As a rule of thumb when interest rates fall, more people go out and borrow. The result is that consumers have more money to spend, causing the economy to grow and inflation to rise. And the opposite is also true. When interest rates rise, people stop borrowing because it becomes too expensive causing the economy to shrink and inflation to fall. An inverse relationship. A rise in US CPI in December and robust retail sales growth has boosted inflation expectations after a long run of weakness. The Labor Department recorded higher than expected growth in December for core prices, which excludes food and energy. Core prices rose 0.30%. Economists cheered the recent numbers and have raised their expectations for 4Q growth. With stronger inflation on the horizon investors are now positioning for the US Federal Reserve to increase interest rates as soon as possible. This has driven the two-year US Treasury bond above 2% for the first time since the GFC. With President Trump’s tax cuts due to kick in, the US economy is firing on all cylinders. Everything is going nuts, the stock market is hitting record highs, commodity prices are soaring, GDP is rising, unemployment is low and minimum wage increases are coming through. The US is doing really well. That can only mean more rate rises from the Fed to prevent it overheating. Some are saying four rate hikes this year. But what about the rest of the world? It’s much the same. The Bank of Japan trimmed its bond purchases and the ECB is looking to reduce its asset buying programme. The whole world is tightening, except us. That’s right. The RBA is one of the only central banks in the world that is stuck in this conundrum. Whilst the whole world joins in on the rising rate environment, the RBA will have to sit tight as inflation remains low and the property market stays hot. What is surprising though, is that the US dollar has fallen. Why is the US dollar falling? It’s quite strange. Usually the US dollar rises with the onset of higher interest rates. There are a few factors but the main one is Europee. Europe is doing well. Really well. The Euro against the US dollar rise has caught many by surprise, especially at a time when US data is positive and expectations are for Fed rate rises. The Euro’s strength has been driven by an improvement in the Eurozone’s economic outlook. Rising PMI’s in Eurozone countries is a good indicator the Eurozone is well on the mend. There is now pressure on the ECB to raise interest…

This article is for members only

To read this article - sign up for a FREE 14 day trial NOW

Blurred Text