US decisions likely to decide between more inflation or deflation

Hunt attributes the improving outlook since November last year to the US Federal Reserve conducting “QE by stealth,” or printing money.

Last year, when the US government started to issue more debt, the bond markets suffered from indigestion and bond yields rose, Hunt told an investment forum in Wellington hosted by Nikko Asset Management.

US 10-year Treasuries reached a 16-year high just below 5% in mid-October but have since dropped to about 4.23%.

Because of concerns the US government mightn't be able to continue funding its fiscal deficit, the Fed then took action in the repo markets to flood the system with money and that's what produced the ensuing rally in both bonds and equities, Hunt said.

That flood of money is also the explanation for why current account balances in countries including New Zealand, Australia and Canada improved.

The US fiscal deficit in the first three months of this year has halved for reasons that aren't yet apparent.

What happens next will depend on what President Joe Biden's administration decides to do, Hunt said.

Either the fiscal deficit expands and the Fed monetises it, “or they drop the ball” and the US economy slows along with inflation and the US economy heads into recession.

If its eases fiscal policy, probably the most likely scenario, then inflation will become a problem again, Hunt said, describing the situation as being “on a knife edge.”

The trend towards “on-shoring” and “friend-shoring” of manufacturing will also generate inflation.

China's economy is likely to be weaker than most people expect, largely because of political decisions, including “directive 47”, an instruction published on Dec 24 last year to 12 regions of China accounting for about US$3.3 trillion of the nation's GDP and 23% of the population, to cease investment.

“The impact on the already weak economy will be severe,” on top the the property market woes that are well known, Hunt said, adding that about a third of properties sold by Chinese developers since 2015 have not been built yet.

“To build those missing properties would cost about 70% of China's GDP.”

The attitude of policymakers in Australia and NZ has been to kill inflation “at all costs” but that also runs the risk of deflation.

Hunt noted that NZ's recession was delayed by the huge post-covid influx of tourists about 18 months ago but that there are now empty shops in Queenstown.

“There's a real danger the NZ economy continues to weaken,” that the labour market weakens and that the housing market starts to go backwards again because the Reserve Bank may have over-tightened.

There's less of a danger of this happening in Australia because that economy appears to have more momentum, although there's a question over the impact of China's slowdown.