JACKSON HEWETT: BlackRock predicts higher rates for Australia as the consequence of global instability

The world’s largest fund manager BlackRock, with $US11.5 trillion under management, believes we are entering a new era of global volatility, driven by geopolitical instability, tariffs, and rising government debts.

If they are right, it is bad news, not just for mortgage holders but the Australian economy in general.

BlackRock sees five global megatrends dominating the next decade, an scenario far different from the “great moderation” of the post-GFC to Covid era.

Among those trends are the massive investments in artificial intelligence and its eventual adoption, the transition to low-carbon energy sources, and ageing populations across the developed world, including North Asia. Shifting financial markets is another.

Perhaps most importantly — in this new era of hostilitas-Americana — are the “geopolitical shifting sands”. After an era of globalisation powered by free trade and international political collaboration, BlackRock now sees a universe where high tariffs and a rewiring of global supply chains will push prices up.

According to BlackRock Investment Institute’s Asia Pacific strategist Ben Powell the pre-COVID years of “great moderation” where “years of very low, stable inflation are deeply embedded into people’s thinking” are over.

“The world has changed. Global inflation will be high and volatile for many years to come,” Mr Powell said.

For Australia, that very likely means upward pressure on interest rates, and quite possibly outside the Reserve Bank’s control.

The warning comes little more than a week after the Reserve Bank cut interest rates by 0.25 per cent, with markets are pricing another two cuts this year to take official interest rates down to around 3.5 per cent.

Mr Powell’s comments were delivered at the same time RBA Deputy Governor Andrew Hauser testified before a Senate Estimates committee reiterating the view that inflation would be closely watched before any further decisions on cutting rates were made.

“Our job … is to bring inflation sustainably back to target and we will set the interest rates necessary to achieve that,” Mr Hauser said.

The risk for borrowers is that the RBA’s ability to cut rates is increasingly constrained by the structural forces reshaping the global economy. Mr Powell argues that investors hoping for a return to cheap money may be in for a rude awakening.

“For those, in our estimation, hoping for a Great Moderation-style cutting cycle and a massive cheapening of money, we just don’t see that,” he said. “Unfortunately, inflation is a genuinely binding constraint, and therefore central bankers have got a much more difficult job.”

That difficulty is partly due to shifting government priorities, and more specifically increased government spending. During the era of ultra-low rates, Mr Powell said, “central bankers were totally central” to managing the economy. Now, fiscal policy is playing a much greater role, with governments increasingly stepping in to drive investment, whether through infrastructure spending or incentives for critical industries like AI and defence.

That means the capacity for significant rate cuts may be limited by inflation that refuses to settle back to pre-pandemic levels and are embedded in the economy and unlikely to dissipate quickly, Mr Powell warns.

“With a tightening in global supply that means higher price pressure for a prolonged period of time, which means neutral rates should be higher today than they used to be,” he said. “We think that’s four (per cent) in the US.”

The neutral rate is the theoretical interest rate at which monetary policy is neither stimulative nor restrictive, and the US Federal Reserve forecast that it should be 2.5 to 3 per cent as recently as a year ago.

Australia’s interest rate is highly correlated to the US rate via the return on 10-year government bonds, said BlackRock’s local based head of fixed income, Craig Vardy. And if the US neutral interest rate turns out to be significantly higher at 4 per cent, that will have serious repercussions for interest rates here because our long term bond rate is higher than that of the much more liquid US treasury market.

According to Mr Vardy, the RBA and market economists still have 3.5 per cent as the neutral rate in Australia, leaving more room for rate cuts.

But if the longer term outlook is for an inflation-driven US neutral rate of 4 per cent, then rate cuts are off the table.

“If you get these (megatrend) forces playing out, then (3.5 per cent) is the wrong number, it is 4 per cent. If it’s 4 per cent we’re already done” in terms of rate cuts.

If we are done in terms of rate cuts, Mr Vardy said the Government will have to step in again to stimulate the weak economy.

“Clearly, growth on the private side will struggle. So therefore fiscal policy becomes more important,” he said.

“That plays through to deficits. It feeds through to issuing more (government) bonds. It feeds through a high term premium (interest rate).

If BlackRock’s outlook is correct, borrowers, businesses, and policymakers alike may have to adjust to a future where interest rates settle at a level higher than seen in the past decade. And while the RBA may still cut in the short term, the era of ultra-cheap money may be well and truly over.