Strategy commentary cont'd: From a macro perspective, our biggest concern remains the spectre of higher long-term interest rates as bond market bandits demand greater risk premia (or term premia). By this we mean more compensation for enormous public debt issuance, fiscal policy uncertainty, and inflation volatility.

Coolabah has been particularly focussed on US fiscal and interest rate dynamics. Since late 2023, we have asserted that the Fed will struggle to deliver the hefty rate cuts that were priced into markets. In early 2024, around 175bps of cuts were priced for that year, yet the Fed only delivered 100bps. Most of the cuts for 2025 have been removed altogether with the Fed doing a 180 degree turn and shifting to a wait-and-see mode on monetary policy.

Coolabah's concern is that President Trump has promised tax cuts that will cost US$9.5 trillion. To pay for these, Trump must implement his tariffs or face a potential fiscal crisis. Even assuming a worst case scenario of a 20% global tariff on all imports and a 60% tariff on Chinese imports, which markets do not expect, Trump would only raise US$4.5 trillion, or less than half the cost of his tax cuts according to the Brookings Institution. This would boost the US budget deficit to 7.25% of GDP over the next 10 years. It would also increase the US debt to GDP ratio from 98% in 2024 to 129%. If more modest tariffs are implemented, these fiscal outcomes are worse.

Then overlay Peterson Institute modelling of the inflation and interest rate impacts of Trump's tariff and human deportation programs, and the picture seems very grim. According to this research, which ignores tax cuts, deregulation, and fiscal reform, inflation could be 7-8 percentage points higher and the Fed's policy rate 3-4 percentage points above where it would otherwise be.

One hope is that Elon Musk slashes public waste. While Coolabah believes there is huge promise here, Trump has to date insulated almost two-thirds of US government spending from these cuts. And yet Musk wants to reduce spending by US$1 trillion or 15% in total. Something has to give.

Strategy commentary cont'd:

US unemployment rate ticks down to 4.0% in January

The US labour market remained solid in January. The number of payroll jobs grew more slowly in the month, slightly below market forecasts. But recent growth was revised up even as benchmark revisions lowered the level of jobs by about 0.5-0.75 million over the past year. The unemployment rate ticked down to 4.0%, which is the lowest level since May, down slightly from its recent peak of 4.2% and below all estimates of the US NAIRU. The numbers are consistent with the Fed remaining on hold, where the FOMC will be more focused on Trump policies (Trump recently said he could impose tariffs on Japan depending on what happens to the US's bilateral trade deficit, while the Canadian press reported that their prime minister said in a closed-door meeting that "Trump's threat to annex Canada 'is a real thing' motivated by his desire to tap into the country's critical minerals").

The number of payroll jobs rose by 0.1% in January, down from 0.3% in December (previously 0.2%). Annual growth was unchanged at 1.3%, while trend annualised monthly growth was 1.75% (previously 1.5%). Benchmark revisions saw the level of payroll jobs revised lower by about 0.5-0.7 million from January last year onwards, which was somewhat less than had been expected.

Strategy commentary cont'd: The unemployment rate edged down from 4.1% in December to 4.0% in January. This is the lowest level of unemployment since May and is down slightly from last year's peak of 4.2%. Surveyed employment rose by 0.2% after adjusting the published increase of 1.4% that was distorted by the introduction of new population benchmarks (oddly, the BLS never adjusts the level of published employment for these periodic structural breaks in employment), with annual growth edging up to 0.4%.

The unemployment rate is below all estimates of the NAIRU, where the median FOMC estimate of the NAIRU is about 4.25% and the CBO and median surveyed economist estimates are both around 4.5%.

Strategy commentary cont'd: Low inflation likely pushes the RBA over the line for a February rate cut

The RBA will probably cut rates given lower-than-expected underlying inflation. The RBA board meets on 17 and 18 February and will release updated forecasts when it announces its policy decision on the second day.

At this stage, the board will probably act on its recently-adopted easing bias, cutting the cash rate by 25bp from 4.35% to 4.1% given underlying inflation came in lower than forecast in Q4 (the board will also be under immense political pressure to cut rates given that the federal election must be held by May and poor polls for the government).

The trimmed mean CPI rose by 0.5% in Q4 after a 0.8% increase in Q3, which was below the RBA staff forecast of 0.7%, with annual inflation slowing from 3.6% to 3.2% (seasonal reanalysis of the data saw the annual inflation rate in Q3 revised up marginally from 3.5%).

Substantial direct government subsidies – which are treated as an effective price reduction by the ABS – held down headline inflation in the quarter, while electricity subsidies alone took about 0.1pp off trimmed mean inflation in Q4 by changing the distribution of price changes.

The Q4 outcome was the largest downside surprise for the RBA in a year and suggests that the staff should tweak the year-ahead forecast for inflation in the February Statement on Monetary Policy, although perhaps not by much given that a simple extrapolation of the monthly core CPI excluding electricity suggests that the trimmed mean CPI could rise by about 0.6-0.7% in Q1, close to the staff's November forecast.

Assuming that the RBA does cut rates next month, it seems likely that the eventual easing cycle should be relatively shallow, barring global extreme fall-out from Trump policies.

This is reflected in the RBA estimating the neutral cash rate at about 3.50% and with the resilience of the labour market, where a 4% unemployment rate is well below the 4.75% staff midpoint estimate of the NAIRU.

In terms of the other detail of the CPI report, our experimental measures of trimmed mean goods and services inflation both improved sharply in Q4, with annualised goods inflation easing to 0.75% and services inflation slowing to 3%.

The broader goods/split of the monthly headline CPI tells a similar story of weaker goods inflation, albeit with more persistent services inflation.

By item, ignoring the temporary effect of the subsidies, perhaps the most encouraging sign for the RBA was the slight fall in new home prices in Q4, which are the largest component of the CPI basket, marking the first decline since 2021.

Strategy commentary cont'd:

Strategy commentary cont'd:

Trump starts a global trade war

Barring last-minute changes, the US is imposing punitive tariffs on its close ally Canada, Mexico, and China, with a EU tariff to come.

The US government is imposing substantial tariffs on imports of goods from its longstanding ally Canada, as well as Mexico and China, with President Trump adding that he would "absolutely" impose a "very substantial" tariff on imports from the European Union at a later date.

Barring last-minute changes, the tariffs take effect soon. Canada will be hit with split tariffs, with 10% on oil and gas and 25% on all other goods. Mexico is subject to a 25% tariff and the additional tariff on Chinese goods is 10%.

President Trump warned that the US could raise tariff rates further if any country retaliates, where Canada has announced a 25% tariff that applies to an increasing coverage of imported US goods over time. Mexico has signalled it will impose tariffs, while China will lodge a largely symbolic case against the US with the World Trade Organisation as it simultaneously takes tariff and non-tariff countermeasures (historically China has gone about one-for-one with changes in US tariff rates).

The White House said the tariffs were mainly in response to the flow of illegal drugs, specifically fentanyl. However, this argument does not tally with the varying tariffs applying to different countries, in that US government research notes that the bulk of fentanyl comes from Mexico, with China and India the main suppliers of the chemicals needed to manufacture the drug. Fentanyl sourced from Canada is negligible.

Another discrepancy concerns how the 10% tariff on China is only a fraction of Trump's election promise of a 60% additional rate. This could reflect the influence of Musk, where Tesla has a large manufacturing plant in China, with China and the US evenly accounting for the vast bulk of Tesla sales.

Strategy commentary cont'd: Canada, Mexico and China account for 42% of US imports of goods, such that the Trump tariffs should increase the effective US tariff rate from 2.5% to 10%, which would be the highest level since World War 2.

Adding in the European Union raises the import share to 61%, such that the effective tariff rate would reach 15% - which would be the highest rate since the Great Depression – on the arbitrary assumption of a "very substantial" 25% tariff on the region.

Goods account for 31% of US consumer spending, such that the tariffs on Canada, Mexico, and China would boost headline PCE inflation by about 1.25pp, building to about 2pp if a similarly punitive tariff is imposed on the European Union.

There are also likely to be significant disruptions to supply chains in key industries such as the auto sector, where some inputs into production cross the US border several times.

Importantly, these preliminary estimates of the potential impact on inflation should be treated as upper bounds because the effect on consumer prices will likely be diluted by some companies absorbing part of the increase in tariffs along the production chain, particularly when the US demand for imported goods should contract sharply, along with movements in exchange rates and possible substantial changes to the scope of the tariffs at a later date.

On the latter point, the tariffs could be subject to legal challenges, while companies will seek waivers. President Trump could also water down the tariffs, or even scrap them, depending on the reaction of the public and the stock market.

Nonetheless, the clear risk for the Federal Reserve is that a sustained increase in tariffs raises expected inflation, which would boost ongoing inflation. Early survey data already show that consumers who view tariffs negatively have materially higher short-term inflation expectations and slightly higher long-term expectations.

Unless the US government backs off at the last moment, the American tariffs should see at least a partial unwinding of globalisation, where globalisation has broadly peaked over recent years. This points to higher average inflation at the margin, as globalisation has helped central banks in restraining world price pressures.

Strategy commentary cont'd:

QLD's budget "black hole" a catalyst for government action

The new state government is forecasting a substantially worse budget outlook, with a massive increase in public debt.

Queensland has seen a substantial blow-out in its budget position according to the mid-year update provided by the new state government.

Budget blow-outs were understandably common at the height of COVID, but this significant deterioration has been driven by the recently-elected government factoring in what it regards as more realistic costings for spending on health, education, child services and infrastructure (state GST revenue is also lower, while spending, including interest payments, is generally higher).

Underfunding of government policies is a common problem for both Commonwealth and state budgets, even though some governments try to deal with the issue by using contingency reserves and the like.

In this case, the revisions are substantial, such that the new government should use the budget "black hole" as a catalyst for cutting spending and raising taxes in this year's budget, a practice more usually seen at the Commonwealth level.

This strategy is clear from the update stating that, "the 2025-26 Budget will be developed in a methodical manner with the objective to deliver a safe and secure pathway to drive budget improvement, with lower debt than under the policy settings of the former government".

Notwithstanding likely policy action, significant risks remain. In the near term, state government workers are pushing for higher wages, while in the medium term the cost of hosting the Olympics in 2032 could greatly exceed expectations and place significant pressure on the budget.

With relatively little change in the economic outlook, the huge spending revisions underpin much larger budget deficits across the forecast horizon, leading to a massive increase in public debt based on current policy settings.

The expected non-financial public sector cash deficit – which is the broadest measure of the budget balance – for 2024-25 has been revised from $19bn to $26bn, before fluctuating between $28bn and $31bn over the remaining three financial years of the forecast horizon (previously expected to narrow from $18bn to $10bn).

Gross public debt, as measured by non-financial public sector borrowings, is expected to balloon from $128bn in 2024-25 to $218bn in 2027-28 (previously a forecast increase from $125bn to $172bn).

To place this in perspective, Queensland debt will almost match the forecast borrowings of the two larger states by the end of the forecast period, where Victorian debt is expected to reach $258bn in 2027-28 and with New South Wales debt standing at $250bn (by way of comparison, Commonwealth securities on issue are forecast to reach $1.2tr by that time).

Strategy commentary cont'd: Put differently, Queensland's non-financial public sector debt is forecast to rise from $23K per person in 2024-25 – which is the lowest debt burden of the three largest states – to $39K per person in 2027-28, which would exceed the expected burden of all other states, including Victoria at $37K.

Queensland Treasury Corporation has updated its issuance programme. On current policy settings, issuance of term debt for 2024-25 has been revised from $24.9bn to $26.9bn, with annual issuance for 2025-26 raised from $32.3bn to $41.9bn (the later years have seen even larger revisions to $44bn per annum).