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In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.

Key points:

• Inflation has largely been beaten, but Trump policies pose a risk to its return
• – US Fed pauses interest rate cutting, as inflation concerns rise
• RBA likely to cut interest rates in February (with more cuts likely in 2025!)
• Global economy mixed, US strength, Europe fading and Australia somewhere in the middle

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

In many countries, including Australia and the US, inflation has largely been beaten. However, there are some data points that are causing some to question whether inflation could return again in the not too distant future.

In the US, the statistical agency produces separate data on the Consumer Price Index (CPI) measure of inflation, an index for shelter (largely rent), and CPI-less-shelter. For the last seven months, inflation in the official CPI-less-shelter inflation has been comfortably below the Federal Reserve’s (Fed) target of 2% p.a.

Except for three months (March to May 2024), US CPI inflation-less-shelter has been below the 2% target since May 2023. The average over the last 19 months (including the three aberrant months) is only 1.6% p.a.! The largest read in those three months was 2.3% p.a. So, what is the problem?

Residential rents in the US account for about one third of the CPI. But because of the way it is calculated, rent inflation only falls slowly after a spike. The Fed has acknowledged this fact in a recent research paper and its chair, Jerome Powell, discussed this point at a press conference last year. Powell noted other agencies calculate rent inflation differently (and hinted possibly better) but he said they were not about to change. Perhaps they will after this cutting cycle is well and truly over!

Rent inflation peaked at 8.2% p.a. in March 2023 and has fallen each month since – except for two small monthly increases – and it now stands at 4.6% p.a. It is highly unlikely rent inflation would increase with a lower interest rate. Indeed, the opposite is probably the case, as owners might pass on rate changes to their tenants. At the current speed of the falls in inflation, it could be 2026 before we see aggregate shelter inflation to get close to 2% p.a. In summary, inflation is not sticky, the calculation for shelter inflation is deficient!

The Fed did not cut rates again in January after three successive cuts totalling 1.00%, or 100 bps (basis points), to stand at a range 4.25% to 4.5% p.a. As it happens, the RBA interest rate in Australia is 4.35% p.a. and there have been no cuts (yet) in this cycle.

Models exist for predicting the chance of future Fed cuts based on the current market prices of interest rate futures and options. One such model prices an 80% chance of a single cut by May and an 80% chance of a second cut by the end of this year.

Powell is hesitant to cut US interest rates again for two reasons. First, economic growth as measured by Gross Domestic Product (GDP) is strong, (the latest estimate is 2.3% p.a. for the December quarter and 2.8% p.a. for 2024) and jobs are holding up (256,000 new jobs were created last month compared to an expected 155,000 and an unemployment rate which has been stable at about 4% for the past six months). Clearly, he feels damage to the economy is not being done at the current monetary policy settings.

Secondly, Powell and many others feel that President Trump will enact several inflationary policies and Powell wants to stay ahead of the game. All the time before Trump’s election, the Fed and most other central banks declared they are data dependent and not expectations dependent. It seems now they are trying to predict inflation from policies that have not yet been articulated in any formal sense – and then many would need to pass through Congress. They are switching from data dependency to expectations dependency without acknowledging it!

Trump talks about imposing lots of big import tariffs, repatriating lots of illegal immigrants, cutting taxes, reducing regulation, and cutting back government spending (among many other policies). Except for government spending, the major mooted policies could add to inflation.
Starting with tariffs, Trump has already walked back on his election campaign rhetoric. He recently said he will raise tariffs in s

mall increments and not from ‘day one’. However, at the end of January, he said he would impose 25% tariffs on Canada and Mexico from February 1st. He is too inconsistent to try and second guess what will actually happen. No details are yet available and Trump has a history of making changes to his views without any real explanation.

We believe that many of his statements were just a vehicle for ‘bullying’ other countries into doing things that would benefit the US.

Take the case of repatriating some immigrants to Colombia near the end of January. Two US military aircraft (with illegals on board) were refused landing permission in Colombia so Trump slapped a large tariff on Colombia that day by executive order. The next day, Colombia capitulated and allowed the US to repatriate the deported Colombians – and Trump removed the tariff after only one day. No inflation consequences. A very big stick indeed.

The President of Mexico was reported to have said Mexico does not think the 25% tariff will come to pass. But even if tariffs are imposed, will they be on all goods and services and for how long?

While Trump has made some big inroads into stemming the flow of migrants into the US it is not obvious that he yet has a plan to remove those already settled in the country.

By executive order, Trump cut international aid. He failed in his attempt to freeze government grants and loans after a judge put a temporary pause on that executive order. He then withdrew the order but that doesn’t mean he won’t try again!

The opponents to Trump’s new immigration policy did not claim slowing down immigration at the borders would cause inflation – just the removal of current cheap labour. The number of illegal immigrants within the US was estimated by the State Department to be over 11 million in 2022. Since then, under Biden, there was a massive increase in immigration. Migration flows best serve a country when they are controlled and accommodated with long-term objectives in place.

There is a long way to go before a reasonable estimate of any inflationary pressure of Trumps putative policies can be estimated. In the meantime, modest cuts in rates by the Fed should go ahead which can be reversed if new obviously inflationary policies get enacted.

In Australia, some economic data look quite reasonable but a deeper dive reveals some major cracks. The latest jobs data looked strong with 56,300 new jobs created in December but that number includes a loss of 23,700 full-time jobs and a gain of 80,000 part-time jobs. The latest unemployment rate was 4.0%, from 3.9% in the prior month. These results are mixed at best.

Because our immigration rate has been high in recent times – resulting in a population growth over 2.5% p.a. – jobs need to be created to absorb the growing population. Jobs growth in aggregate does not signal a strong economy unless it is compared to population growth.

Recently, it was reported that a majority of the new jobs created in 2024 were in the National Disability Insurance Scheme (NDIS). While it might be laudable to create this service, it does not reflect the strength of the economy. These jobs are funded by the taxpayer and so reflect a fiscal stimulus and not an aggregate demand story. When the NDIS jobs reach their target, a serious deficiency in the demand for labour could be exposed.

In our latest round of data measuring inflation, all the key measures were within the RBA target band of 2% to 3% p.a. There is little argument for the RBA to not start cutting interest rates at its February meeting. The market has one interest rate cut priced in at 95% probability for this meeting and a better than a big chance (around 80%) of four cuts in total this year. That would still not get our rate down to as low as Canada’s or the European Central Bank’s (ECB) current rates – and our economy would be exposed to restrictive monetary policy while we are cutting.

Elsewhere in the world, Canada is in a per capita recession like us but the Bank of Canada (BoC) just cut for the sixth successive time to bring its rate down to 3% p.a. from 5% p.a. (before the interest rate cutting cycle started). Canada has endured six consecutive quarters of negative growth in per capita GDP – just like Australia!

The ECB just cut its interest rate by 25 bps to 2.75% p.a. In answer to a question at the media conference, the President of the ECB said they did not even discuss a 50 bps cut – even though the European Union (EU) growth was reported to be 0% in the latest quarter hours before the rate decision. Being so data dependent when the lags between policy change and the reaction in the economy are known to be ‘long and variable’ almost guarantees creating a recession – and then the central bank has to ease rates below the neutral rate to help the economy recover.

Japan has monetary policy moving in the opposite direction to most countries. The Bank of Japan (BoJ) had a negative interest rate for 16 years in its fight against deflation and low inflation. It has now increased its rate twice (to 0.5%) with an aim of achieving a 1% p.a. rate by the end of the year. Inflation had been too low for a very long time. Japan is hoping for modest inflation. The latest CPI inflation read was 3.6% p.a. when 3.4% p.a. had been expected! Stripping out volatile components to get the core rate, inflation came in on expectations at 3.0% p.a.

Asset Classes

Australian Equities 

The ASX 200 had strong capital gains in January (+4.6%) in spite of elevated market volatility. Presumably, much of the momentum is due to what investors think Trump might bring to markets and the heightened chance of several interest rate cuts by the RBA this year.

The Consumer Discretionary sector (+7.1%) and the Financials (+6.1%) sectors were the standout performers in January with only the Telco ( 1.5%) and Utilities ( 2.4%) sectors going backwards.

In the run up to the February reporting season, there has been a modest improvement in company earnings expectations (as surveyed by LSEG). We are now expecting a better than average capital gain in the ASX200 this year. The 4.6% gain in January does not put this index in anything more than a modest over-bought situation by our metrics.

International Equities 

The S&P 500 also had a strong January (+2.7%) but there was much disruption towards the end of the month for two reasons. Firstly, ‘DeepSeek’, a China generative AI app was launched causing NVIDIA, the US GPU chip manufacturer, and several massive US tech companies, together with energy companies, to have their share prices slashed. Secondly, Trump stated on the last afternoon of January that he would introduce tariffs of 25% on each of Mexico and Canada – and 10% on China in a punitive move to address the illegal importation of fentanyl into the US.

The London FTSE (+6.1%) and German DAX (+9.2%) had particularly strong months but the Tokyo Nikkei ( 0.8%) and the Shanghai Composite ( 3.0%) went backwards. There were modest gains in Emerging Markets (+1.5%). The World index rose +3.5% in January.

The DeepSeek story is far too complicated for an Economic Update. However, based on technical advice, we believe the rout in US technology company share prices was overblown on the first day. A simple version of the argument is that DeepSeek is far more efficient than competitors like ChatGPT and Gemini so less (NVIDIA) GPU chips would be needed and, hence, the AI industry would be less of a drain on energy resources.

The claim that DeepSeek only cost US$6m to ‘train’ is misleading. CNBC argues the true cost of getting to launch was in excess of US$500m!
Importantly, the -16% fall in the Nvidia stock price on the day of the DeepSeek announcement did not cause an across-the-board fall. On that day, more stocks had gains than losses. A big sector rotation had started.

But this DeepSeek story misses a big point in Artificial Intelligence (AI) work. There is a ‘model training’ part which is very expensive to run as models consume as much data as they can from the web and elsewhere. Then there is the ‘model inference’ component that follows the research and development (R&D) ‘training’ component. We believe we have yet to scratch the surface of what the inference component will require in years, decades and maybe more to come. Perhaps a parallel can be drawn from the 1940s when the then Chairman of IBM conjectured there might be room in the world for five computers!

There are also reasonable uncertainties regarding the veracity of the DeepSeek claims, security concerns and censorship. We saw a report that said DeepSeek couldn’t answer the question, “Who is the President of China?” [due to censorship].

We still see the S&P 500 achieving a positive return this year. In the latest US quarterly reporting season there have been some very strong earnings reports and outlook statements. One notable exception was Telsa, which missed expectations on many fronts but the share price went up in after-hours trading and the next day. Was this possibly due to the blossoming connection between Trump and Musk?

Bonds and Interest Rates

The Fed seems to have successfully engineered a soft landing for the US economy. The 10-year US Treasurys’ yield is now just over 4.5% from below 2% at the end of 2021. The yield curve is no longer inverted (which occurs when the 10-year bond yield is below the 2-year bond yield).

The RBA has yet to start cutting its overnight cash rate (OCR) but we expect the easing cycle to start in February 2025 and the RBA reduce the OCR from its current 4.35% p.a. by 0.25% to 4.10% p.a. with the prospect of more interest rate cuts to follow. Seldom does a central bank cut or raise interest rates only once in a cycle.

The BoJ just hiked for the second time in this cycle – to 0.5% – with the aim of a 1% p.a. interest rate by year end.

The UK is in danger of creating a serious recession not just because of interest rate policies but because it is introducing some sharp tax increases. The BoE was on hold at 4.75% p.a. at its December meeting.

The Bank of Canada (BoC) has just made its sixth interest rate cut in the current easing cycle – down to 3% p.a. from 5% p.a.

The ECB needs to cut rates further from the current 2.75% p.a. as the German economy – the powerhouse of the EU economy – has just posted its second year of negative GDP growth ( 0.2% in 2023 followed by 0.3% in 2024) and EU growth was 0% in the latest quarter.

Many central banks held rates too high for too long in their quest to be “data dependent”. Only the US seems to have dodged that bullet and possibly because – at least in part – of former President Biden’s Inflation Reduction Act producing strong fiscal stimulus.

Other Assets 

Brent Crude Oil (+3.2%) and West Texas Intermediate (WTI) Crude Oil (+1.1%) prices were up in January. The future of oil prices is clouded by any impact from Trump’s policies. He wants the Saudis to increase supply to reduce oil prices. In turn that would hurt the Russians and, potentially contribute to an end to lead to the war in the Ukraine.

Secondly, one of Trump’s new mantras (energy policy) is ‘Drill baby drill’. He is overturning much of Biden’s green energy push and wants fossil fuels to support the economy more until green energy can reasonably do its job.

If Trump is successful, oil prices could fall from current levels which, in turn, would lower headline rates of inflation.

Of course, if the Saudis bring down oil prices too much, there will be less incentive to “Drill, baby, drill”.

The price of gold also rose strongly (+7.0%) in January.

The prices of copper (+4.1%) and iron ore (+4.4%) were also up strongly in January with the price of iron ore closing out the month at $US105 per tonne after dipping to $US96.76 during January.

The VIX share market ‘fear’ index came down from its intra-month high of 19.5 to close the month at 16.4. We think of the normal range being around 12 to 14.

The Australian dollar (AUD) was largely flat (+0.1%) over January. If the Fed does slow down interest rate cutting, but the RBA becomes active in cutting interest rates, some further weakness might be seen in the AUD.

Regional Review

Australia

Australia is marching towards a general election – not yet called – and it is unclear at this stage what the protagonists are plotting in any detail for their campaigns.

Jobs data were mixed but, importantly, jobs growth has been reportedly dominated an expansion of NDIS jobs such that most of employment growth in the last year was due to NDIS. While this might be a great source of work for the employees and a source of benefit for the recipients, the jobs are funded by the taxpayer. While these jobs are genuine, they are not an indicator of the strength of the economy but simply from fiscal stimulus. The RBA encouraged to factor this component into its calculations when discussing the need for interest rate cuts.

Retail sales enjoyed a welcome bounce in the latest data. Sales were up 3% in dollar terms and 0.5% after an inflation adjustment. That’s not greater than population growth so we are all (on average) buying less ‘things’ than last year but, at least, ‘real’ sales did not go backwards as they have in recent history.

China 

The China story for January was overshadowed by the launch of the ‘DeepSeek’ AI software. NVIDIA, the biggest company in the S&P 500 had its price fall about 16% on the news. Lots of ‘Mag 7’ stocks fell a few percent with it as did lots of energy stocks.

As one broker wrote, China may have taken out lots of put options over the Nvidia share price. There is no doubt Trump and China’s President Xi are going toe to toe. Trump has so far changed from saying he would place a 60% tariff from ‘day one’ on China to a 10% tariff from 1 February 2025 – less than on Mexico and Canada!

But the good news (if it wasn’t generated by DeepSeek!) was that China Q4 GDP growth came in at 5.4% making 5% for the year – maybe a coincidence but exactly what the government’s policy target was. The last four quarters’ results were 5.3% p.a., 4.7% p.a., 4.6% p.a., and 5.4% p.a.. Looks like a bottom in Q3 when the big stimulus package was launched.

US

The nonfarm payrolls (jobs) data came in at 256,000 against an expectation of 155,000 with the unemployment rate at 4.1% and below the expected 4.2%. Wage growth was 3.7% which is not high enough to upset price inflation forecasts.

The initial reaction to the jobs report on Wall Street was negative because investors feared no more interest rate cuts – or even a rate hike! The inflation data that followed soothed market nerves.

CPI-excluding-shelter inflation is well under control and inside the 2% p.a. Fed target.

The preliminary estimate of December quarter GDP growth was 2.3% p.a. against an expected 2.5% p.a. The final estimate for the September quarter was 3.1% p.a. GDP growth for 2024 was 2.8% p.a. following 2.9% p.a. in 2023. Consumer spending rose by a very robust 4.2% in the December quarter.

Europe 

The ECB cut its interest rate to 2.75% p.a. and EU growth was flat in the latest quarter. EU inflation rose for the third consecutive month to 2.4% p.a. having previously been below the target of 2% p.a. Further interest rate cuts are expected this year. The rise in inflation has been attributed to energy prices no longer falling and cancelling positive inflation in other goods and services.

Germany posted its second consecutive year of negative GDP growth: 0.2% in 2023 and 0.3% in 2024.

The UK is reportedly facing a recession as new taxes are introduced.

Rest of the World 

Colombia has accepted some of its citizens who were deported from the US.

Slow progress has been made on a cease-fire and hostage exchange in the Israel-Gaza conflict.

Trump is calling on the Saudis to cut oil prices to increase financial pressure on Russia with the hope that it may help end the war in the Ukraine.

We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report.

In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.

Key points:

• The Fed cut US interest rates in December and the economy remains resilient
• The RBA remains on hold, but the chance of a February 2025 rate cut is rising
• The rally in AI related shares looks set to continue
• Trump policies appear to be positive for equities but also inflationary – how this plays out is unclear

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

In early 2024, it became obvious that the performances of a small number of stocks were dominating growth in the US S&P 500 Share Index. The market has been led by the so-called ‘Magificent Seven’ (or, later, the ‘Mag 7’), which are the biggest mega-cap technology companies and includes Microsoft, Apple, Amazon Nvidia, Alphabet (Google) Meta (Facebook) and Tesla.

At the same time, in the popular press, ChatGPT, became the poster-child of the Artificial Intelligence (AI) industry. However, the so-called ‘generative AI’ applications that could write a resume or even an assignment at school or university wasn’t the main game; it was just an easy-to-understand, visible application.

Generative AI applications are only a segment of the entirety of AI innovations. Think facial recognition on CCTV cameras, detection of who is using a mobile phone while driving and the universe of applications is rapidly expanding. Then add on some serious scientific work in medicine, exploration and defence and we quickly conclude that it is almost impossible to even try to guess the magnitude of the impact of the AI-led new industrial revolution.

So, when some corners of the media and finance commentators were obsessing with the notion of a speculative bubble in the price of shares related to AI in early 2024, we felt that this rally was for real and that relevant share prices were supported by commensurate growth in earnings. Of course, all rallies are not a straight-line event and have dips along the way but what we are experiencing now is not like the dotcom boom and bust that occurred at the turn of the twenty-first century. In 1999-2000, companies were launching on the share market on the dream of some new, unproven idea. In 2024, NVIDIA, the major AI-chip manufacturer, was already scaling up production and making big profits. By mid-2024, NVIDIA was the biggest company in the world by market capitalisation.

To inform our views we base some of our market analysis on the survey of broker-forecasts of company earnings by LSEG (formerly Thomson Reuters). Led principally by the Mag 7 the S&P 500 index quickly got ahead of its ‘end of year’ 2023 forecast in 2024. Australia has much more limited exposure to AI and the forecasts of the ASX 200 were a much closer fit to what was actually achieved.

The question we now face is – where do we go from here? The S&P 500 gained 23% in 2024 when historical averages have been single figure growth rates. And that 23% was on the back of 24% growth in 2023! The AI rally started before most realised it! In two years, the S&P 500 index had gained 53%! Any investor who exited the market at the end of 2022 for whatever reason (wars, pandemics, etc) has failed to participate in this significant rally.

Broking analysts have caught up – to some extent – with the possible impact of the AI revolution. Forecasts of the growth in the S&P 500 for 2025, based on the broker survey, are at about half the gains experienced in either 2023 or 2024. But that is still a double-digit growth and greatly in excess of previous historical averages.

Many things are likely to buffet the market in 2025 but investors with an appropriate understanding of the risks involved might consider staying with the momentum trade currently in play in the US – at least for a while to come.

Another huge change in sentiment over 2024 was in the opinion of when (or indeed if) central banks would start cutting interest rates. Inflation was falling – but not initially quickly enough for everyone.

The US Federal Reserve (Fed) was not the first to start its cutting cycle but, on 18 September 2024, the Fed started off with a ‘double cut’ of 0.50% (or 50 basis points (bps)) and everyone took note. The latest and third Fed rate cut was in December and by 25 bps to have the Federal Funds cash interest rate in the range 4.25% to 4.50% at year end, a full 100 bps below the level before the interest rate cuts started.

The Reserve Bank of Australia (RBA) hasn’t started cutting its official cash interest rate yet and has maintained an interest rate of 4.35% since early November 2023 – this is about the same level as the Fed after its extensive 100 bps of rate cuts.

The RBA is claiming our rate of inflation has been too stubborn in falling to its target range of 2% to 3%. That might be true, but some of the components – such as rents – are unlikely to be reduced by higher interest rates. In fact, the opposite is true if landlords are trying to maintain their margins by raising rents because of higher mortgage rates.

The Royal Bank of New Zealand (RBNZ) learned its lesson the hard way. It was particularly aggressive and vocal in raising rates higher for longer because it stated it wanted to see inflation fall first before it started cutting rates. It was forced to do two 50bps cuts back-to-back but that didn’t save the economy – it just slipped back into recession. Further evidence that monetary policy takes effect with long and variable lags.

So, did the RBA dodge a bullet and do the right thing over the last couple of years? Using a simplistic definition of a recession (two consecutive quarters of negative growth in GDP), Australia hasn’t yet slipped into one – but that is because of our unusually high immigration following the pandemic. When we look at per capita (per household) GDP growth, we have just experienced seven consecutive quarters of negative growth. Soft retail sales bear this out.

Our peer group of developed world central banks such as the Bank of England (BoE), European Central Bank (ECB), Bank of Canada (BoC), Swiss National Bank, and the Swedish National Bank, have all started cutting their interest rates. Indeed, the BoC has now cut by a total of 175 bps from 5.0% to 3.25%. Canada, like us, has experienced a string of negative per capita growth rates.

If there was any credibility to the ‘theory’ of how monetary policy works, this array of different actions and responses should not have happened.

The impact of interest rates on GDP also requires some assessment of what has been happening to fiscal (Government economic) policy. The Australian government had a big influx of revenue (tax) from the impact of a very fast ramp up in economic activity following the relaxing of Covid restrictions. These tax revenues in part were used to provide additional fiscal stimulus. This in turn kept upward pressure on prices due to rampant demand but still constrained supply which fed inflation and led to the RBA increasing interest rates in response.

We can see the impact of government spending on GDP by examining the latest National Accounts. The latest (not per capita) GDP was 0.3% for the September quarter. Since government expenditure contributed 0.3% to GDP, it would have been 0.0% without it. On top of that contribution, another 0.3% was due to government investment. In other words, without the government contribution, our GDP would have fallen by ?0.3%. Because of the windfall gain in government revenue, the government deficit did not blow out! Treasurer Jim Chalmers is claiming this as a victory for the government as it helped to avoid a recession.

If we dig deeper, the government pump-primed the economy for possibly very good reasons (pandemic slow down). However, the RBA was trying to do the opposite. We can argue that the excess demand that the RBA thinks is causing inflationary pressures is not from households (private sector) but the government or public sector. Households are hurting in the continued cost-of-living crisis.

The average wage price index is down about 7% since the end of 2019 – after we allow for inflation. If all wages were spent on the consumer basket of goods and services that would be a bleak signal for households. They would be consuming 7% less ‘things’ like quantities of meat, number of weekends away, education and the rest. But the situation is even worse than that for many, particularly those with variable interest rate mortgages.

Some of the wages are spent on mortgages or rents (only about one third of the population are immune from both). Huge jumps in mortgage rates combined with largely variable rate mortgages have taken a big slice from wages so the impact on consumer goods and services is much worse than the picture we just painted. In the US, most mortgages are fixed rate and are based on 30-year interest rates so Australian households hurt much more than their American counterparts in a monetary policy tightening cycle.

For renters, we know that rents are running well ahead of the Consumer Price Index (CPI) Inflation due to pandemic-related supply issues and higher than average immigration. Renters are also hurting more than the 7% fall in inflation-adjusted wages would suggest. What about the much-maligned baby boomers in, or going into, retirement who own their own homes? Many of them do not earn wages anymore; they are living off past savings, superannuation and government pensions. They are also negatively impacted by the cumulative impact of inflation. The RBA argument about households (particularly boomers) causing inflation is a difficult one to make.

And the argument that boomers are better off from higher interest rates is a misnomer as Bank account interest rates, while higher now, never-the-less have been consistently below the rate of inflation, meaning that the purchasing power of their savings is dwindling and most do not have enough super to maintain a comfortable lifestyle.

It might be heretical to raise, but some leading economists have argued interest rates do not affect inflation. Could inflation have fallen as it did – across the globe – because the supply constraints dissipated? Its quite possible but not provable. But to argue that some of the pain caused by central banks was for nought cannot be dismissed by economic evidence.

Returning to the US Fed, it does seem almost a miracle that growth and the labour market still seem strong, and inflation excluding shelter, has been under 2% for months. What about US President Biden’s Inflation Reduction Act? It has been liberally scattering cash around to households. This may be a good thing but economics never gives clear cut outcomes. When central banks (monetary policy, interest rates) work against governments (fiscal policy government spending) it is difficult to determine cause and effect.

So which way are the central banks heading in 2025? The Fed cut back its ‘indicative’ four US interest rate cuts in 2025 to two at its last meeting. Market rates suggest that there is little chance (11%) of a rate cut at its next meeting in January but a cut before mid-year is quite possible. Another rate cut might be forthcoming in the second half of 2025.

Market interest rates (government bonds and corporate debt) now are pricing a greater than 50% chance of an RBA interest rate cut at its February meeting and more cuts might follow quickly. It is harder to predict RBA activity because we do not yet know the full extent of the impact of recent policy decisions i.e. to not cut interest rates. The US might have pulled off a miraculous economic ‘soft landing’ as economic growth and employment are so far holding up. Conversely, Australia is already in a per capita recession.

We see 2025 setting up to be a good but not great year for investors. There are a combination of positives and negatives for investment performance that will impact the outcome.

On the negative side, growth in some large economies is slowing which could see corporate margins come under increasing pressure. Also, some sectors of share markets are considered expensive e.g. IT and financials which could make further increases in share prices somewhat harder to achieve.

On the positive side, corporate balance sheets are not over stretched and margins have been maintained which is supportive of share prices. Trends in markets remain positive driven largely by bigger technology companies and, in particular, those exposed to AI.

In relation to AI, revolutions happen from time to time. There was the invention of the wheel, weaving machines to make cloth, and transport was massively sped up by applications of the internal combustion engines in ships, trains, cars, and aeroplanes. While we cannot predict whether AI is a revolution, there is no doubt it is a significant innovation and technological advancement. What we are confident of is that it would be foolish to ignore it or dismiss it as a fad. 2025 will see further developments in, and applications for, AI. Whether these developments continue to support the rally in share prices and markets is a separate question which will be addressed as the year unfolds.

Elsewhere, conflicts in the Ukraine and the Middle East continue. China’s economy is struggling a little but the government has started a major economic stimulus programme – which we expect to continue in 2025 and be a positive fillip for Australian exports, resources in particular.

Incoming US President Donald Trump will be inaugurated on 20 January 2025, heralding what we think will be a presidency similar in character to Trump’s first term from 2016 to 2020. There are three of Trump’s key policies that are getting our serious attention: tariffs, immigration and government expenditure.

It is hard to argue that Trump’s motives do not reflect his believes but the method and extent needs analysing. Trump placed tariffs on many countries and goods in his first term. The world did not end and President Biden seemingly made no attempt to remove them. We suspect Trump wants to negotiate better deals with the world and is brandishing his big tariff stick as his chosen method of persuasion.

Illegal immigration was getting out of hand even before Trump’s first term. A government department estimated that there were over 11 million illegal immigrants in the US three years ago – and Biden opened the floodgates quadrupling the flow but then cut that flow to ‘just’ doubling the previous immigration rate.

Trump started to build his ‘Border Wall’ in his first term. A bit more of a wall and other restrictions might help. But as to ejecting those 11 million plus illegals, is ambitious in the extreme. To suggest that the authorities could even find them all, transport them to some other country, and have that country accept them is a monumental challenge let alone the cost of it. While this policy is popular with voters, we do not see how it can be effectively implemented.

As to the Elon Musk led Department of Government Expenditure (DOGE) cutting massive amounts from expenditure immediately is also fanciful but someone needs to try and address the 36 trillion-dollar debt. The US Government deficit was recently reported as being $1.8 trillion of which $1.16 trillion were interest payments on that debt. That situation cannot continue and growth in the deficit needs to be addressed. The problem got a lot worse over the last four years. Some of that worsening was necessary as it helped the US economically survive the pandemic but that level of Government expenditure was not pulled back as the pandemic receded. Indeed, the massive Inflation Reduction Act just kept the problem growing.

Besides these three pillars of Trump’s policies, it seems to be widely accepted that Trump will cut the corporate tax rate from 21% to 15% and emphasise deregulation for US companies. It is yet to be established how the tax cut would be funded. Trump may think revenue from tariffs might cover part of the tax shortfall but, as yet, costings do not seem to be available.

Here in Australia, we are soon to vote on who will govern our country. The suites of competing policies have not yet been announced. The electorate, based on recent polling, does not appear to be too happy with Albanese’s government so the election has the potential to deliver a close outcome.

Since we must always make our investment decisions based on what we currently know or reasonably expect, we are comfortable with a portfolio diversified across a range of higher quality assets. The future is uncertain and our goal is to manage the portfolio to be positioned to benefit from changes in the economic, geopolitical and investment environment as they occur.

Asset Classes

Australian Equities 

The ASX 200 had a strong 2024 – up 7.5% and up 11.4% when reinvested dividends are included. However, the index lost ground in the final month (?3.3%). Most sectors were down in December.

If the newly announced China stimulus package takes hold, it could help our resources sector to play catch up.

International Equities 

The S&P 500 recorded many all-time highs during 2024 finishing the year up 23.3%. However, the index lost ground in December (?2.5%).

The LSEG survey of broker-forecasts on US company earnings points to above average returns in 2025 – but not as good as the last two years.

Bonds and Interest Rates

The Fed cut in September (50 bps), November (25 bps) and again in December (25 bps) – but it cut back its dot plot insight into future rates from four to two cuts for 2025. The market is comfortable with that.

The RBA stood firm again at its December board meeting but almost flagged a first cut in February. Some modelling is suggesting a second cut in quick time. Only recently, three of the big four banks pushed out their forecasts for a first cut from February to mid-year. The market is very uncertain and such uncertainty is not good for sound planning.

The Bank of Canada is all but in panic mode with its cutting cycle. It has now cut rates from 5.0% to 3.25%. Sweden also cut in December (?25 bps) and the Swiss National Bank by a double cut of 50 bps. The Bank of Japan and Bank of England were on hold. The RBA is emerging as a central bank that is behind the curve!

Other Assets 

Brent (2.3%) and WTI (5.3%) oil prices were up in December but largely flat over the year.

The price of gold pulled back (?1.3%) in December but up 27.1% on the year.

The price of copper was down in December (?1.1%). The price of iron ore also fell in December (?3.2%) but finished the month just above $US100 /tonne.

The VIX ‘fear’ index ended December at an elevated level (17.4) after starting the month in the normal range,

The Australian dollar further depreciated against the US dollar by -4.6% for December and ?9.2% for the year.

Regional Review

Australia

Australian jobs data remained in a ‘normal’ range. 35,600 jobs were created of which 52,600 were for full-time positions and ?17,000 were for part-time positions. The unemployment rate fell to 3.9% from a recent high of 4.3%. Wages are not acting as though the labour market is tight.

When the employment data are transformed into year-over-year growth rates, full-time, part-time and total growth all converged on 2.3% indicating that the part-time bubble might be behind us. Only a few months ago, part-time positions were growing at 6.8%!

CPI inflation looks to be in the range at 2.4% but some of this reduction is due to a statistical artefact introduced by the ABS to include government energy subsidies.

GDP growth came in at 0.3% for the quarter and 0.8% for the year. In per capita terms, those rates are ?0.3% and ?1.5%, respectively. The household savings ratio rose to 3.2% from 2.4% suggesting households have been able to restore some sort of reasonable savings plan. An indicative range in ‘normal times’ for households is 5% to 6%.

China 

The China manufacturing PMI improved to 50.3 from 50.2 in November; a modest value but, nonetheless a slight improvement. The December PMI slipped to 50.1. Industrial profits fell over a 12-month period to November (?7.3%) – the fourth such consecutive negative read.

Retail sales missed expectations at 3% compared to expectations of 4.6% and from a previous read of 4.8%. Industrial production matched expectations at 5.4%. We expect China to continue to monitor the situation and add more stimulus as necessary.

US

The nonfarm payrolls (jobs) data came in at 227,000 after a hurricane-affected very low number the month before but the unemployment rate climbed to 4.2% from 4.1%.

Inflation is largely contained in the US. If we exclude shelter from the CPI, the inflation read would have been 1.6%, or well below the target 2% rate.

Retail sales volumes showed some strength at +1.0% for the latest 12 months. The final (revised) GDP read for the September quarter was 3.1% up from the preliminary read of 2.8%.

The expected Trump corporate tax cuts and an emphasis on deregulation should support profitability in the US.

Europe 

UK inflation rose to 2.6% from 2.3% and the Bank of England remained on hold at 4.75% after recently making its first cut. The ECB cut its rate to 3.0%.

Rest of the World 

Canada, like Australia, is experiencing positive GDP growth. However, Canada has posted six consecutive negative quarters of per capita growth (compared to Australia’s seven). Yet Canada has made 175 bps worth of cuts to end 2024 with a terminal rate of 3.25%. Australia has not yet made any cuts and its overnight cash rate at the end of 2024 stands at 4.35%!

The US commenced attacks on Iran-backed Houthis based in Yemen who are in turn attacking shipping in the Red Sea.

We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report.

In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.

Key points:

– ‘Red wave’ in US elections buoyed markets
– China continues to stimulate with the release of a further 10 trillion yuan ($US1.4 trillion) package
– Government Bond yields rise on expectation of inflationary policy settings under Trump
– Australian Senate endorses new interest rate setting committee separate for the RBA Board

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please get in touch with your adviser.

The Big Picture

For the best part of the year, market commentators were focused on the November 5th US presidential election. With current president Biden faltering in front of cameras and ‘Trump being Trump’, commentators had a close call between Harris and Trump both in their narrative and their polls.

Except for a brief ‘honeymoon’ period for Harris after she took the Democratic nomination, sports betting thought Trump was a clear favourite. This proved to be the case and Trump convincingly won the election. Republicans (Trump) now hold the presidency, the House of Representatives and the Senate. A clean sweep. While the Republicans have a majority in both the House and the Senate given the number of discontents within each party, the majorities are not necessarily big enough to guarantee Trump’s policies will seamlessly navigate the path to law and implementation.

Stock markets voted in favour delivering healthy gains in the S&P 500 and the ASX 200. Trump judged his degree of success in his first term by the improvement in stock market indexes. If he continues to be so motivated, it could be good for investors even if they don’t like Trump.

Two of Trump’s policies that attracted most attention during the campaign are: he wants to impose big tariffs on imports, and he wants to undertake a mass deportation of illegal immigrants.

Many economists have made dire predictions about the imposition of tariffs. The expectation being that tariffs from one side are met with tariffs from the other, resulting in a trade war, which historically has not led to an overall favourable economic outcome.

We also think that some of Trump’s rhetoric is part of a bargaining process in that the additional tariffs so far announced, 25% on Mexico and Canada and 10% on China will be removed if the three countries address the respective actions the tariffs are imposed to penalise.

We do not think the US will impose the full range of tariffs currently on the table. By and large, we also note that Biden did not repeal Trump’s first-term tariffs. If tariffs were so toxic, Biden should have repealed them on day one!

During November, the Federal Reserve (Fed) cut rates by 0.25% points to a range of 4.5% to 4.75%. At the recent peak, the rate was the range of 5.25% to 5.5%. In its September meeting, the Fed suggested there may be two more cuts in 2024 (after the 0.5% cut in September) and four more in 2025. Expectations have been pulled back slightly. That means the US is likely to have quite restrictive monetary policy until at least the end of 2025

So far, US economic data has largely held up. The latest September quarter growth data was 2.8% and inflation seems to have been contained. The jobs data have been a bit patchy. The numbers are scaled up from a small sample and the pandemic has redefined what is a normal job.

The latest labour force data were poor. Only 12,000 jobs were created but the unemployment rate was only 4.1% (down from 4.3% in July). Given the enormity of the effect of the two big hurricanes and the Boeing strike on the economy, it is difficult to estimate what the jobs number would otherwise have been. We await a fresh number on the first Friday of December.

China stepped up to the plate by announcing a $US1.4 trn stimulus package to be spent over five years. As it happened, exports surged 12.7% against an expected 5%. Imports just missed expectations at -2.3%.

The Bank of England (BoE) cuts its reserve interest rate for the second time in November. The UK inflation number had got down to 1.7% in October but that rate jumped to 2.3% in data released late in November. The UK unemployment rate just jumped to 4.3% from 4.0% three months earlier. These mixed signals will make it hard for the BoE to manage interest rate policy going forward.

At this juncture, a number of Developed World central banks have started their interest rate cutting cycles. Because of ‘the long and variable lags’ for policy to work, the data might be a little hard to interpret early in the cycle. Nevertheless, most leading economies (excluding Japan) still have highly restrictive interest rate policy settings and in our view a continuation of current interest rate reduction policy is the prudent course.

Australia’s RBA also has a very restrictive monetary policy but it has been reluctant to start policy easing. This situation might soon improve now that the Senate has passed the bill to initiate a new interest rate-setting committee to work alongside the RBA Board. If appropriate members are selected, the new committee might quickly react to almost two years of negative per capita (household) growth and about the same period of negative growth in retail sales volumes.

While it is true that Australia’s labour market has seemingly stood up well to high interest rates, we question the use of pre-pandemic views on what constitutes a strong labour market. International data show that the average working week in Australia is several hours longer than similar countries such as Canada, the UK and the US. Additional survey data also shows that many part-time workers in Australia would prefer to work more hours.

As we drift towards Christmas and the January holiday period, we have good data to support the view that markets in the US and Australia can continue to perform. Survey data of broker forecasts of company earnings suggest 2025 will be strong for these two stock markets even after very strong capital gains in 2024.

Asset Classes

Australian Equities 

The ASX 200 had a strong month in November – up 3.4% for the month and 11.1% for the calendar year-to-date. The Energy and Materials sectors went backwards but the rest were positive. IT gained 10.4% over November, Consumer Discretionary (+6.7%), Utilities (+9.1%), Financials (+5.9%) and Industrials (+5.7%) led the way.

If the newly announced China stimulus package takes hold, it could help our resources sector to play catch up.

International Equities 

The S&P 500 reached an all-time intraday high on the last day of November making for an impressive gain of +5.7% for the month and +26.5% for the year.
Some of the strength in the US market is from the expectations formed following the Trump victory in the US Presidential election on the November 5th.

It wasn’t just Wall Street that rallied on the election result. The London FSE (+2.2%), German DAX (+2.9%) and the Shanghai Composite (+1.4%) all had strong months too. However, the Tokyo Nikkei ( 2.2%) and Emerging Markets (-2.6%) did not share the optimism.

Bonds and Interest Rates

The RBA stood firm again at its November board meeting electing to keep the official Cash interest rate ’on hold’. Pricing indicators give very little chance of a cut at its December 10th meeting. However, some indicate two or three cuts next year starting in the second quarter. The current official interest rate is 4.35% p.a.

The Fed cut its interest rate again (-0.25%) in November following its initial -0.50% cut at the previous meeting. There have been some marked changes for the chance of a cut in December (from about 60% to over 80%). The current odds are set at about 0.66% for a single cut on December 18th. One pricing model agrees with that assessment but also place a 90% or more chance of an additional cut by the January meeting. The current interest rate range is 4.5% to 4.75%.

The BoE cut a second time by -0.25% to 4.75%. Recent UK data confused the outlook for further interest rate cuts.

In October, the Bank of Canada cut by 0.50% following three -0.25% cuts. The current rate is 3.75% p.a.

If the RBA doesn’t cut for a few months, it seems probable that it will have the highest cash interest rate of its peers. Moreover, Australians are particularly reliant on variable rate home loans and owner-occupiers get no tax breaks. Australian households are feeling the pressure of higher short-term interest rates more than most.

It is true that some components of the Australia Consumer Price Index (CPI) Inflation basket have been running too hot and contributing to our inflation rate being higher. However, those components are highly unlikely to be interest rate dependant i.e. not necessarily or directly respond to RBA interest rate movements.

We continue to argue rent inflation might be exacerbated by high interest rates and this result might also flow on to insurance inflation.
Japan’s inflation fell to 2.3% from 2.5% and its central bank declared that it still plans to lift its interest rate to 1% in the second half of next year. After years of having a negative interest rate, Japan is trying to normalise its interest rate from below.

Other Assets 

Brent and West Texas Intermediate (WTI) oil prices were down slightly in November. There seems to be less concern about prolonged tension in the Middle East. For possibly a similar reason, the price of gold pulled back ( 3.0%)

The price of copper fell -5.2%. The price of iron ore rose +1%.

The VIX ‘fear’ index for the US equity market ended November at a normal level (13.9).

The Australian dollar depreciated against the US dollar by -0.8%.

Regional Review

Australia

Australian jobs data were back in a ‘normal’ range after a couple of strong months.15,900 jobs were created of which 9,700 were for full-time positions. The unemployment rate was 4.1% for the third month in a row.

When the employment data are transformed into year-over-year growth rates, part-time jobs growth started to retreat after peaking at 6.8%. While 3.4% is still above long-term population growth, this result is indicative of the recent surge in immigration flows stabilising. Full-time employment growth was 2.4% which is about in line with recent population growth.

Because the Australian Bureau of Statistics (ABS) chose to treat the government energy subsidy payment as an equivalent change in price, electricity inflation came in at -35.6% when, in fact, tariffs had hardly changed. This component, together with the -2.8% inflation in transport costs resulted in headline CPI coming in at the bottom of the RBA target range of 2% to 3% annualised to the end of October. Rent inflation remained elevated at 6.7%. Without the unusual ABS electricity price adjustment, CPI inflation would have come in at 3.5%.

Retail sales volumes grew by a very modest 0.2% over the year when compared to population growth of around 2.5%. Consumers have had to cut back because of the cost-of-living crisis. The wage price index rose by 3.5% which translates to 0.7% when price inflation is taken into account. However, the latest so-called real (inflation-adjusted) wage is -6.6% below its pre-pandemic level.

The latest reads for consumer and business confidence were higher. The business conditions index was flat.

China 

Exports were very strong at 12.7% particularly when compared to the expectation of 5%.

China has initiated a number of stimulus policies, the latest of which was a 10 trillion yuan ($US1.4 trillion) package to be distributed over five years. If it transpires that this amount of stimulus is insufficient, it appears the government is committed to adding more.

US

The US election results seemed to stun many commentators. It would appear that some commentators’ personal preferences biased their interpretation of the polls.

US jobs data were seemingly contaminated by the impact of two hurricanes and a major strike at Boeing. What is a bit more disturbing is the magnitude of the revisions to the previous two months’ worth of employment data. The August figure was reduced from the preliminary estimate of 159,000 to 78,000; September’s jobs number was reduced from 254,000 to 224,000. Moreover, the latest 12,000 reading was swamped by the contributions of government (+40,000) and Health Care and Social Administration (+51,300). Jobs in the other sectors collectively went backwards!

CPI inflation was 2.6% which became 1.4% when shelter inflation was removed from the calculation. There are well-known issues with the calculation which have been noted by the Fed.

The Department of Homeland Security estimated that there were 11 million illegal immigrants at the start of 2022. That number will be a lot higher when the cases during Biden’s term are added. It is not feasible to even find them all, let alone repatriate them. It is not even clear if notionally home countries would take them back.

It is somewhat disturbing that Trump does not have a feasible plan to reduce the national debt. Since he plans to cut taxes of many, large cuts in government spending are called for. Elon Musk has been appointed to a non-official department to try to cut out government waste. The name, Department of Government Expenditure (DOGE), happens to have its acronym mimic a crypto currency that was created as a ‘joke’. Moreover, it would appear that Musk may be conflicted in some of the recommendations he will make.

Europe 

UK inflation came it at 2.3% after the prior month’s 1.7% and the unemployment rate rose to 4.3% from 4.0% in only three months. Since unemployment and inflation moved above previous levels, it is not clear that the BoE will continue to ease interest rate policy as planned.

Rest of the World 

The US and France reportedly brokered a ‘permanent cease fire’ between Israel and Lebanon.

Biden reportedly gave permission for the Ukraine to send US long range missiles deep into Russia. Thus far, there has been no adverse impact on markets.

We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report.

In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.

Key points:
– Trump sweeps the US election, Republicans take both houses
– The US cuts interest rates by 0.25%, other Central Banks, ex Australia, still cutting interest rates
– Australia’s RBA unlikely to join policy easing just yet
– US economy holding up and Private Consumption Expenditure (PCE) inflation close to target

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

Donald Trump has won the US election with an emphatic victory. The Republicans are in control of the Senate and appear poised to take control of the House of Representatives. Billed as the most important election in a generation and considered too close to call by most, the American voters have now spoken. The world now waits for what comes next. It appears that Trump’s agenda from a policy perspective at least, is pro-business, stimulatory and possibly more inflationary than under the current Biden administration. From a global perspective there will be much interest in Trumps foreign policy particularly with respect to the wars in the Ukraine and the Middle East as well as the potential fallout from increasing tariffs on China. While we have a sense of policy direction, timing and implementation remain the subject of intense scrutiny and speculation. Worth noting Trump is not president until his inauguration on 20 January 2025.

It was only on Melbourne Cup Day last year that the Reserve Bank of Australia (RBA) last raised its overnight cash interest rate (OCR). Despite forecasts at that time of three interest rate cuts by the end of calendar 2024, none of these cuts have eventuated. The RBA remains data dependent and reported inflation has remained stubbornly higher than anticipated, despite the per capita recession. But the world of central bankers has moved on a lot this year – and particularly since the September 18th meeting of the US Federal Reserve’s (Fed) FOMC (Federal Open Market Committee) that handed down a 0.50% or 50 basis point interest rate cut to start its easing cycle and followed up last week with a further 0.25% rate cut as did the Bank of England (BoE) on 7 November.

At the September meeting, the Fed pencilled in two more cuts of 25 bps this year and another four for next year. The market is strongly expecting (90% chance) a rate cut two days after the November 5th US presidential election.

The Fed certainly seems to have opened the floodgates. The Bank of Canada (BoC) just cut by 50bps (after three 25 bps cuts) to 3.75% because the long and variable lags of past rate hikes are cratering their economy. The Royal Bank of NZ (RBNZ) also just cut by 50bps to 4.75% following an initial 25 pbs cut.

The ECB has cut three times to 3.25% and its job is not yet done. Inflation is below its target and the economy is weak. The ECB President, Christine Lagarde, kept emphasising that they are being data dependent. As we repeatedly write, being data dependant risks being late with policy changes and growth slowing more than intended, driving the economy into a recession. Monetary policy is far from being an exact science.

Sweden’s central bank cut three times to 3.25%. The Bank of England (BoE) just got caught short because its inflation read came in at under target (at 1.7%) and it has only recently made its second cut – to 4.75% – more cuts are expected.

The People’s Bank of China (PBOC) has a broader set of monetary policy tools. The PBOC just cut its loan prime rates (LPRs) this week – to 3.1% for 1-year (mainly for corporate) loans and 3.6% for 5-year (mainly for mortgage) loans.

With all our peer central banks already having started their cutting cycles – and many having their rates below our 4.35% (or soon to be there) – the RBA is looking very alone.

Australia has already had six consecutive quarters of negative per capita growth. We have had five consecutive negative quarters of growth in retail sales volumes (without allowing for our rampant population growth). The IMF just released its updated global forecasts for growth. It has pencilled in 1.2% for Australia in 2024 and 2.1% for 2025. With both being well below population growth, the per capita recession might take us up into 2026. It beggars belief that the RBA can talk about demand pressures fuelling inflation. Our problems are all supply-based. True, if we crushed the economy until it needs its last rites, we could get inflation down to any number we want. But the RBA has a dual mandate of price stability and full employment. The ‘fix’ should be on the supply side with home building and electricity generation investment.

It is true that the unemployment rate is near historic lows at 4.1% but the world has changed and the old data are largely irrelevant. Almost anybody can quickly get a job in food delivery or Uber rides these days. Lots of people reportedly have two jobs because one doesn’t put enough food on the table. And it should be noted that many governments are aware that sampling unemployment numbers with telephone calls no longer works. A graphic on Bloomberg TV showed that survey response rates to phone calls is down to 18% from the pre-pandemic average of above 50% in the US. Apparently, GenZ and others are no longer as responsive to answering inbound phone calls.

In the US people complain about the effect of inflation on the cost of living. But, since 2019, wages in the US have risen 5% more than prices so that, at least on average, US folk are much better off than pre-pandemic. Not so for us! Our wages have risen 7% less than prices. But the RBA stands stubbornly steadfast on interest rates. In a relative sense, we have lost 12% (=5%+7%) to our US brothers and sisters in purchasing power since the onset of the pandemic.

US growth is holding up better than many thought possible. The first estimate for the September quarter was 2.8% p.a. which is only just a little down from the prior quarter’s 3.0% p.a. The consumer is reportedly holding up but, also, government spending is playing a material role in attaining growth.

The presidential election is dividing the nation. We can’t recall such vitriol being hurled from both sides. We think both sides are exaggerating the economic problems that would flow from their opponent’s proposed policies for political gain.

Despite the apparent policy divide between the Trump and Harris policies, in our opinion, we see no evidence that either side would address the massive government deficit. The latest report is the US Government has a deficit of $1.83 trillion (trn) with interest payments making up $1.16 trn, or two thirds, of the deficit. Total debt now stands at about $35 trn!

US government debt rose sharply in the pandemic – and for good reason – but, as conditions improve, the debt mountain needs to be addressed before it risks rendering the economy dysfunctional.

Recent data suggest US consumers are getting more positive about their future prospects. A monthly consumer confidence index rose to 108.7 from 99.2. A figure below 100 signifies quite gloomy times but the same index was consistently over 125 for the years leading up to the pandemic.

We see some cause for concern in the US regardless of the election outcome. A possibly crippling dock strike on the East and Gulf coasts in the run-up to the election was settled (at least as an interim measure) within days. The union was offered pay rises totalling 62% over the next six years and a pledge not to introduce automation.

Boeing machinists were offered a 35% increase over four years but they turned it down. If this is the start of a wage-price spiral, inflation could return with a vengeance.

US consumer price inflation (CPI) has largely been contained. If it were not for the problems in calculating shelter inflation (which makes up a third of the CPI) all would seem to be fine. However, retail sales grew 1.7% over the last year which drops to -0.7% when sales are corrected for inflation. There are mixed signals in the data about the strength of the consumer.

Australia’s quarterly inflation read came in at the end of October for the September quarter. Because of the way the Australian Bureau of Statistics (ABS) allowed for the electricity subsidy, the inflation reading is artificially low and will spring back when the subsidy ends. The headline rate was 2.8% but it would have been 3.5% had electricity price inflation not fallen by the subsidy impacted -24.1%. Of course, electricity tariffs did not fall by that amount. The fall is due to the way the ABS imputed the across-the-board flat subsidy. Rents rose by 6.6% and tobacco prices by 12.9%. Neither of those would likely fall if our interest rate was increased!

The first week of November was dominated by the Fed and RBA board meetings, US jobs data and the presidential election. Nevertheless, we see the company earnings expectations – as collected by LSEG (formerly Thomson-Reuters) for the component listings on the S&P 500 and the ASX 200 – indicate strong optimism for the next 12 months. These forecasts imply above average capital gains for both indexes. But, with so much important information to be imparted in the very near term, it would be foolish not to expect some additional short-term market volatility.

 

ASSET CLASSES

Australian Equities 

The ASX 200 was down in October (-1.3%) but the movement was far from even across the sectors. Most sectors were down -2% to -7% but Financials, the largest sector by market capitalisation, grew by 3.3%.

Our analysis of the LSEG survey of broker-based company earnings forecasts suggest that they are expecting a capital gain materially above the long-term average of 5% (plus dividends and franking credits).

International Equities 

The S&P 500 fell in October (-1.0%). The World index was down less (-0.4%) and Emerging Markets were down -2.2%. The Nikkei was up strongly at +3.1%.

With some of the ‘magnificent 7’ US companies reporting well in October, together with the general AI revolution, the LSEG forecasts for growth in the S&P 500 are again well above the historical average over the next 12 months. However, not all agree. Indeed, there was a big sell-off on some big tech stocks based on their forward guidance at the end of October.

The reputable Goldman Sachs is predicting an average 3% p.a. growth in the S&P 500 over the next ten years against an average 13% over the last 10 years. Goldmans is one of the contributors to the LSEG survey. We think there is merit in going with the consensus average rather than any one forecaster – and there is solid academic research to back that approach.

Bonds and Interest Rates 

Central banks were unusually active during October, with most now well into a cutting cycle. But it is already too late for some to avoid an economic downturn. The US might just pull off a ‘soft landing’ but there is so much restrictive monetary policy response still in the pipeline, it is far too soon to call a soft landing as having been achieved.

US 10-year Treasurys yield got down to below 3.7% in September but it has since risen to about 4.3%. The yield curve between maturities of two and 10 years is no longer inverted. Some of the variation in yields is possibly due to perceptions in how the Middle East conflict might be resolved and some due to how US domestic policy might change under a new president.

The RBA left interest rates ‘on hold’ at its last meeting and few expect any change at its next meeting in December. The RBA is still under the cloud of having stated that rates would not go up before 2024. And if they start to cut now, it is too soon after their last hike 12 months ago to do so without losing face. But they will lose much more credibility if they wait too long to start cutting, particularly as almost everyone else of significance is well into their cutting cycles. The four big banks are all now predicting the first cut in February.

China cut its loan prime rates this month – to 3.1% for 1-year (mainly corporate) loans and 3.6% for 5-year (mainly mortgage) loans. It also relaxed some conditions on home lending.

Japan has experienced some instability in its monetary policy stance as the new prime minister was thought to have a different view from the man he replaced. The election at the end of October took away the government’s majority. It is not yet clear how that scenario will unfold.

Other Assets 

Brent and West Texas Intermediate (WTI) crude oil prices were up slightly over October (1.9% and 1.6%, respectively). There was some intra monthly volatility as opinions varied about how the Israel-Iran conflict may or may not escalate.

The price of gold continued its charge; it gained 4.1% on the month. It is up 32.7% on the year-to-date!

The price of copper fell -3.0%. The price of iron ore fell sharply (-7.1%) but closed October at just above the $US100 / tonne mark.

The VIX ‘fear’ index was elevated throughout October and closed the month at 20.4 a level at the top of its normal trading range. It has subsequently declined post the US election.

The Australian dollar depreciated against the US dollar by -5.2%.

REGIONAL REVIEW 

Australia 

Australian jobs data are starting to look more resilient than they were a few months ago. 64,100 jobs were created in the latest month of which 51,600 were full-time positions. The unemployment rate dropped to 4.1% from 4.2%.

Reports of hardship in the payment of mortgages and companies going into liquidation seem to tell a different story. Except for the jobs data, there are no important macro data points for Australia that are encouraging. Historically, jobs hold up the longest going into a slowdown because of the cost of re-hiring and training. The unemployment rate then rises sharply if the economy hasn’t been sufficiently stimulated.

The Westpac consumer sentiment index did improve to 89.8 from 84.6. The latest reading is the best since May 2022 but it was well above that read just before the pandemic and after the 2020 lockdowns. The NAB business conditions index rose to 6.9 from 3.6 and the business confidence index rose to -1.9 from -4.5. While both business indicators rose, they did not do so by enough to bring much joy.

Retail sales rose 2.3% for the last 12 months or 0.1% after adjusting for inflation. With the population growing at around 2.5%, the volume of goods and services bought by the average household has fallen by over 2% over the last 12 months.

China

The China Purchasing Managers’ Index (PMI) for manufacturing climbed back above the 50 level that divides expected contraction from expansion, for the first time since April. The reading was 50.1 against an expectation of 49.9 and a previous month’s reading of 49.8.

Exports and imports were both much weaker than expected but economic growth at 4.6% was just above the expectation of 4.5%. Retail sales, at 3.2%, beat the expected 2.5% and industrial output at 5.4% beat the 4.6% expectation. Following this data release, China’s leader, Xi Jinping, called for a concerted effort to return growth back to the Party’s expectation of 5%.

The PBOC has started making moves to help stimulate the economy using several tools. We think that it is now possible that the economy will start to perform as expected by the government.

US

The jobs data released in October easily beat expectations of 135,000 new jobs. The 254,000 jobs created helped bring the unemployment rate down to 4.1% from 4.2%.

Nevertheless, retail sales adjusted for inflation continue to fall over a trailing 12-month period. However, wages grew by 5% more than price inflation since 2019.

Headline Private Consumption Expenditure (PCE) inflation came in at 2.1% but the Fed-preferred core rate was 2.7%. The CME Fedwatch tool now attaches a 65% chance of a 0.25% interest rate cut in December down from a 73% chance prior to the election outcome being known.

Europe

UK inflation came in at 1.7% which is under its target of 2.0%. The economy is not looking great so it seems that the BoE is behind on cutting its interest rates. The current reference rate is 4.75% following a further reduction of 0.25% at its meeting on 7 November.

Rest of the World

Canada appears to have realised too late that it was too slow in starting to cut interest rates. The unemployment rate rose from 5.0% at the start of 2024 to 6.5% in the latest reading for September. That is why the BoC has cut four times this year to a total of 1.25% points of cuts to 3.75%.

The RBNZ has similarly been aggressive in cutting. Its OCR now stands at 4.75%.

 

We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report.

In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.

Key points:
– The US Federal Reserve cuts its cash interest rate by 0.50%
– Inflation is now largely contained, the US is cutting interest rates – Australia however, is still ‘on hold’
– Share markets were buoyed by the first US interest rate cut and solid economic data
– China embarked on further stimulus – their share market rallied strongly on the news

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture

September ended on a high note. There was good news from the US Federal Reserve (Fed) who cut their interest rate by 0.50%. Other key developed world central banks, Europe, Canada, Sweden and Switzerland also cut their interest rates. China cut a number of its main policy interest rates and eased home lending restrictions. Iron ore prices rose about +9% on the last day of September on this news and several important stock market indexes hit all-time highs near the end of the month. The odd-one-out was Japan. It chose a new PM and this unexpected selection caused concern about rate hikes – so the Nikkei fell by more than 4% on the last day of the month.

We’ve been waiting for over a year for the US Fed to start its interest rate-cutting cycle. We have argued the inflation measure it uses is flawed and the Fed has all but acknowledged that. We have reason to believe a true representation of inflation would show it has been on or below the 2.0% target for a while – also there are some growing signs of weakness in the US economy.

The Fed surprised some when it started cutting interest rates with a 0.50% reduction at its September 18th meeting. Importantly, it flagged another 0.50% (or two 0.25%) interest rate cuts before the end of the year. And another 1.0% next year! The US is likely to be out of restrictive monetary policy interest rate settings by very early 2026 at the latest. This was a significant change in the outlook and while markets have been anticipating this move for some time, they have responded positively to the change.

There is a lot of money held as cash or invested in other high quality short maturity investments like Cash Management Accounts, Short Term Deposits and Bank Bills. Some of that will be looking for a new home as short-term rates fall i.e. investors will seek longer maturity instruments to lock in higher interest rates for longer. The other avenue, in the nearer term at least, will be share markets.

The latest US Consumer Price Index (CPI) inflation gauge data were good. The monthly rate of +0.2% and +2.5% for the year, was the lowest since the start of the inflation bubble in early 2021. The core inflation rate that strips out volatile items such as food and petrol was +0.3% for the month and +3.2% for the year.

The official CPI, less shelter inflation, was only +1.1% for the year. The shelter inflation component on its own was +5.2% on the year which, at a 30% weight of the CPI, almost entirely explains the high reading of +3.2%.

The US Personal Consumption Expenditure (PCE) inflation report (a measure preferred by the Fed) was released at the end of September. It showed that the headline rate for the month was +0.1% and +2.2% for the year (and this includes the ‘old’ shelter calculations). The core rate was +0.1% for the month and +2.7% for the year. The Fed’s 2% inflation target is all but been achieved.

The Fed had already steered us onto a course to expect more cuts of 1.50% by the end of 2025. Now the updated results from the CME Fedwatch tool that many turn to for guidance on the timing and magnitude of expected interest rate cuts, projects about a 60% chance of the Fed interest rate being under 3.0% by the end of 2025, at the time of writing.

With a neutral interest rate thought to be in the range of 2.5% to 3.0%, the implication is that the US only has just over a year of restrictive monetary policy to go. However, with lags between interest rate changes and their economic impact thought to be in the range of 12 to 18 months, it will be quite a while before we can judge whether or not the Fed achieved a ‘soft landing’ and contained inflation without the economy experiencing a recession.

The Bank of England (BoE), European Central Bank (ECB), Bank of Canada, the Sweden Riksbank, and the Swiss National Bank, the Peoples Bank of China (PBOC) and the Royal Bank of New Zealand (RBNZ), among others, have all started their interest rate cutting cycles. China seemed particularly aggressive in its reduction to policy interest rates as it seeks to help stimulate growth in its sluggish economy.

The major central bank missing from this list is, of course, our own Reserve Bank of Australia (RBA). For a level of completeness, we note that Norway also is yet to implement interest rate cuts. The RBA met in the middle of September but decided to keep interest rates on hold. There is a slew of data showing that the Australian consumer is hurting as a result of high interest rates but the RBA only seems to be focused on one of its twin mandates: ‘price stability’ and ignoring its obligations with respect to ‘employment’.

The problem with the RBA and government focus is that they seem to be confusing the RBA official cash interest rate (overnight cash rate for settling commercial bank imbalances) with the home mortgage interest rates charged by home lenders.

It is misleading to say that we were less aggressive than the US Fed in raising rates. Since most home mortgages in the US are funded as 30-year fixed-term loans, the average mortgage interest rate hardly budged in the last two or three years in the US. Australian borrowings typically are based on variable or ‘floating’ interest rates with some exposure to short-term fixed rates – usually less than three years. Our average mortgage rate has gone up from around 2.6% p.a. in early 2022 to 6.0% p.a. now. That’s why mortgage-holders in Australia are suffering! By comparison, the US borrowers have had an easier time of it in the post Covid period.

To further emphasise this problem for borrowers, Australia’s latest National Accounts data for the June quarter showed that the household savings ratio was only 0.6%, or the same as in the previous quarter. The average ratio in ‘normal’ times is about 5% to 6%.

If 0.6% is the savings ratio, households are spending 99.4% of their disposable (after tax) income. People, in typical jobs, are required to set aside 11.5% into an appropriate superannuation account. That means, by saving only 0.6%, the super guarantee payments are (on average) implicitly coming out of past (non-super) savings or current living expenses!

It is true that the savings ratio did get this low and lower in the run-up to the GFC. However, that time there was a debt-fuelled surge in spending and investing (such as with margin loans for shares). This time is different. Households are struggling as can be noted by inflation-adjusted (average) wages being down by more than 7% since 2020. Retail spending, adjusted for prices but not population, has been down over the previous year for five consecutive quarters. Per capita (household) GDP has experienced negative growth for six consecutive quarters. The latest quarterly GDP read was only +0.2% or +1.0% for the year which was buoyed by well over 2% population growth!

Some observers point to strength in our labour market but they typically do not point out full-time employment has not been strong. Yet the population has been growing at record levels. Sky News reported that close to 600,000 of the jobs created during the current government term (over two years) were in the public sector – hence funded by the tax-payer – or about two-thirds of the total jobs created.

There almost seems a sense of euphoria in markets after the Fed’s first cut and the accompanying dovish statement about the future. A number of major stock market indexes reached new highs in the last week of September: Australia’s ASX 200; the US S&P 500, the Dow Jones index and the European Stoxx 600. The China CSI 300 index didn’t reach an all-time high but by recording a weekly gain of +15.7%, it registered its best week since November 2008 and then it popped another +8.5% after the new policies were announced on the last day of September (a 16-year record).

There is always the chance of a negative shock and at least a ripple in stock markets but we do not see a significant chance of bad macro data this year – except possibly in Australia. Even if, say, the US labour market deteriorates, the fact that interest rate cuts are already underway might support markets. The Fed has left the door open to alter the pace of changes in this interest rate cutting cycle.

Asset Classes

Australian Equities

The ASX 200 reached an all-time high after the Fed interest rate cut and was up +2.2% on the month. Five sectors went backwards in September but Materials (+11.0%), IT (+7.4%) and Property (6.5%) made impressive gains.

Our analysis of the LSEG survey of broker-based forecasts of company earnings showed a marked improvement in the Financials sector, and, hence, the broader index. We now think capital gains may be above the historical average over the coming 12 months.

International Equities

The US S&P 500 share index and its equally-weighted version, both reached all-time highs after the Fed interest rate cut. The S&P 500 was up +2.0% on the month. Since the ‘magnificent seven’ stocks dominated the first half gains in the broader index, it is encouraging to see the gains spread to a broader range of companies.

China’s Shanghai Composite was up +17.4% (including +8.5% on the last day of September – a 16-year record) and Emerging Markets were up +5.7%. The Nikkei was looking at a strong month until the new prime minister sparked interest rate hike fears brought the index down -4% in one day and more at the open on the last day of September. The Nikkei finished down -1.9% on the month.

Bonds and Interest Rates

The US Fed has been the focus of our attention even though a number of other central banks had already started cutting their interest rates. A 0.50% cut by the Fed was taken very positively in both equity and bond markets. Since most US mortgages are written as 30-year fixed term loans, we do not expect a big bounce in consumer expenditure in the US. If mortgage rates do start to fall, mortgagees in the US can refinance with no penalty if they had taken the loan out at recent higher interest rates.

The market and the RBA are at odds with each other. The markets (and us) think that there is a reasonable chance of an interest rate cut in November or December whereas the RBA is still talking in terms of no cuts this year. Three of the big four banks state that they see the first cut in February next year. However, pricing tools based on derivative markets imply a material chance of an interest rate cut this year.

The Bank of England was on hold in September after its first interest rate cut in four years at its prior meeting. The UK’s latest monthly inflation read did rise from +2.0% to +2.2%.
The Bank of Canada has already cut its interest rate three times in this cycle. Switzerland, the ECB and Sweden have also cut more than once. Norway is perhaps the only other ‘major’ central bank not to have yet commenced policy easing.

We do not see any evidence of a worrying build-up of wage or producer price inflation in the economies of the countries that we follow. China has just made a number of easing moves in an attempt to stimulate the economy which is in danger of not keeping up with government growth forecasts. We think that the current paradigm of cutting interest rates around the world has a lot of merit.

Other Assets

Iron ore prices dipped below $US100 per tonne but recovered towards the end of the month – up +9.6% on the month. China eased home lending restrictions and iron ore prices popped +9% on September 30th.

Crude oil prices Brent and West Texas Intermediate (WTI) were down sharply at around -9% and -8%, respectively.

The price of gold is on a charge as it gained +5.1% on the month.

The price of copper was also up sharply at +8.0% for September.

The VIX ‘fear’ index, a measure of US share market volatility, was back to a ‘normal’ range at 13.1 but then closed the month at 16.7 on the last day.

The Australian dollar appreciated against the US dollar by +1.9%.

Regional Review

Australia

We saw several reports in September extolling the strength of our jobs market because 47,000 jobs had been created. Delving only slightly deeper into the report, we noted that full-time employment went down by more than -3,000 jobs. Part-time jobs made up the difference. Our unemployment rate was reported as 4.2%.

June quarter economic growth data were published this month. Our economy only grew by 0.2% this quarter which became -0.4% when adjusted for population growth. Over the year, growth was 1.0% and per capita growth was -1.5%. That result made for the fifth successive quarter of negative per capita growth – and extended the per capita recession by most people’s definition.

Our monthly CPI read looked good in both headline (+2.7%) and core (+3.0%) but we have issues in the way the ABS has addressed the electricity subsidy. A lump sum subsidy is not a price change but the ABS treated it so. Electricity price inflation was reported as a fall of -17.9% over the year. As soon as the subsidy is removed, electricity inflation must spring back to near prior levels unless something else impacts prices.

RBA Governor Bullock stressed in her post board-meeting press conference that one good number wouldn’t budge her on rates. We agree with that view but keeping rates high does not impact positively on CPI inflation. It is time to focus on the other of the RBA’s policy responsibilities – employment.

China

The China Purchasing Managers’ Index (PMI) for manufacturing still seemed stuck at just below the ‘50’ mark at 49.1 from 49.4 for August (at the start of September) but it bounced back to 49.8 at the end of the month.

Exports were strong at +8.7% but imports only recorded growth of +0.5%. CPI inflation was +0.6% against an expected +0.7%.

Retail sales grew by +2.1% following +2.7% the previous month. Industrial output rose +4.5% following +5.1% in the prior month.

These generally weaker numbers appeared to have pushed the government into trying to stimulate growth in China’s economy. The People’s Bank of China (PBOC), unlike most other central banks, uses a variety of instruments to help guide its direction. An unusually large number of ‘levers’ were pulled in September to affect a more stimulatory environment. It is difficult to assess what the aggregate response by the economy will be. What we can reasonably say is, now that they have started stimulating the economy with a purpose, if more stimulus is needed, they will do what it takes to achieve their objectives.

US

The contest between presidential candidates Harris and Trump is still tight in the sports-betting markets. Harris is just ahead but Trump has taken a couple of brief turns in front in the recent past.

There seems to be lots of bias in how analysts judge the candidates’ policies. Left-leaning analysts write of the inflationary consequences of Trump. For example, the removal of 8 million-plus illegal immigrants would cause massive disruption but they would first have to find them and then the means to remove them. Assessing the amount of actual disruption to growth and inflation is fraught with severe difficulties.

With regard to Harris’ policies, we have not seen too much in terms of detail or costings. Giving free medical insurance to all illegal immigrants and more is not apparently funded. Obama failed with Obamacare so what chance dealing with illegals? Similarly, Harris’s $50k automatic tax deduction for start-ups sounds great but we have seen no costings.

Apparently, the election result is forecast to turn on three key states and there is an inherent bias towards the Republicans in the electoral college. Although everyone is entitled to express an opinion in a democracy here or in the US, we suspect the election outcome is all too close to call.

US jobs improved from the low 89,000 figure reported in August to 142,000 in September. The unemployment rate went down from 4.3% to 4.2%. But there are some anomalies in the component pieces of the labour market puzzle. Powell is obviously concerned but we think he is well aware of the situation.

The Conference Board Consumer Confidence Index fell from 105.6 to 98.7.

The US has three important sets of inflation data released each month. Since, in essence, the Fed has declared the inflation fight is of secondary importance, if not over, suffice it to write here that there were no disturbing features in this month’s plethora of inflation data. The Fed has accepted the position we have held for quite some time. But what if the Middle East conflict ramps up? We can’t predict that or any consequences. Investing is a process of dealing with risk as it becomes apparent.

Europe

The UK economy put in two successive months of 0% growth or +0.5% for June quarter. This followed the +0.7% growth rate in the March quarter. Its inflation read went up from +2.0% to +2.2% so the BoE was ‘on hold’ this month.

The ECB is dealing with a weakening eurozone economy but it cut for a second time in this cycle to deal with the problem. There are lags in the system but cutting interest rates now is better than not cutting at all.

Rest of the World

The Israeli conflict is apparently expanding into Lebanon with no real signs of a solution in sight. Thus far, there has not been a material spillover into instability in major financial markets. Iran doesn’t seem keen to get involved.

Canada’s inflation, at 2%, is the slowest since February 2021. It has now made its third cut in interest rates. Its unemployment rate climbed to +6.6% in August – up from +5% in early 2023.
Japan changed PM in a fresh election and, with fears of interest rate rises, the Nikkei opened down -4% on September 30th.

 

We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report.

In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.

Key points:
– ‘The time has come for interest rate policy to adjust’ Jerome Powell
– Has the Fed managed to steer the US economy to a soft landing?
– RBA governor Michelle bullock rules out an official interest rate cut this year
– More evidence the easing cycle has begun, Bank of England makes first rate cut in four years

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact your Financial Adviser.

The Big Picture
Jerome Powell, the Chairman of the US Federal Reserve (Fed), announced that ‘The time has come for policy to adjust’ at the annual Jackson Hole Symposium for Central Bankers in August.

It was hardly a surprise given that the market had been pricing in cuts but the clarity and simplicity of Powell’s statement was well received by markets. He stressed that the exact timing and extent of the cuts will be determined with reference to the data.

The market has priced in four cuts this year starting on September 18th. Given that there are only three meetings left this year, the implication of four cuts is that at a ‘double cut’ of 0.5% may be announced at one of the Federal Open Markets Committee (FOMC) meetings.

But August wasn’t plain sailing for the Fed or markets. The US jobs data, released on the first Friday of the month, reported that only 114,000 jobs had been created when 185,000 had been expected. The unemployment rate was 4.3% which ‘triggered’ the so-called Sahm Rule for calling a recession. The Sahm Rule is based on the increase in the unemployment rate over a given 12-month period. We do not believe that there has been sufficient experience with this rule since it was created by Claudia Sahm, then a Fed staffer, in 2019 for us to follow it with any conviction. It is a rule that was simply fitted to the data in hindsight. There has been no recession declared since then.

It had previously been stated that a recession might be expected in the ensuing 6 – 24 months after a Sahm signal. Professor Campbell Harvey, who gave us the ‘inverted yield curve trigger’ for recessions disagrees. He said the Sahm rule was a lagging indicator by an average of about four months. You may recall that his trigger gave a false signal of a US recession a few years ago. Perhaps it is a duel between those who ‘own’ a trigger?

Our independent analysis showed that the inverted yield curve trigger produced too many false positives to be reliable. We also found the Sahm Rule to be lacking. However, it is wise to track these popular measures as some market participants believe in them – and therefore markets are affected by them.

It is also important to stress that the US jobs data are based on a small sample of companies and, as a result, data can bounce around quite a lot. Markets have looked past the previous few low jobs numbers! Moreover, illegal immigrants are not included in the unemployment data but they may be counted in the employed ranks!

Following the US jobs data, and a manufacturing expectations index (ISM) showing weakness, markets sold off quite heavily in the first week of August but bounced back a few days later after fresh, more positive data were reported. Markets can be fickle and short termist!

And then the Bureau of Economic analysis (BEA), that publishes the jobs data, revised down the previous years’ worth of data by 68,000 jobs per month or 818,000 in total! That is the biggest of the regular annual revisions since 2009. However, on the economic growth side, the June quarter revision to Gross Domestic Product (GDP), a measure of growth in the economy, came in at 3.0% – up from the initial 2.8% estimate.

We think it is fair to say that most people think the Fed may have pulled off a ‘soft landing’ (meaning a slowdown and end to inflation without a recession). Given the lags in interest rates on the real economy we think it is far too soon to pop the champagne corks. The general thinking is that interest rate cuts take 12 – 18 months to work through – just as interest rate hikes do.

The August season for June quarter US company reports of earnings, revenues and prospects went reasonably well. Virtually the last company to report, Nvidia, was the big one. As the poster child of the ‘Artificial Intelligence (AI) revolution’ it was fortunate that the chip-manufacturer exceeded market expectations on the top (sales) and the bottom line (profit) – and in its prospects going forward (guidance). Clearly the good news was not good enough for everyone as the share price took a bit of a hit in the following trading session.

If a US shallow recession does ensue, we don’t think that will bode particularly badly for markets. And the presidential contest between Harris and Trump culminating with the election in November will keep markets somewhat distracted.

In Australia, the RBA held its scheduled August board meeting and kept interest rates ‘on hold’. After the governor, Michele Bullock, had repeatedly said at the previous media conferences she won’t rule anything in, and she won’t rule anything out, at this meeting she ruled out an interest rate cut for the remainder of 2024! She may well live to regret that, as her predecessor Phil Lowe regretted his ‘no hikes before 2024’ prediction.

The RBA is worried about inflation being too high and not responsive enough to tight monetary policy. However, we argue that the recalcitrant components of the Consumer Price Index (CPI) inflation measure are unlikely to respond to tight monetary policy (higher interest rates). In the latest data release, inflation in tobacco prices was 13.5% for the year – no doubt due to recent increases in government taxes. And rent inflation which happens to be a major component of the CPI, was 6.9%. We have argued that higher interest rates are more likely to raise rents rather than bring them down – for obvious reasons, namely the cost of borrowing to invest in property.

The latest monthly Australian CPI read was buoyed by an improvement to 3.5% p.a. from the previous read of 3.8% p.a. largely due to the government one-off subsidy for electricity consumption. Electricity inflation came in at  5.1% p.a. from +7.5% p.a. the month before. Since the subsidies were equal for each consumer (rather than having changed in the price of a unit of electricity) it was not really a lower inflation read. Rather, it is a statistical jiggle that will work its way out of the calculations as it is not expected to be repeated next year.

A significant part of the market is expecting an interest rate cut by the RBA this year – say, on Melbourne Cup Day. The latest labour market data looked a bit too good to be true with 60,500 full-time jobs added and the unemployment rate being only 4.2%. We expect these data might soften in months to come.
With meaningful caps now being discussed on international student numbers, our population growth might soon better mimic the historical rate rather than the recent 2.5% p.a. plus rate of the post Covid era.

In turn, this reduced immigration might have the effect of converging per capita (household) and aggregate growth data (national level) around the current per capita behaviour. If this occurs then a recession would be unquestionably called in Australia.

The Bank of England (BoE) just cut its interest rate for the first time in four years. The latest British growth rate was 0.6% for the June quarter which follows 0.7% for the March quarter. Since the BoE interest rate cut was based on a 5:4 split vote, they might not cut interest rates again soon.

The Bank of Japan (BoJ) raised rates for a second time after 16 years of a negative rate. As a result, the Japanese yen appreciated against the US dollar and largely ended the ‘carry trade’ – the phenomenon by which investors borrowed in yen at low (or negative) interest rates and invest it elsewhere. It is a bit like the Swiss loans’ case that saw many farmers caught out in the mid to late 1980s in Australia as the Swiss Franc appreciated strongly against the Australian Dollar and borrowers had to pay back significantly greater amount of capital than they borrowed as they invested in Australian dollar assets but had to pay back the loan in Swiss Francs.

In unrelated news, Japan’s prime minister stepped down but some good macro data were recorded. June quarter growth came in at 3.1% p.a. when 2.5% p.a. had been expected. Exports slightly missed expectations at 10.3% p.a. but imports came in at a huge 16.6%p.a.  when only 4.1% p.a. had been expected.

There appears to be a general consensus forming that central banks around the world – except for the BoJ, which is attempting to normalise rates from below neutral, and the RBA, which seems to be confused – are in the process of starting to ease the global monetary policy cycle (reducing interest rates) and a deep recession has largely been averted. Markets can see through any shallow recessions as they are based on expectations rather than published data which are reported with a lag.

And with the AI rally still underway, companies might benefit from producing associated hardware and software as well as from productivity gains from using AI.

Asset Classes

Australian Equities
The ASX 200 was flat over August. IT made strong gains at +7.9% and Energy was the biggest loser at -6.7%.

With much of the latest company reporting season behind us, it is interesting to note that there is no material aggregate change to earnings expectations from our analysis of the London Stock Exchange Group (LSEG) survey of brokers expectations.

Forecast yield from the LSEG database is lower than its long-term average. Yield is expected to be 3.3% over the next 12 months, plus franking credits where relevant. Our analysis of the prospects for capital gains on the broad index over the next 12 months is for a little below the long-run average of 5%.

International Equities
The US S&P 500 Index finished the month strongly with a 1% gain on the last day and +2.3% for the month. Other major market indexes were mixed. Japan’s Nikkei was down -1.2% while China’s Shanghai Composite lost -3.3%. The German DAX was the best of the rest at +2.2%. Emerging markets posted a small gain of 0.2%.

Our analysis of the LSEG data for the S&P 500 point to a continuation of the strong momentum seen so far in 2024.

Bonds and Interest Rates
Every year at about this time, central bankers congregate in the US at a resort in Jackson Hole, Wyoming. The location was chosen because of its proximity to a great fly-fishing spot – the pastime of the then chair of the US Fed!

Often not much happens – at least that filters through to investors. But this year, Powell made a totally clear statement that there are no more ifs and buts – interest rates are on their way down. He did qualify that statement a little by saying that the timing and extent of the interest rate cuts are not set in stone.

The CME Fedwatch tool interprets the new Fed policy stance as follows: one or maybe two cuts in September; another in November and there is a good chance (around 70%) of four cuts by the end of the year. A double cut is on the cards to get Santa starting a Christmas rally in markets.

The prospects for interest rate cuts in 2025 are obviously less clear but CME is pricing in a fair chance of rates being normalised – or nearly so – by the end of 2025. Providing this path is swift enough to avert any more than a shallow recession, markets might thrive.

We don’t expect the Fed to need to go below a neutral rate of 2.5% to 3.0% unless the wheels fall off the economy i.e. growth slows materially.
Most major central banks are guiding their interest rates towards neutral levels – except for Australia. After the last media conference when governor Bullock ‘ruled out’ any cuts before 2025, it seems a bridge too far for her to cut at the September 24th board meeting – not quite a week after the Fed will almost certainly have cut its interest rate. But Melbourne Cup Day could be a goer. Let’s hope so because so many people are struggling with mortgage stress and price inflation of even basic commodities and goods.

Another danger for us is that the RBA hangs on too long to its current interest rate setting while the US interest rates decline putting upward pressure on our dollar. That wouldn’t help our exports including commodities (iron ore), agricultural produce and education.

Other Assets
Iron ore prices dipped below $US100 / tonne during August but finished at $101 with a gain of 0.5%.

Brent crude oil prices fell  2.4% over the month while West Texas Intermediate (WTI) crude oil was down -5.6%. Both prices traded above $80 / barrel earlier in the month but fell well below that mark as tensions in the Middle East dissipated. The oil price spike was likely not enough to flow through into global inflation in any meaningful way.

Copper prices were almost flat for the month but the price of gold surged by 3.4% to close above $US2,500 per ounce.

The Australian dollar appreciated 4.9% against the US dollar. With projected movements in global interest rates, there may be pressure for a further appreciation over the next month or two.

The VIX index, being a proxy for the price of insurance against falls in the S&P 500 share market index, retreated to 15.0 after peaking at 38.6 during the month. While 15.0 is, perhaps, not average, it is close enough to normal levels to declare the early August recession panic is over – for now.

Regional Review

Australia
Employment rose by 58,200 and full-time positions expanded by 60,500 at the expense of a loss of 2,300 part-time jobs. In growth terms, full-time employment expanded by 2.1% which is a little above long-term average population growth. Part-time positions grew by 5.8%. The unemployment rate stood at 4.2%.

We found that US and Australian unemployment data behave quite differently in relation to GDP growth and we think it would be flawed to try and rely on a Sahm-Rule trigger for Australia. The latest unemployment data – using the same (misguided) Sahm-rule calculations – would have triggered a recession call here.

The quarterly wage price index for the June quarter was reported in August. Wages grew by 0.8% for the quarter and 4.1% for the year. When we correct for price inflation, real wages fell by  0.2% over the quarter and grew by +0.2% over the year.

While it might at first seem inflationary to have nominal wages grow by 4.1% it should be noted that wages, after correcting for price inflation, are more than 7% below where they were at the start of the Covid pandemic. Workers need to catch up to reduce the cost-of-living pressures long before wages and prices can start to contribute to a wage-price spiral.

Retail sales for July were flat but up 2.3% on the year. When adjusted for inflation, sales were down -1.2% for the year – the 18th successive negative change.

China
The China Purchasing Managers’ Index (PMI) for manufacturing seems stuck at just below the ‘50’ mark at 49.4 – down from 49.5.

Growth for the first half of 2024 was 5.0% p.a. Retail sales grew at 2.7% and industrial production at 5.1% in July. China CPI inflation was 0.5% p.a.

Imports bounced back to come in at 7.2% against an expected 3.5% but exports missed at 7.0% against an expected 9.7%.

US
The contest between presidential candidates Kamala Harris and Donald Trump is tight in the betting markets. Harris was just ahead but Trump has taken a couple of brief turns in front recently.

While many commentators are trying to distinguish between the candidates with ‘estimates’ of how inflationary their policies would be, we feel much of this part of the discussion as being too heavily influenced by the commentators’ personal preferences for the candidates. The TV debate(s) might wedge some daylight between them!

If it weren’t for the problems with measuring inflation in shelter, US inflation looks very much under control. For the last three months, official CPI-less-shelter inflation has come in at 2.1%, 1.8% and 1.7% all at the bottom end of the 2% p.a. to 3.0 % p.a. inflation target range of the Fed.

Producer Price Index (PPI) inflation, reflecting input cost inflation was +0.2% for the month and +2.9% for the year. Average weekly earnings only grew by 0.2% for the month or 3.6% for the year. There is no price pressure brewing!

The Fed’s preferred Personal Consumption Expenditure (PCE) core inflation measure came in at 0.2% for the month and 2.6% for the year – 0.1% (one notch) below expectations. Given the strength of Powell’s Jackson Hole address, there seems little to stop the Fed from starting its interest rate cutting cycle on September 18th possibly (but not likely) with a double cut of 0.5%.

US retail sales grew by 1.0% for the month or 2.7% for the year; 0.3% was expected for the month. When adjusted for price inflation, real retail sales grew by 0.8% for the month but fell  0.3% for the year. The US economy is no longer strong but it hasn’t yet slipped into recession – if, indeed, it will.

Europe
The UK economy grew by 0.7% and 0.6%, respectively, in the first two quarters of 2024.

European Union (EU) inflation drifted up a notch to 2.6%.

Rest of the World
The big ‘misses’ on Japan imports and exports predictions we reported last month were largely reversed this month with double digit gains on both.

The Middle East conflict is going through some new stages as countries north of Israel are now appear more engaged. Oil prices did spike in line with increased hostilities but that spike has now largely dissipated.

The Ukraine has reportedly attacked inside Russia but there do not (yet) seem to be any major consequences for markets.

The Reserve Bank of New Zealand (RBNZ) cut its Official Cash Interest Rate (OCR) from 5.5% p.a. to 5.25%. p.a. It signalled 4.92% as its end-of-year target so one more cut of 0.25% is to be expected.