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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:

• Trump policy changes continue to drive instability and uncertainty
• Trump’s global tariff policy has the potential to bring on economy sapping trade wars
• The US Federal Reserve keeps interest rates on hold as it awaits the outcome of tariffs on the economy
• Markets reflecting concerns that US tariffs could result in slower growth and consumption

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

It is nigh impossible to keep up with Trump’s claims and executive orders. Even if we compiled a detailed list, Trump changes his direction – sometimes within 24 hours – and judges have thrown out many of his attempts to change policy. Trump has already signed more than double the number of executive orders he did in his first term as president (Trump 1.0) during the first 100 days!

Trump’s strong supporter, and unelected official leading the Department of Government Efficiency (DOGE), Elon Musk, seems to be accountable only to Trump. He appears to try and close departments without reasoning, and he too gets some of his policies overturned by judges when his actions are challenged through the courts.

There has been a very strong pushback against Musk both within and outside the US. The share price of his flagship company, Tesla, has fallen from over $400 to nearly $250 since Trumps inauguration on 20 January. Sales of Tesla cars have fallen by 30% to 40% in a number of countries, including the US, and by a reported 70% in Germany. To make matters worse Tesla was forced to recall nearly every cyber truck to fix a defect. And there are reports of the vandalising of Tesla vehicles in the street and in car dealerships as a protest. With the apparent chaotic approach of this Trump administration there are very few parallels with that of the former Biden presidency.

Here in Australia, we have had a Federal Budget and Prime Minister Albanese called an election for May 3rd. The importance of this has been overwhelmed by events in the US this week.

We are uniquely in the position of being able to count on Dr Janet Yellen’s expertise. We recently heard her speak on this topic to a closed room. She spent a five-year term as Governor of the US Federal Reserve – the equivalent of the Governor of the Reserve Bank of Australia (RBA) – and a four-year term as Secretary to the US Treasury. She held several other public offices, including leading the White House Council of Economic Advisers – and she has been a long-serving Professor of Economics at the prestigious University of California – Berkeley (since 1980).

There is no one more qualified to speak on these issues from both an academic and a public office perspective.

One of Trump’s main stated reasons for introducing tariffs is to redress the US trade deficit. Yellen says they won’t; exchange rates adjust to accommodate the tariffs. Historical evidence supports this view.

Trump seems to talk in terms of import tariffs being paid by the exporting country. Yellen says the US consumer will bear the brunt and consume less as a result. We agree. Even Trump urged current Fed Chair, Powell, to cut rates now to ease the burden on the consumer.

Yellen thinks tariffs might only cause a blip in inflation unless they seep into the formation of inflation expectations. The latest University of Michigan estimate of long-term inflation expectations is 4.1% which is the highest since 1993!

Some countries have already responded with new retaliatory tariffs for US exports. This tariff war could end badly. But Trump has often said – and we have written in past Updates – that Trump wants to use tariffs as a bargaining chip to get his way on other things – such as concessions on the location of industry, curbing drug importation and immigration. He said at the end of March – just before his April 2nd reciprocal tariffs are due to kick in – ‘there’s some flexibility on reciprocal tariffs’.

We, like Fed Chair Powell, think it is wise to wait for policies to be firmed up before we finalise our opinions. But the US consumer is confused (and why wouldn’t they be?). Both the well-regarded University of Michigan and Conference Board consumer confidence indexes have plummeted in the last three months.

On top of falling confidence, retail sales in the US are weakening yet, unlike in Australia, wage inflation is outpacing price inflation, so people are getting better off but not spending! The danger of stagflation is mounting as there are some signs of inflation rising a fraction – whether it be from tariffs or not.

At the time of writing, Trump has imposed or increased tariffs on Canada, Mexico and China. He has imposed tariffs on all aluminium and steel imported into the US. At the end of March, he imposed a 25% tariff on all (finished) autos but, importantly not on auto components.

Had tariffs been imposed on car parts, the US auto export industry would have been hurt. A significant proportion of the components of autos built in the US are imported. And, according to Yellen, autos cross the Mexico border six to eight times as autos pass through the production process. Will foreign auto makers like BMW start to export autos as components with final assembly in the US? We don’t know but quite likely the world might respond to Trump’s tariffs.

One point Yellen stressed was that all these new trade policies could be reversed in less than four years when a new president is elected. At the moment, US presidents can only serve two four-year terms in office. However, there is ongoing speculation that Trump will try to challenge this rule.

While all these political disruptions were taking place, some hard macroeconomic data were posted. Since data are published in hindsight and with a lag, there has not yet been much opportunity for the data to reflect Trump’s economic impact.

US inflation data has been ‘sticky’ in the sense that inflation is only slowly returning to the Fed’s 2% target. We have argued for some time, most of this stickiness is a statistical artifact created by the way in which shelter (or rent) inflation is calculated. The problem has been acknowledged by the Fed but they have not acted to correct the situation.

Our calculations based on official US data reveal that Consumer Price Index (CPI) inflation less shelter inflation has already returned to the 2% target. Moreover, there are sound economic reasons to believe further rate cuts could flow through to falls in mortgage rates and make room for landlords to cut rents. However, in the last couple of months there has been some signs of possible increases in CPI inflation.

US jobs data have continued to be reasonably strong both in terms of the number of jobs created and in the unemployment rate. The current unemployment rate is 4.1%, up from 4.0%, but low by historical standards. Of course, the nature of work has been evolving in recent times and it is not clear how appropriate it is to compare current unemployment rates with those of 5 to 10 years, or more, ago.

The US Fed is comprised of 12 regional Federal Reserve Banks. One such bank is the Atlanta Fed which provides updates on economic statistics before the official data are released. After strong GDP growth data in 2024, the Atlanta Fed came up with an early estimate of March quarter 2025 growth of 2.3% which was reasonably similar to the official 2024 growth. However, subsequent updates have turned sharply negative. The latest estimate is 1.5% which, if confirmed at the end of April, when the official data are released, could cause the Fed to quickly change tac with monetary policy.

The current year started with major hurricanes on the east coast of the US and an unusually destructive wildfire in California. They could have impacted the March quarter 2025 data. Furthermore, the Atlanta Fed’s early estimates often show some instability over the course of data collection and updating.

Until recently, most commentators were siding with the notion of a soft landing in the US. That is, the Fed was binging inflation down to target without causing a recession. In late March, the calls for a recession increased markedly under the barrage of Trump’s executive orders.

At the latest Fed meeting on March 19th, the Fed kept interest rates on hold. Fed Chair, Jerome Powell, argued that it was in a good position to act appropriately as new data are posted. The Fed’s ‘dot plots’ showed the individual views of members of the committee on where interest rates might be heading.

The latest dot-plot has two more interest rate cuts pencilled in for the rest of 2025. Market pricing gives a reasonable chance of two or three more cuts this year.
Importantly, Powell conducted himself with calm and self-assuredness under questions from the media after the recent interest rate decision. He is not a man who fears Trump. When asked whether his job was in jeopardy, Powell calmly replied, ‘I answered that question in previous meetings. Nothing has changed’. The president has no power to dismiss the Fed chair and Powell is not a man to be bullied.

The Australian Federal Budget, delivered by Treasurer Jim Chalmers, on March 25th was ‘election-friendly’ but it didn’t announce any big policy changes. After seven successive quarters of negative per capita growth, the latest quarter’s growth was deemed to have been positive to the tune of +0.1%. That rate is very close to zero!

Australia faces a cost-of-living crisis far more than that in the US. Australian wages, after adjusting for price inflation, are over 6% below what they were at the start of 2020. Even if these so-called ‘real wages’ caught up with that 2020 level, there would still be five years of ‘lost’ wages to regain before Australia could get back to its previous position.

Chalmers did deliver some improvements in the budget: Tax, healthcare, childcare and other social conditions. Albanese announced on March 28th that there will be a general election on May 3rd. Let’s hope both parties come up with a more comprehensive plan for Australia’s future by then.

Immigration has been central to Australia’s growth and prosperity. But immigration flows must be co-ordinated to match the needs in the workforce and the supply of suitable housing. Probably because of the pandemic, immigration and housing got out of kilter causing big increases in home prices and rents. Energy prices have also become unsustainable, but for other reasons.

The government did introduce a stop-gap measure by way of a flat subsidy for electricity, but this subsidy will end this year. The way the Australian Bureau of Statistics (ABS) has calculated CPI inflation has artificially brought headline CPI inflation to within the RBA’s target band of 2% to 3%. When the subsidy ends, CPI inflation will most likely jump well above the target band. A long-run solution is needed.

Some of Australia’s macroeconomic data looks quite reasonable. The latest labour force survey indicated the unemployment rate was steady at 4.1% but 52,800 jobs were lost in February. We are not alarmed like some over the job losses because there was an unusually large jump up in the prior two months. ABS data can be volatile.

The unemployment rate might be a bit flattering for those comparing it with rates in years past. Reportedly, the NDIS has contributed a significant number of jobs – some from people previously doing similar work without pay for family and friends. We are not arguing the scheme is not worthwhile, but it should change the way economists view labour market data. These jobs are funded by the taxpayer and not market forces. They are essentially a form of fiscal stimulus.

As expected, the RBA did not change our official cash interest rate at its April 1st meeting. A cut at the following meeting – after the election – is a possibility as are a couple more later in the year.

Even with this optimistic view of monetary policy, we will end 2025 with an interest rate above the so-called neutral rate meaning that monetary policy will still be restrictive.

Any relief to mortgage holders would be most welcome. The 6% fall in real wages we wrote about would still be a major issue but households would have a greater disposable income after mortgage payments fall. Renters too might gain from rate cuts as landlords may pass on the cost savings to tenants.

Elsewhere, the Banks of China and Japan kept their interest rates on hold. Both the ECB and the Bank of Canada cut their respective interest rates by 0.25% points to 2.5% and 2.75%. It was Canada’s 7th successive cut. By comparison, our official cash interest rate stands at 4.1% which is well above the neutral rate of 2.5% to 3%.

China’s Purchasing Manager’s Index (PMI) climbed back above 50 to 50.2 from 49.1 when 49.9 had been expected. Its retail sales beat expectations with a growth of 4.0% but industrial production was just under expectations at 5.9%. China’s trade data disappointed, possibly due to the tariff war. We expect China to add further stimulus as needed.

It is a difficult time to give strong guidance for investors. We do think Trump’s blustering style has led many to fear conditions far worse than may eventually transpire. Those who look at recent stock market falls as indicative of bad times might be over-reacting. So far, the US and Australia’s main markets have suffered no more than a 10% correction and that follows two successive years of gains above 20% for the S&P 500. Corrections are the norm and not the exception in stock market behaviour. It is too soon to run for cover.

By next month we should have a much better view of what is happening with Trump’s policy agenda. We should also know by then what the respective main election promises are for Australia.

Asset Classes

Australian Equities 

The ASX 200 fell sharply ( 4.0%) again over March with only one sector, Materials, registering a gain (+1.5%) while nine sectors recorded losses and Utilities was flat.

The index finished March down 8.3% since the recent all-time high of 8,556. During this sell-off – which is about the same as that on the S&P 500 – the broker-based forecasts of the ASX 200 component-companies’ earnings forecasts remained strong and forecast capital gains above the historical average over the next 12 months.

International Equities 

Except for the Shanghai Composite and the Emerging Markets indexes, all the six major international indexes we follow were well down.

Unsurprisingly, the S&P 500 was the worst, affected by news of tariffs with a loss of 5.8%; Emerging Markets gained +1.7%. The Shanghai Composite also posted a gain but only +0.4%. The Nikkei and DAX were down with losses of 4.1% and 1.7%. The London FTSE index was down 2.6%.

Bonds and Interest Rates

The ECB and the Bank of Canada have been the most active of the central banks we follow in cutting interest rates in this cycle. The RBA has been the least active in cutting rates.

Market pricing suggests that there will be two or three more interest rate cuts this year by the Fed in bringing the Fed interest rate down to a range of 3.5% to 3.75% or 3.75% to 4.0%. Market pricing also suggests two or three cuts in the RBA official cash rate to 3.6% or 3.85%.

It is important to note that most mortgagees in the US hold 30-year fixed rate mortgages and so many locked in very low rates during the pandemic. In Australia, most mortgagees have variable rate loans or a mix of variable and fixed-rate loans for a period of only 1 – 3 years. Therefore, Australian homeowners were hit much harder than their US counterparts when rates were on the hiking cycle. It is fallacious to state that the RBA should be in less of a rush to cut rates because they did not take rates to the same level as the US Fed.

The Fed left interest rates on hold in March but there is an 14% chance of a cut priced in at the next meeting on May 7th but a 76% chance of one or two cuts by June 18th. The RBA has a 75% chance of an RBA interest rate cut by May. There is a 91% chance of three interest rate cuts by the RBA during the rest of the year.

Other Assets 

Brent Crude oil (+2.1%) and West Texas Intermediate Crude oil (WTI) (+2.3%) prices were up in March.

The price of gold was up +9.6% in March finishing the month at $US3,125

The price of copper (+4.9%) was up sharply again but iron ore prices ( 1.6%) were down. However, the price of iron ore held above $US100 / tonne

The VIX ‘fear’ index is still elevated at 22.3 but down from its intra-month high of 27.9.

The Australian dollar (AUD) traded in a wide range ($US0.6191 to $US0.6375) over March but finished up (+0.5%).

Regional Review

Australia

Australia will hold its general election on May 3rd. Polls suggest the election may be close between the two major parties but the prospects for the Greens, Teals and Independents is much harder to judge. Rather than comment on recent press releases and speeches, we will reserve our opinion until we have seen the full set of election promises.

The jobs data posted in March disappointed many commentators because 52,800 jobs were lost. However, we note that there were unusually large increases in the two previous months of 59,800 and 30,500. After allowing for the usual noise in these data and possible inaccuracies in seasonal adjustment procedures we think it is far too early to suggest an imminent problem in the labour market.

When we look over the last 12 months, we see that total employment grew by 1.9%, full-time jobs by 2.0% and part-time jobs by 1.6%. This is the first time in a year or two that the three measures were in alignment. Recently, part-time employment was growing by over an unsustainably large 6%.

The unemployment rate was steady at 4.1% but we have noted that a big increase in taxpayer funded NDIS jobs makes it harder to understand the new dynamics of the labour market.

GDP growth for 2024, was released in March. Growth was 0.6% for the quarter and 1.3% for the year. Per capita growth for the December quarter 2024 came in at 0.1% after seven consecutive negative readings. The household savings ratio improved to 3.8% from 3.6% in the previous quarter. We regard 5% to 6% as a healthy savings ratio based on historical data. This ratio sank to 1.5% in 2023. Households need to put aside savings for emergencies, durable goods, holidays and retirement. The Superannuation Guarantee Levy is a part of this definition of household savings.

China 

Late last year China seemed to need a stimulus package, and it provided one. Most economic data – except trade – are getting back to normal. China has set 5% as its goal for growth this year.

Trump imposed a further 10% tariff on imports from China making 20% in total. In addition, the 25% tariff on finished cars and the steel and aluminium tariffs are headwinds facing China. It has been reported that China’s electric vehicles (EV) are providing stiff competition for US EV autos, particularly Musk’s Tesla offerings.

US

The nonfarm payrolls (jobs) data came under expectations at 151,000 new jobs as 170,000 had been expected. The unemployment rate climbed one notch to 4.1% from 4.0% and wage growth at 4.0%, undershot the expected 4.2%. With CPI inflation well below 4% – even with the shelter inflation problems – means that the US worker is experiencing improved compensation month by month.

Retail sales, adjusted for CPI inflation, came in at 0.0% for the month and 0.3% for the year. These are not strong numbers, but we have noted that consumers have adopted a more cautious approach to spending. They have the money to spend but they are (sensibly) applying caution in these troubling times. Sales could spring back quickly when consumers feel more confident.

Europe 

Trump’s reaction to North Atlantic Treaty Organisation (NATO), and the Ukraine in particular, has acted to galvanise Europe in providing a more concerted and unified response to conflict and geopolitical tension in the region. Germany just passed a massive bill to issue over one trillion dollars’ worth of debt to build a military capability to make up for a possible US withdrawal or disengagement from NATO. Europe looks to be working hard to replace any gap left by Trump’s apparent receding commitment to NATO. Of course, in four years’ time, the old normal could be restored.

EU inflation fell to 2.4% and the European Central Bank (ECB) cut its rate from 2.75% to 2.5%.

Rest of the World 

Such is the extent of Trump-created chaos that so much of the world is now caught up in the ensuing economic maelstrom.

Mexico sent a number of drug-cartel ‘suspects’ to the US for trial but that didn’t seem to overly appease Trump’s appetite for blaming Mexico for the US’s drug problems.

Mark Carney, a celebrated former governor of both the Bank of England and the Bank of Canada was sworn in as the Prime Minister of Canada. He has the credentials and the apparent resolve to take on Trump over the tariffs imposed on Canada.

The cease fire between Israel and Hamas in Gaza has again run into difficulties.

Japan recorded stronger than expected economic growth in 2024. A rate of 0.6% for the December 2024 quarter was much stronger than the 0.4% which had been expected. That’s good for the global economy.

The Ukraine-Russia ceasefire seems to exist in concept only without any real headway being made save for a supposed naval truce in the Black Sea.

New Zealand recorded growth of 0.7% in 2024 – a bounce back from recession.

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:

• President Trump policy initiatives drive increased volatility in markets and geopolitics
• -Despite some economic softening corporate earnings continue to hold up
• Without the NDIS impact our labour market is not as robust

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

At last, the Reserve Bank of Australia (RBA) has started its interest rate cutting cycle by reducing its overnight cash rate (OCR) by 0.25% (or 25 bps) to 4.1%. The last hike (+25 bps to 4.35%) was made in November 2023 and the first hike in that cycle was in May 2022 after more than a year at the ‘emergency setting’ of 0.1% to help withstand the impact of the pandemic. While we believe the rate cut was needed last year, getting it now is a better outcome than continuing to wait.

The RBA is charged with a dual mandate of maintaining: (1) price stability and (2) full employment. The problem is, inflation and unemployment data have been confounded in the last few years by the interest rate rises and the growth in the NDIS scheme.

At the end of February, the Federal Treasurer, Jim Chalmers, argued that landlords should bring rents down in line with the first interest rate cut and those that might follow. We agree with this causal relationship but it makes no sense unless Chalmers also admits that the interest rate rises in the overnight cash rate, from 0.1% to 4.35%, flowed through to a rapid rise in mortgage payments and, hence, to rents. Part of the rate increases caused higher inflation – working against RBA reasoning.
Rents are a significant component in the Consumer Price Index (CPI) basket of goods and services and the current rate of rent inflation is 5.8%, which is down from 7.8% in August 2023. Because of the length of leases, rent inflation tends to react to changes more slowly than many other items in the CPI basket.

The RBA argument that inflation was sticky and that delayed making interest rate cuts is fallacious. Cutting rates sooner would have taken pressure off mortgage rates and rents.

Recent reports highlighted that the National Disability Insurance Scheme (NDIS) has expanded rapidly in the past two years. Many of the people now employed through the scheme were previously doing similar work but without being paid and, hence, classified as being unemployed.

While the principle of the scheme is laudable, the newly classified ‘carers’ and others as among the official employment data has led to a misunderstanding of how to interpret employment growth and levels of the unemployment rate.

It has been reported that the majority of jobs created in 2024 were due to the NDIS expansion. Since the jobs are funded from taxpayer revenue, they do not reflect how ‘hot’ the labour market is from market forces.

It is true that the same could be said about other government employees – such as teachers, nurses and police – but we are not saying that this source of employment and funding is inappropriate. We are saying that the rapid change in the NDIS means that a 4.1% unemployment rate today is not comparable with 4.1% two or three years ago. Our ‘back of the envelope’ estimate of what the unemployment rate would be without the NDIS is in the range of 5% to 6%. If the Australian Bureau of Statistics (ABS) had published unemployment rates in that range, the RBA would have been slashing its cash interest rate much earlier in this cycle.

When the growth in the NDIS slows as the programme reaches maturity, it will not make the unemployment rate rise but employment growth should fall. This situation will become the ‘new normal’; the ‘old normal’ is not entirely relevant now.

It has also been reported that the NDIS sector has lower productivity than the traditional sectors – and NDIS pay is lower. Therefore, we expect aggregate wage growth and productivity to continue to be lower going forward.

February began with US President Trump signing executive orders to impose 25% tariffs on Canada (but 10% on energy) and Mexico – and an additional 10% tariff on China.

The Mexico and Canada tariffs were pushed back from an immediate start to the beginning of March. The delay was due to Mexico and Canada each agreeing to put 10,000 more troops on their respective borders with the US to combat illegal immigration and the importation of fentanyl (an addictive pain relief medicine).

At the end of February, Trump announced in a speech that he was also going to impose a 25% tariff on the European Union (EU). On the last day of February, Mexico announce it was sending a number of ‘drug cartel lords’ to the US to face charges. That maybe enough to keep Trump pushing back the deadline for the new tariffs.

It is important to appreciate that Trump has a very different way of communicating from most other leaders. He blusters and barks to appeal to his supporters. He has stated that tariffs and other measures are designed, in part, as a negotiating tool to get other ‘deals done’. For this reason, it is extremely difficult to interpret what Trump will do as opposed to what is said in the threats. Markets move on these Trump diatribes and so cause market volatility as the normal market approach is to sell first and ask questions later.

We regularly analyse the LSEG (Refinitiv) survey data on forecasts of individual company earnings and dividends collected from prominent brokers. The data so far are holding up well so the medium-term market trend might be reasonable but short-term volatility might make for a bumpy ride.

Recent market volatility was exacerbated by the launch of DeepSeek by ‘high-flier’ a hedge fund based in China. This software uses a different technology to ChatGPT and other US generative AI applications. China claims it was very much cheaper to develop and has big efficiency gains in terms of the need for advanced chips (such as those designed and sold by Nvidia) and power consumption.

Since there appears to be no independent corroboration of the China claims, we do not know to what extent DeepSeek will be adopted in the West.
Nvidia, the once biggest stock in the US by market capitalisation, took a sharp price hit on the news but Nvidia’s CEO, Jensen Huang, seems confident about the future of its business. He predicts the next generation of AI will require ‘100x more’ computing power.

Five of the seven ‘mag 7’ stocks (7 largest technology companies listed in the US) just reported earnings above consensus broker expectations and similarly six of them on revenues as well. All the hyperscalers (large, powerful and heavy users of data) reporting their earnings after the DeepSeek launch. All predicted strong growth in capex (capital expenditure) going forward.

For security reasons, DeepSeek has been banned from use in various government and military departments in the US, Australia and elsewhere.

As far as the Artificial Intelligence (AI) boom is going, it is important to appreciate that companies like Nvidia provide infrastructure – advanced chips that are used in mammoth computing systems.

Some fund managers in the tech space are predicting that the next wave in AI will be in software. Currently, many of these companies are small but will grow rapidly over time. We think the AI boom will last many years, if not decades but, as always, we don’t expect markets to move in straight lines!

Around the world many central banks are scampering to cut their interest rates. New Zealand just made its fourth successive cut – the latest being 50 bps – to 3.75%. The ECB has cut interest rates four times since June and is expected to cut again in March. The German economy is struggling with 0.2% growth in the December quarter of 2024 after 0.0% in the September quarter. Canada made its sixth rate cut at the end of January.

In essence, there are long and variable lags between interest rate changes and the reaction in the real economy – these are typically of the order of 12 to 18 months. As we wrote last year, being ‘data dependent’ was destined to fail because waiting for weakness to appear before starting to reduce interest rates means at least another 12 – 18 months of economic weakness after rates are returned to neutral levels.

Australia’s situation has been masked by immigration flows and the growth in the NDIS. There have already been seven successive quarters of negative per capita growth. The RBA might not cut rates at its next meeting (April 1st) because of the proximity of that board meeting to the impending Federal election. The latest Sydney Morning Herald (SMH) poll has the Liberal National Party (LNP) ahead of Labor by 55:45 in a two-party preferred vote.

The US was thought to have dodged a bullet and engineered a soft landing – but some economic data softened at the end of February. GDP was revised downwards slightly to 2.3% for December quarter 2024 (from 3.1% in September) but per capita personal disposable income was revised downwards in December 2024 from 2.1% to 1.9%.

More telling is the latest US consumer confidence index published by The Conference Board. It fell from 112.8 last November to 98.3 in February coinciding with the increased chatter over Trump 2.0! And inflation expectations are up. It is not surprising if the pundits keep talking about problems arising from mass deportations and big tariffs that the general population factors in that scenario. We think the effects have been exaggerated not least because some of the measures will not be implemented – or will be quickly removed.

Markets are only pricing in one or two more interest rate cuts in the US this year and up to three more in Australia. US inflation (excluding shelter) has been on target for many months, but fear of the unknown exacerbated by Trumps policies and style of governing is unnerving many. If there are a few months of ‘reasonable’ Trump policies being enacted, the Fed could start cutting interest rates again.

Asset Classes

Australian Equities 

The ASX 200 fell sharply ( 4.2%) over February but the selling was not across the board. Indeed, four of the eleven sectors witnessed healthy gains. This behaviour is symptomatic of a sector rotation and not a panic sell-off.

The index is up 0.2% for the year-to-date. The financial (FY25) year-to-date witnessed gains of 5.2% which is a very reasonable return given past historical averages.

In essence there has been a big momentum rally over the last two years and it seems investors are now searching for the next big theme.

International Equities 

The S&P 500 also lost heavily over February before recovering somewhat in the last couple of trading hours ( 1.4%). The DeepSeek launch seems to have triggered a sell-off of the Mag 7 stocks but there has been plenty of interest in non-tech sectors.

The German share market index the DAX (+3.8%), London’s FTSE (+1.6%) and the Shanghai Composite (+2.2%) swam against the US tide.

Bonds and Interest Rates

Doubt surfaced towards the end of February that the Fed might not have successfully engineered a ‘soft landing’ (lowered interest rates without having an economic recession) for the US economy. The 3-month to 10-year bond yield spread (differential) on Treasurys inverted again (the yield on 3-month securities is higher than the yield on 10 year securities). Whilst this ‘inversion’ is touted as a precursor for a recession it didn’t work as an indicator of a recession in 2022 – and a few times before – so we are not in the recession-is-imminent camp but nor are we saying that a recession will not happen we are keeping an open mind and monitoring data and events closely.

The market has walked away from the US Federal Reserve’s (Fed) prediction of four interest rate cuts this year made in December 2024. However, the market is still expecting one or two rate cuts in the remainder of 2025 – and, maybe, even three.

With one interest rate cut under its belt, the RBA could be set for another two or three cuts this year, but a lot will depend on how the Trump tariffs and other policy machinations work out. There is too much ‘noise’ around to get a good feel for direction of the markets and economies.

The Bank of England (BoE) cut interest rates again in February – by 25 bps to 4.5%.

There is sufficient strength in Japan inflation to expect that the Bank of Japan (BoJ) will achieve its desired aim to get its interest rate up from the current 0.5% to 1% by the end of 2025. The decades of low inflation and even deflation now appear to be behind it.

New Zealand has a struggling economy, and the Reserve Bank of NZ (RBNZ) just cut interest rates at its fourth successive meeting – this time by 50 bps to 3.5%.
The Reserve Bank of India (RBI) just cut its interest rate for the first time in five years by 25 bps to 6.25%

Some have questioned whether the ’neutral rate’ that neither quickens nor slows the economy has increased in recent times. It was thought to be around 2.5% to 3% for Australia and the US before the interest rate hikes started post Covid. Some are now saying the neutral rate might be closer to 4%. We think this view might be misguided as the full force of the interest rate hikes has not yet filtered through to the real economy.

All four Australian major banks were quick to announce cuts to their mortgage rates – by 25 bps – after the RBA cut its interest rate in February.

Other Assets 

Brent Crude Oil ( 4.7%) and West Texas Intermediate Crude Oil (WTI) ( 3.8%) oil prices were down in February.

The price of gold rose 1.5% in February.

The price of copper (+5.1%) was up sharply but iron ore prices ( 1.3%) were down.

The VIX ‘fear’ index measure of US share market volatility rose to moderately high levels (21.1) towards the end of February as the possible tariff wars resurfaced, but it closed the month at 19.5. Given the intense concern over what Trump may or may not do, it is somewhat surprising that the VIX has not been trading higher.

The market seems to be trading on the ‘Trump put’ – that he will take corrective action when necessary. There is the common belief that he judges his success by the state of the market.

The Australian dollar (AUD) traded in a wide range ($US0.6116 to $US0.6397) over February but finished flat.

Regional Review

Australia

Australia must hold a general election by mid-May. Whoever wins the election will be faced with an uphill task to breathe life back into the economy. As population growth slows, it will become even more apparent that economic growth has stalled.

However, the jobs numbers just out for January seemingly painted a rosy picture of the health of the labour market. The unemployment rate only rose to 4.1% from 4.0% and 44,000 new jobs were created. We believe the faster-than-usual population growth, together with the rapidly growing NDIS scheme is masking the poorer level of health of the economy.

Retail trade grew over the year by 4.6% but that is reduced to 1.1% when price inflation is taken into account. The volume of sales are growing at about half of the pace of population – we are consuming less per person on average than a year ago.

CPI inflation was in the middle of the RBA target range, but electricity price inflation was 11.5% because of the way the ABS is trying imply a price inflation figure from a fixed-dollar subsidy per household.

The wage price index rose 3.2% over the year or 0.8% after price inflation is accounted for. Wages, after being adjusted for inflation, are still about 6% less than in 2020 as the pandemic began.

China 

China needs to expand its stimulus package. Last year, growth came in (exactly) on target at 5.0% and 4.7% is expected for 2025.

A lot will depend on how China and the US interact over the tariff and trade situation, and the related tensions that have escalated recently.

US

The nonfarm payrolls (jobs) data came in at an increase of 143,000 from an upwardly revised 307,000 in the prior month. The unemployment rate was 4.0% and wage inflation was 4.1%. We note many of the created jobs are in the government sector.

December 2024 quarter economic growth was only minimally revised in the first of the two planned revisions each quarter. December quarter 2024 growth stands at 2.3% compared to the 3.1% recorded in the September 2024 quarter. Per capita real disposable income was revised down for the December 2024 quarter from 2.1% to 1.9%.

Retail sales were up 4.2% on the year or 1.2% after allowing for price inflation.

However, the Atlanta Fed, that publishes a regularly updated GDP forecast reported that earlier in the month their preliminary forecast for the March quarter 2025 was 2.3% but it fell to 1.5% on the Private Consumption Expenditure (PCE) Inflation measure report on the last day of February.

Trump has started so many initiatives it is not possible to report and discuss all of these in this update. We prefer to wait and see what actually changes before attempting to assess the implications.

Europe 

The European Central Bank (ECB) continues to cut its interest rate and is expected to continue to do so. EU inflation rose to 2.5% from 2.4% but this is not, we believe, due to interest rate cuts. Rather, there are many factors at work in determining inflation. The EU economy is weak.

It was reported that the average German worker in 2023 took 19.4 days sick leave compared to 15 days the year before. The UK reported only 5.7 sick days in the same year. It was reported that the younger workers – GenZ – are struggling to keep up with the older workers.

German inflation came in at 2.8% for February after having been under 2% in September of last year. Rising inflation and a slowing economy are the preconditions for stagflation. It is too early to call that yet, Europe’s economy is struggling.

The BoE cut its rate to 4.5% from 4.75%. UK growth was 0.1% in the December 2024 quarter following 0.0% in the September 2024 quarter.

Rest of the World 

Trump started to negotiate directly with Russia over the Ukraine war. He started off without including Ukraine’s President Zelenskyy but when he did, in front of cameras in the Oval Office, the meeting got heated.

Trump blamed Zelenskyy for not wanting a cease fire and not thanking the US for its support. Trump campaigned on being able to negotiate a swift end to the war and he was visibly frustrated by Zelenskyy’s intransigence as he sought security guarantees as part of the deal. Trump all but threatened to withdraw support. Various European leaders followed up giving their support which has been lacking to date. Given the state of the European and UK economies, it is not obvious that they could match the support that the US has given to date.

The S&P 500 fell from about +0.5% before the discussion on the last day of February to 0.5% as Trump cancelled the press conference. A White House official reported (tweeted) that ‘Trump had kicked Zelenskyy out of the White House’ – with no official farewell. The index then rallied very hard to close up +1.6% on the session.

Trump also suggested that the USA should rebuild Gaza and resettle the current residents. That suggestion quickly lost traction as did the notion of taking charge of the Panama Canal, Greenland and turning Canada into the 51st state of the US. As they say, “The situation is fluid”.

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:

• 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.