much bigger, down 40bps to 1.68%, coming off a near-panic spike in Australian bond yields in late-October in the wake of higher-than-expected Q3 underlying inflation and the earlier tussle between the bond market and the RBA forcing the abandonment of the 0.10% yield ceiling on the 3-year bond yield.

The RBA’s inflation and wage forecasts listed in the August Monetary Policy Statement were rendered in need of upward revision by the Q3 CPI and wage reports. Inflation and wage forecasts for 2022 and 2023 were lifted in the early November Monetary Policy Statement and to the point where they implied the possibility of a cash rate hike in 2023. The RBA was in a bind. It had to lift wage and inflation forecasts while not fanning financial market forecasts of the need for a series of cash rate hikes starting as early as mid-2022.

Essentially, the RBA still views wage and inflation pressures in Australia as being less pronounced than those emerging in the US and Europe. In the RBA’s view, it will still take time, even with the economy rebounding strongly out of lockdowns, for annual wage growth to accelerate above 3% and support consistently higher inflation. The RBA is, in its own words, prepared “to be patient” and wait for evidence of higher growth in wages and inflation.

The RBA’s revisions to its economic forecasts and repositioning of its interest rate guidance in November have effectively stared down the bond market vigilantes for the time being. Heightened uncertainty about the pandemic and global economic growth have helped too. However, we see a high risk that the bond market selling will return and drive bond yields higher again.

Over the next few weeks, global growth prospects could brighten markedly if the omicron variant turns out to be milder illness than its predecessors helping to build herd immunity and hasten the demise of the pandemic to a seasonal nuisance ailment.

Inflation risk remains elevated and heightens the risk that the RBA is forced to raise its wage and inflation forecasts next year in February and probably again in May. These forecast revisions may add to bond selling. Our view remains that while macro-policy settings, both monetary and fiscal, are set so firmly towards priming growth and inflation it is likely that both continue to strain higher. We still expect a first RBA rate hike in July or August next year. We also expect that with household debt so high the RBA will have no option but to move gently and slowly. The first official rate hike may be only 15bps to 0.25%.