Ying Yi Ann Cheng: Why is US inflation is higher than Australia’s?

Ying Yi Ann Cheng, Portfolio Manager of the Switzer Higher Yield Fund appeared on Switzer TV to discuss why the US inflation is higher than Australia’s, and what this means for the Switzer Higher Yield Fund.

Watch the full interview here:

Video Transcript

Peter Switzer (PS): We’re catching up now with Ying Yi Ann Cheng from Coolabah Capital. This subject is her favourite, it’s what she sleeps and thinks about 24/7, interest rates. Ying Yi, how are you?

Ying Yi Ann Cheng (YYAC): Hi Peter, thank you for the introduction.

PS: Well, it makes you an unbelievably exciting person to be continually preoccupied with something that’s really important to the world of money, interest rates.

YYAC: True. It is very important and topical at the moment.

PS: Yeah, without a doubt. I’ve got a whole pile of, I think difficult questions, but people would be curious about what your business is thinking about, because Coolabah specialises in bonds and bonds is driven by interest rates what might happen. Let’s just try and get the latest feeling from you guys. The first question is how many rate rises are you guys expecting in the US this year?

YYAC: There’s currently around seven rate hikes priced in. I think that’s fair. That would imply that they would need to go at pretty much every meeting, live. I think that’s realistic. Obviously, our views around inflation are that the fed is already behind the curve. So arguably they probably should be doing more whether they do more than seven hikes this year is obviously questionable. The market’s obviously, jump to that sort of view quite quickly. I mean look, probably think that they should do 10 rate hikes if anything. But you know the question of should and whether they will is obviously a very different one.

PS: This one question I didn’t suggest I might ask you, but you’re so smart you can handle it anyway. A potential very difficult situation Ukraine, Russia, and NATO allies could that make the fed hesitate to put another negative in there for financial markets?

YYAC: Yeah, that’s definitely a legitimate sort of a question, but I think the reasons for taking monetary policy away from zero percent interest rates and super loose policy is related to inflation and there’s definitely an inflation problem. The more that they delay hiking rates the more of an inflation issue that they are creating down the track and the harder it is to stay on track of. Zero percent interest rates is obviously the lowest as you can get obviously without going to negative rates, but even if they were to hike to 0.25%, 0.5%, 1% that’s still expansionary.

PS: Yeah. Okay, let’s go to the really hard question. Will the first rate rise, which we pre warn that it’s going to be March so the upcoming month. But will it be 0.25%, 0.5% or is James Bullard, the St. Louis president of the fed 1%? What’s your best guess?

YYAC: Yeah, we’re probably of the view that it’s going to be 0.25%. I mean 0.5% is definitely a risk, but if you look at the rhetoric coming out of other fed members it would point towards more like 0.25%.

PS: Yeah, okay me too I agree with that. Let’s go to our first rate rise here. What’s Coolabah’s best guess on when we’ll see rates go up?

YYAC: Our core expectation is that we’ll see the first rate hike in August. Obviously, there are people of different views and camps. Some people are looking for May. Our view around the August rate hike is more so a couple fold. The RBA is firstly quite keen on seeing several inflation prints or CPI prints before they make a decision around hiking interest rates. Secondly, I think from a political perspective, regardless of whether labour or liberal do come into power hiking in May maybe a bit too soon from a political perspective, even if the RBA is deemed to be independent it probably wouldn’t look good politically.

PS: Okay, let’s go to how many rate rises are you guys expecting in Australia this year?

YYAC: Good question. Probably just about two rate hikes this year out of the RBA. We have a very different inflation profile versus the US so obviously in the US, core inflation is running or core PCA I should say which is the fed’s preferred measure is running around 4.7%. Wage inflation is around 4.7% as well. Whereas here, sure we’re like bit over 2% which is within that sort of target range and at the same time wage inflation which will get numbers out, this week as well that is running a bit over 2% as well. So definitely different profile and they’re obviously not in as much of a hurry versus the US.

PS: Have you thought about why US inflation is higher than Australia inflation?

YYAC: Well, we were already behind the curve in terms of inflation I should say, not the RBA necessarily. The RBA even heading into the pandemic was already undershooting its inflation objectives in terms of targeting two to 3% inflation. So, we’re coming from a very different base to begin with. Over in the US there’s tightness in the labour market. Whereas here, while we do have tightness in the labour market here as well, they definitely haven’t had closed borders in that respect and so we are expecting them to open our borders and therefore that influx of immigrants and also international students will help to moderate a bit of that wage inflation pressure.

PS: I’ve only just thought about this when I was listening to your as usual brilliant answer. And I’m wondering whether JobKeeper actually has actually taken the pressure off wage demands because for lots of workers their wages didn’t change over the course of the pandemic, but in the US where the market labour market is far more flexible they might have actually seen a lot of wage falls and now they’re playing catch up.

YYAC: Yeah, but they did also have stimulus checks and JobKeeper obviously is not around anymore, but yes initially JobKeeper was definitely very attractive. I mean, I definitely had heard of anecdotes whereby people were getting paid more on JobKeeper than they traditionally would be in their normal job because they worked casually, or they worked part-time for example. It definitely was a good measure from the government in terms of an immediate blanket policy response, but it was very blunt, and it was far reaching in that respect. In the US there was obviously stimulus checks as well. You know people going on unemployment benefits, but you also had people come out of the labour force in the US as well, disenfranchised by COVID and moving out of certain sort of industries around hospitality et cetera, just because of the dangers associated with working in that industry given the pandemic. So, encouraging those people to come back is obviously… There are people that are coming back, but then there at the same time those people have just left permanently and maybe working in what they call the gig economy now.

PS: Yeah, it’s a great question could be great PhD paper that one. Finally let’s go to inflation. Do you think inflation’s in both US and Australia will eventually prove to be temporary or though it might take longer for it to start to dissipate and fall or do you fear that there may well be a number of years of rising inflation?

YYAC: Yeah, well this is why central banks need to nip it in the butt, right? Because inflation expectations have been moving higher. If you look at the US, you know the University of Michigan surveys have inflation pointing to, inflation expectations over the next sort of 12 months, quite high. I think it’s around a bit over 6%. If we look at the New York fed inflation expectations they’re around four point something percent. Over the next 12 months over the next three years people are expecting three point something percent. So, as we know if we’re expecting something we’re going to change our behaviour in line with that expectation.

If people are behaving in a way such that they expect higher prices in the future, then that can be self-fulfilling and that is a concern. Unless central banks depending on their hiking profile and whether they nip this inflation problem sooner rather than later will have a huge impact on these inflation expectations. That’s hugely important and that will impact how far reaching or how long this inflation will last. At the same time, our view is that it isn’t there are supply chain constraints, but in some ways, you could argue that everything that could affect inflation or that is bad with respect to, priced profile has already happened, but there could be potential issues down the line.

We could have a wage price spiral that could perpetuate things. So, things start costing more so I demand higher wages. Higher wages then feed through to the cost of goods and services. Then for it we get that wage price spiral which is obviously not desirable. Hence why I mentioned that central banks need to nip in the butt. Secondly, you also have the risk of other variants which could affect the supply chain town to track as well.

PS: Yeah, good point. One final one and this is purely a vested interest question. You guys manage the Switzer Higher Yield Fund but it’s on a floating rate. So rising interest rates should be good for that fund?

YYAC: Yeah, it’s beneficial because in a floating rate fund your interest rate is not fixed so because it’s floating. For example, if you have invested in a fixed rate fund usually you’ve fixed your rate at a lower rate if interest rates are moving higher. So, you don’t benefit from that high yield or that high income that comes from the bond. As, you know, interest rates move higher that benefits floating rate funds like the Switzer Higher Yield Fund because the underlying income that’s coming from the investments within that fund are going to be higher.

PS: Yeah, great. I’m glad that Chris talked me into it. Good on him. Okay thanks for doing this, Ying Yi.

YYAC: Thank you, Peter.

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