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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:
– Four major developed world central banks have already cut interest rates
– The US Federal Reserve and the Bank of England have all but flagged they are ready to start
– Australia’s RBA will be late to the party as inflation data fails to respond to high interest rates

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 the team.

The Big Picture

Many central banks are now claiming at least a partial victory over controlling inflation, but it is far from clear by how much inflation would have fallen without rate hikes. Just through the rolling back supply chain blockages caused by the Covid lockdowns; and the war in the Ukraine not continuing to escalate; and oil prices coming back to more reasonable levels – inflation would likely have fallen – the question is by how much?

Indeed, it is apparent that the interest rate increases may have actually caused inflation in some of the Consumer Price Index (CPI) components, in particular shelter costs such as home rentals. That component makes up about 33% of the US CPI and 7% of the Australian CPI.

Inflation in rents and a few services like energy costs and insurance, are not going to come back to more reasonable levels because of interest rates being higher for longer.

The trouble with economics is that it is not possible to do controlled scientific experiments – as is the case for clinical trials of drugs – to determine what our monetary and government spending policies are doing to the economy. Rather, we must rely on ‘rational arguments’ based on economic theories and past experience.

Nevertheless, there is light at the end of the tunnel. Central banks are starting to cut rates and some economies are bouncing back – if only by a little.

The Swiss National Bank (SNB) started the ball rolling with an interest rate cut of 0.25% on 22nd March this year to a rate of 1.5% p.a. followed by another cut to 1.25% p.a. in June.

The Swedish Riskbank (SR) was the second major central bank to cut its interest rate – on 8th May by 25 bps to 3.75% p.a.

Then, in quick succession, the Bank of Canada (BoC) and the European Central Bank (ECB) each cut rates by 25 bps in the first week of June – to 4.75% p.a. and 3.75% p.a., respectively.

The Bank of England (BoE) came to a different conclusion in June. Inflation fell from 2.3% to 2.0% but they kept their interest rate on hold. However, the UK had a General Election on July 4th so the BoE might have not wanted to get involved in politics. It has all but said it will cut its interest rate at its next meeting in August. Interestingly UK retail sales volumes grew at 2.9% p.a. for the year to 30 June, a rate well ahead of the expected 1.5% p.a.

The US Federal Reserve (Fed) took yet a different approach. It too kept rates on hold but Fed Chair Powell spoke at length about the measurement of shelter inflation problems. Two stories on the news wires amplified that view and one of those even mentioned the possible perverse effect that high rates were having on rents.

Powell made it clear that their shelter inflation measurement is a problem and that other methods exist. Indeed, other methods are used by other national statistical agencies. But Powell said he wasn’t going to change what they do (yet?).

Regular readers might recall that we have been running this rent argument for some months. If Powell has only just caught on, he might need a month or two to digest the problem and investigate alternatives. The official US CPI data, less shelter inflation, is below the 2.0% p.a. inflation target, clearly a data point the Fed is aware of.

The market is betting on a Fed rate cut in November and another in December. Another market indicator is pointing to a possible third cut which would see the Fed start to cut interest rates before its November meeting.

That brings us to the Reserve Bank of Australia (RBA) and its June board meeting. They also kept rates on hold saying that decision was based on the ‘stickiness of inflation’. They said they didn’t even consider a cut at the meeting and they wheeled out the old, ‘We can’t rule anything in or out mantra’. This, in our view, was problematic in terms of meaningful guidance.

More importantly Governor Bullock talked about trying to avoid a recession. While it is true that the simplistic definition of a recession is for two consecutive quarters of negative growth in GDP, most professional economists dig deeper into the data before they are prepared to confirm an economic recession.

We believe that Australia has been in a ‘per capita’ recession for nearly 18 months noting negative per capita growth in GDP and negative absolute growth in retail sales volumes (i.e. sales adjusted for inflation). However, the significant population growth due to massive immigration flows has, at the national level, resulted in GDP increasing modestly (the number of households has gone up in percentage terms more than GDP per household has fallen).

Some say the jobs data for Australia are strong. We note full-time jobs grew by only 1.0% over the last twelve months – far below even normal population growth rates. Part-time employment grew by 6.2% over the same period. Since a large proportion of the immigration flow has been comprised of overseas students, it seems reasonable to consider the massive growth in part-time employment is due to foreign students taking part-time employment to supplement their living costs.

We believe that the per capita data is more representative of the economic experience of actual households and as a consequence of the RBA not responding with cuts to interest rates, the risk of Australia entering a more severe recession continues to grow.

Also, because of the well-known lags in monetary policy taking effect, an interest rate cut now would not stop the pipeline of past high interest rates continuing to slow our economy down for some time to come. Hence our concern in relation to the RBA inaction with its monetary policy.

There are nascent signs of broker forecasts of company earnings in Australia slowing down a fraction – but not enough to indicate an imminent downturn. Indeed, we expect average capital gains in FY25.

The US economy is riding high on the AI boom. Nvidia briefly overtook Microsoft in being the biggest listed company on the New York Stock Exchange (NYSE).

Government Bond yields have been reasonably stable for some months with 10-year yields on Australian and US government bonds being above 4.3%. This stability is indicative of a level of indecision on the part of investors identifying that they accept that the interest rate tightening cycle is likely finished but they are not yet prepared to commit capital to a recession and falling interest rate scenario.

China’s economy is also showing renewed signs of life. If it does manage to engineer a revival, it could mean a strong revival in the Australia resource sector and, indeed, various agricultural commodities as the 2022 restrictions on trade have now been relaxed. Only lobsters are still on that restricted list.

The year to 30 June was a very good one for global equities – by and large – and the dip we had into October 2023 was short-lived. Despite some concerns, momentum in equities generally remains positive for the coming months and equity markets are factoring in lower interest rates without economies falling into deep recessions – and in some cases no recession at all.

But there are some key unknowns for the year ahead. Who will win the US election and how will they shape geopolitics and the economic environment? What will happen in the Ukraine in particular, if Donald Trump is elected president?

The Israel-Gaza issue has polarised global views. We do not recall such vocal opposition to Israel’s actions in the past. What are the implications of this and for the region generally?

China continues to pursue its territorial expansion in the South China Sea and in relation to Taiwan how does this play out? And what of the events that are yet to be revealed, will they be positive or negative?

Without evidence to the contrary, we remain cautiously optimistic.

Asset Classes

Australian Equities

The ASX 200 made strong gains (7.8%) over the year to 30 June despite its October setback. The index was up 0.9% over June.

The index didn’t have a big driver in the year just ended like the rise and rise of Artificial Intelligence (AI) in the US or resources in Australia during China’s growth boom.

Our analysis of LSEG broker-forecasts of companies listed in the ASX 200 indicates a possible average year ahead.

International Equities

In the US the S&P 500 gained 22.7% over the year to 30 June on the back of a small number of stocks from the so-called ‘magnificent seven’ predominantly exposed to the AI theme.

While we do not see the AI boom as a bubble, there is no doubt that market expectations can run well ahead of a company’s ability to deliver on such lofty expectations which ultimately leads to a correction. While this can be a painful experience it is how markets work. In our view this boom is so different from the dotcom bubble experienced in the early 2000’s. The latter was largely based on hype and hope. AI is already producing goods and services across a wide range of industries and as such we believe will persist.

It is impossible to say whether AI will play as big a role as the industrial revolution or ‘the invention of the wheel’. At the start of the industrial revolution in the North of England, threatened hand-loom workers (the Luddites) smashed up the new mechanical looms for fear of losing their jobs. Did anyone then predict trains, motor vehicles, planes, computers and space travel would soon be invented while looms were being smashed? We doubt it. But also, we don’t need such a far-reaching vision as we have a wealth of history which has shown that innovation, disruption and change are the norm not the exception. To not participate in this momentum play could bode badly for those who ignore it.

June was mixed for of the other major indexes we follow. Over the year to 30 June all major share indexes, except for the Shanghai Composite, did reasonably well.

Bonds and Interest Rates

Except for Australia, all the major central banks have cut, or are poised to cut, their prime interest rates. The Fed was on hold at a range 5.25% to 5.5%. The dot plot chart displays the forecasts of the 19-member interest rate setting Federal Open Markets Committee. At the end of June, the dot plots median interest rate is for only one rate cut of 25 bps by December. However, if only one member had nominated two rather than one rate cut, the median would have been for two rate cuts. We do not expect the Fed to be overly concerned by the US election later in the year but we are mindful they do not want to be seen to be supporting either side.

With respect to Australia, there is little guidance being provided by the RBA and while we do not anticipate another interest rate increase in Australia, we do not expect that Governor Bullock will cut interest rates ahead of the US Fed. At this point we do not anticipate an interest rate cut here until 2025.

Other Assets

Iron ore prices ranged over $100 to $143 during the year to 30 June. It settled at US$105 per tonne down just under 9% for the month of June.

Brent oil prices also experienced a wide range over year to 30 June – from US$73 to US$97 per barrel – with the year closing out at US$86 per barrel.

Copper prices ranged $7,824 to $10,801 during year to 30 June closing the year at US$9,456.

Gold prices ranged from $1,818 to $2,432 in the year to 30 June closing the year at US$2,326.

The Australian dollar against the US dollar traded between US62.78 cents and US68.89 cents. It finished year to 30 June 24 at very near the same level as it did in June 2023.

Regional Review

Australia

Employment rose by 39,700 and all of that, and more, was from full-time job creation; part-time jobs were lost. The unemployment rate fell a notch from 4.1% to 4.0% in May.

What we find disturbing is that a longer-term view (over 12 months) shows that full-time employment rose by only 1% when long term population growth was more like 1.6%. Total employment rose by 2.5% which is broadly in line with recent population growth (including immigration) but part-time employment rose by 6.2%.

The massive influx of foreign students perhaps got some part-time work to supplement their cost of living. All good in the Australian spirit but it hinders people analysing the true strength of the jobs market. Jobs growth for the longer-term residents is quite weak.

Our quarterly GDP report was weak. Our economy grew by only 0.1% (and -0.4% after allowing for population growth) over the quarter or 1.1% over the year (-1.3% in per capita terms).

Our household savings ratio fell to a worrying low of 0.9% from an historical average of 5% to 6%. Since this ratio includes superannuation guarantee levies, it is particularly low. Australians are suffering in economic terms. They are not dis-saving but neither are they able to build for their futures.

Fair Work Australia awarded minimum wage and award wage workers a 3.75% pay rise. Since (nominal) wages are lagging well behind cumulative price indexes movements, this increase is not inflationary and, indeed, more is needed to redress the losses most experienced during the pandemic.

Australian CPI inflation was a little higher than the RBA felt comfortable with and flirted with an interest rate increase. Our analysis shows that the main drivers – housing (inc. electricity at home), food, transport (inc. auto fuel), and alcohol & tobacco are largely unaffected by interest rate changes, with the possible exception of food.

The food inflation component has halved in its contribution to headline CPI over the past 12 months. Inflation of so-called tradables (goods and services that are or could be traded overseas) has been below 2% for nearly 12 months.

Since the RBA is charged with the dual mandate of full employment and stable prices, we think it has done more than enough on prices and the true employment picture has been disguised by the big immigration flow.

It is almost too late for a single interest rate cut to save the economy from having a more serious recession, particularly as the backlog of the impact of past interest rate increases has not had time to work through to the real economy.

China

China’s exports rose 7.6% against an expected 6%. However, imports rose only 1.8% against an expected 4.2%.

In the previous month, exports and imports reversed their roles: imports were strong and exports were weak. The manufacturing Purchasing Managers Index (PMI), a measure of manufacturers expectations, was weak.

US

US jobs were again strong with a gain of 272,000 jobs against an expected 190,000. The unemployment rate was 4.0% and average hourly earnings only grew by 0.4% for the month or 4.1% for the year. No inflationary pressure from there!

The private jobs survey (from ADP) was less flattering and the number of job openings per unemployed person has fallen from 2:1 recently to 1.2:1 this month. The US also has an immigration problem. We conclude that the US jobs market is less strong than the headline ‘nonfarm payrolls’ data suggest.

US inflation, because of the shelter component, does not look that good. But (official) US CPI-less-shelter inflation stands at 2.1! Producer Price Inflation (PPI), inflation for inputs, was negative for the month (at -0.2%). Rents are the only material problem and high interest rates are unlikely to curb that source of inflation in the broader index. Indeed, high interest rates may exacerbate investors willingness to build more supply.

At the end of June, the Fed’s preferred Personal consumption Expenditure (PCE) inflation came in at 0% for the month and 2.6% for the year. The core variant that strips out volatile fuel and food rose 0.1% for the month and 2.6% for the year. We think that this will encourage the Fed into making at least two cuts, but probably after the November 5th election.

The University of Michigan Consumer Sentiment Index fell again to levels well below normal – but not (yet) at historic lows. US retail sales adjusted for inflation rose 0.1% for the month but -0.9% for the year.

The month closed out with the first presidential election debate. Biden performed so poorly that the Democratic Party is reportedly searching for an alternative candidate for the November 5th election. Trump seemed far more composed and assured but many disagree with his policies.

Europe

The UK economy sprang back to life with a +2.9% increase sales volume for May against an expected 1.5%. Inflation fell to 2.0% from 2.3%.

The 14-year-old Conservative government lost the July 4th election to Labour in a landslide.

Rest of the World

While the big players are questioning first and second decimal points on inflation figures, Turkey just posted a 75% read for inflation to May (up from 69.8%) but only 3.3% for the month!

The Turkey central Bank was on hold at an interest rate of 50% while Mexico was on hold at 11%!

Canada GDP grew by 1.7% and it cut its interest rate!

Japan exports grew by 13.5% against a prior month of 8.3% in April.

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

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

Key points:
– The US Fed gets back on track talking of ‘when’ for rate cuts as data continues to soften modestly
– RBA inflation data still on the high side but in per capita terms the situation is considerably weaker
– Markets, lead by AI stocks, remain positive and bond yields are likely to have seen cycle highs in 2024

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 the team.

The Big Picture

Support for the rate hike scenario canvased by many for the US Federal Reserve Board (Fed) and the Reserve Bank of Australia (RBA) has all but vanished from the agenda. There had been a brief ‘wobble’ as people grew impatient waiting for the fruits of the higher-rates-for-longer programme.

The Fed remained on hold in May – as expected. It did however, slow down ‘the run-off of the balance sheet’. That is, the Fed is not performing QT (quantitative tightening) with as much zeal as it once was. Is that the first sign of the Fed thinking it might have over-tightened?

The RBA was also on hold but it again opted for the ‘can’t rule anything in or out’ explanation. Imagine if you presented at your GP with a condition that you were worried about. The GP replies, “I can’t rule in that I need to prescribe some serious course of action; and I can’t rule out that you are fine – so I’ll do nothing for the moment.’ Wouldn’t you, in horror, rush up the street to the next clinic?

In the GP analogy, it seems perfectly sensible for the GP to say something like, ‘you might have a touch of … so I’ll start you off with a low dose of …’ or ‘I think you are fine but if you get any signs of … in the next week or two come straight back.’

The Bank of England (BoE) was also on hold in May but they seem to be flagging a possible cut for June. The European Central Bank (ECB) is on a similar tack. The Bank of Japan (BoJ) is weighing up its options. It wants to go for a second hike of 0.1% points to steer monetary policy back to something looking a little more like normal. But it doesn’t want to move too hastily after 16 years of a -0.1% rate! The current BoJ rate is in a range of 0.0% to +0.1%.

The Bank of China has a much more complicated approach to enacting monetary policy but it is making moves to ease policy to cope with the property development debt crisis.
In short, global central banks reacted somewhat nervously to inflation, unemployment and growth data in May. While we saw no clear-cut signals in the major economies, we did note some nascent signs of weakness in the US and continued weakness in Australia. US jobs data were a fraction softer, retail sales were flat and wage growth was only 0.2% for the month.

Australia data still points to an ongoing recession. The unemployment rate jumped up to 4.1% and, on a per capita, inflation-adjusted basis, retail sales and economic growth have been going backwards for over a year. It is only the major inflow of migrants that masks the underlying problems for those unwilling to do a proper economic analysis. Aggregate GDP demand has been rising but more slowly than population growth.

The Australian Federal Budget was handed down in May. Apart from the stage 3 tax cuts (which are not really cuts but mere lip-service to tax indexation from bracket creep in the face of strong inflation), there was a little rent assistance for some and a $300 rebate for any household with an electricity bill! That’s less than a dollar a day for each household. Anything is better than nothing but we can’t expect much in the way of a stimulatory effect after inflation-adjusted wages have dropped to around 7% less than they were in mid-2022.

In our opinion, the real issue in managing monetary policy is dealing with the so-called perceived ‘stickiness’ of inflation. In the US, rents make up about 33% of the CPI. Official CPI less shelter data have been well-contained for a year. The average of the last 12 such monthly measures is only 1.8% (less than the 2% target) and the latest two numbers were 2.3% and 2.2%, respectively; not a problem!

Because of the way shelter inflation is calculated, it cannot react in a timely fashion to an improving situation as does inflation-for-everything-else. Shelter inflation peaked at 8.1% in the first quarter of 2023. It had inched down only to 5.5% by April 2024. Leases are usually written for 12-months or more and the statistical agency only samples rent every six months. There is a massive lag between actual inflation and measured inflation! A simple improvement in the calculation could remove the inflation problem in a trice!

The latest US CPI-less-shelter read was 2.2% and that for shelter was 5.5%. With a third weighting to shelter, the aggregate CPI is 3.4% = (1/3) 5.5% + (2/3) 2.2%. In our opinion, it is almost impossible for shelter inflation to get down to 2% until 2025 but only because of the method of calculation. So, aggregate inflation has almost no chance of dipping below 2% unless the whole economy collapses in a heap.

Even if one ignored the calculation issues with shelter inflation, what school of economic thought would advocate raising rates to reduce rents? The dominant factor in determining rents is the demand-supply imbalance of people who need shelter.

US March quarter GDP growth was revised downwards from 1.6% to 1.3%, or 0.3% for the quarter. This further sign of weakness causes us some discomfort but on the positive side, it could help the Fed to decide to start cutting rates.

US PCE inflation data were more or less on expectations. The headline rates were 0.3% and 2.7% (for the month and the year) while the core were 0.2% and 2.8%. We believe these estimates are biased in the same fashion as the CPI variants owing to the way shelter inflation is calculated.

The housing inflation component of the Australian CPI is calculated differently from that in the US and with different weights. There is a new-home sales component and a rent component in Australia. New home-sale inflation peaked at 22% in July 2022 and it has since fallen to 4.9%. Rent inflation was within the 2% to 3% band when new home inflation peaked in 2022. Rent inflation has since increased steadily, as rates were increased, and it has climbed to 7.5% in April with no real sign of relenting. Rents in Australia also have at least an 18-month lag in the formulae between measured rent inflation and the underlying cause.

The latest official headline and core monthly CPI reads were 3.6% and 4.1%, respectively. Alcohol and tobacco inflation came in at 6.9%. Other big-ticket items were insurance, 8.2%, auto fuel, 7.4%, and health, 6.1%. Our frustration with the RBA’s monetary policy management can be expressed through the question, which of these rates would fall if interests remained on hold or increased? The apparent answer is probably none, maybe a little on insurance.

CPI inflation less housing (our estimate) was 3.4%. While these data were above the RBA target band of 2% to 3%, they are not sufficiently high to cause us any material concern.

It is clear that the Australian data are significantly impacted by the immigration issue and not so much by higher interest rates. Indeed, if the RBA unwisely raised rates, it would further negatively impact home owners on variable-rate mortgages and do nothing for the renters. Indeed, higher rates might slow down development in building new apartments.

To be clear, immigration is not the problem. Australia was built on the concept. The problem is not planning – specifically for accommodation – this time around which has also been impacted by supply side aftershocks from Covid.

We only have to look to Australian retail sales volumes (i.e. inflation-adjusted) to understand the plight of the Australian consumer. The first quarter result was -0.4% for the quarter or -1.3% for the year. With population growing at over 2.5% pa, retail volumes on a per capita basis fell by nearly 4% over the year to 31 March. The RBA board say they can’t rule anything in or out! Our next GDP data for the March quarter are to be released on June 5th and we think that data will amplify this story.

There is a glimmer of hope in Europe. Economic growth in both the UK and the EU was positive in the March quarter reversing some of the negativities witnessed in 2023.

The China economic situation is never easy to read. Problems in the property sector abound but imports for the latest month were up 8.4% compared to an expected 4.8%. Exports were up 1.5%. There were mixed results in the monthly data releases.

As a general conclusion, we think there is no clear-cut path back to prosperity here, in the US or elsewhere. However, neither do we think we are on the precipice of disaster. Rather, we believe there are strong benefits to easing monetary policy now. Seemingly paradoxically, we think the ASX 200 index can do well in Australia while the consumer is languishing. Companies earn profits on aggregate sales, both at home and overseas, and not on the average individual’s economic health in Australia.

The so-called ‘AI bubble’ does not appear to be out of control. Nvidia reported well. Unlike in the dot.com boom when little was being built and the ‘dream’ was on sale, serious AI companies are making things – and selling them – that people will want. Of course, there will be speed bumps as technology interfaces with reality. We think the investing future is relatively bright in many markets.

Asset Classes

Australian Equities

The ASX 200 didn’t have a great month. It limped over the line at 0.5% because of a stellar run on the last day. Its gain over the year-to-date of 1.5% isn’t impressive either. Our index is lagging the big guns but our data are consistent with Australia being in a recession. The month’s gains of IT (5.4%) and Utilities (3.4%) certainly helped the ASX 200 to perform.

International Equities

In contrast to the ASX 200, the S&P 500 powered ahead in May with a gain of 4.8%. The London FTSE (1.6%) and the German DAX (3.2%) also did well.

Our regular update analysis of company earnings’ expectations suggest that the rally can continue but, of course, central banks may play a part and there is always the chance of a geopolitical event upsetting progress.

Bonds and Interest Rates

All the major central banks were on hold in May. But the BoE, ECB and BoJ seem to have their fingers on triggers for rate changes. The RBA is dithering.
The market pricing tools for expected central bank changes over the rest of the year have stabilised but the momentum for cuts has been substantially reduced since the beginning of the year. There is now about an 80% chance of one or two cuts in the Fed funds interest rate by the year’s end.

Other Assets

Iron ore prices proceeded in a tight range of US$114 – US$122 per ton over May.

The Saudis are reportedly controlling oil production to counter moves in US shale oil production which left oil prices down by over 5% over the month. Interestingly the geopolitical premium in the oil price appears to have diminished.

Gold and copper prices were relatively flat over May while the Australian dollar (against the US dollar) rallied by 1.7%.
Regional Review

Australia

The Federal Budget was largely considered a non-event by most economic commentators however, the government was in a bind. If it had produced the fiscal stimulus necessary to turn the economy around, it could have been accused of fuelling inflation.

Housing supply is the key issue but it takes a substantial time to move from housing approvals to completions. The job needed to have been started a couple of years ago when the gates to immigration were being re-opened following the pandemic.

There were 38,500 new jobs created in April but full-time jobs fell by 6,100. The unemployment rate rose to 4.1% following 3.9% in March and 3.7% in February. That is not a strong set of numbers.

The wage price index rose 0.8% in the March quarter and 4.1% over the year. While these reads were slightly ahead of price inflation, there are two years of ‘catch-up’ needed before workers can celebrate getting back on track.

The latest monthly read of retail sales (value) was 0.1% and 1.3% for the year. When adjusted for inflation, the numbers were -0.1% and -2.4%. And then there is the population effect to account for!

China

Retail sales came in at 2.3%, below the expected 3.8%, but industrial production exceeded the 5.5% expectation with a 6.7% outcome.
The bright light was China’s 8.4% growth in imports and, to a lesser extent, its 1.5% increase in exports.

China has agreed to re-open trade to all Australia beef exporters – except two – but lobster exports are still caught in the claws of policy intransigence.

US

At last, the US jobs data did not produce a mega number of new jobs. The market expected 240,000 new jobs but ‘only’ 175,000 were created. However, in times before the pandemic, 175,000 new jobs would have been considered a very strong result.

The US unemployment rate has climbed to 3.9% from a recent low of 3.4%. Wage growth was 0.2% for the month or 3.9% for the year. Neither cause us any concern for commencing a rate-cutting cycle. There is a big pipeline of ‘lost’ real wages to be rectified before wage inflation would be seen to be a problem.

Economists often look to participation rates (the percentage of the population to be in, or looking for, work) to understand the dynamics of the labour market. When participation rates fall, economists often ascribe the move to the ‘discouraged worker effect’.

The opposite has just happened, at least in regards to the female side of the equation. The female participation rate stands at the highest since 1948!

While there are positives accompanying this number – it is a positive if women are able to join the workforce, if they so choose. A darker side to this observation is that women may be feeling compelled to work to help support a household in times of economic stress. We do not yet have the data to choose between these alternative scenarios.

In a disturbing turn of events, the University of Michigan Consumer Sentiment index fell in a hole to 66.5 from 76.0 but then recovered slightly on revision to 68.8. If this index continues to reflect US residents’ feelings, worse spill-over effects may be on their way.

US retail sales came in at 0.0% for the month and +3.0% for the year but, on correcting for inflation, the figures were -0.3% for each of the month and the year. That does not reflect a strong consumer.

It is too soon to call the start of a weakening US economy, even though March quarter growth got revised downwards to 1.3%, but it does alert us to monitor the situation more closely. If the US economy does start to soften, it could do so rapidly. That is the often the pattern from the past.

Europe

The EU posted a positive economic growth figure in the March quarter but ruled off 2023 in a downwardly revised pair of negative growth statistics for the second half of 2023.

As EU growth came in at 0.3% for the quarter, the ECB is poised to start cutting rates. The latest EU inflation was 2.4% (headline) and 2.7% (core).

Germany’s March quarter growth was +0.2% for the quarter and -0.1% for the year. German inflation was 2.8% which was slightly above expectations and the prior month.

Reportedly, the ’blip’ was due to the removal of a price subsidy on rail travel.

The UK growth of the March quarter, 0.6%, was a big beat over the expected 0.4%. The BoE seems set to start its easing cycle in June.

The ruling UK Conservative party is going to the polls on July 4th and one of its policies is compulsory service in the army or organisations like the police or hospitals for 18-year-olds! We don’t think this will be overly popular with the folks impacted. What would happen to their ‘side hustles’? We’re not sure what the net impact would be for the economy but the social media comments should be informative!

Rest of the World

Japan registered its 24th successive monthly negative growth in real wages with the latest annual statistic being -2.5%. Its PPI inflation was +2.5% and its core variant was +2.2%. Japan’s household expenditure was up 1.2% in March but down -1.2% over the year against an expected loss of -2.4%. GDP in the March quarter was down -2% putting doubts on an imminent interest rate hike. That view was further compounded by April’s industrial output with a big miss at -0.1% when +0.9% had been expected for the month.

May also closed with Japan’s three, main monthly inflation indicators all coming in at less than 2%; below expectations; and, less than that in the prior month. We find it implausible to believe that the 0.1% interest rate hike a while back, following 16 years of negative interest rates, could be the cause of the softening in inflation but it looks more likely that the BoJ will now stay on hold a little bit longer.

The conflict in the Middle East seems no closer to resolution but, at least, there does not seem to be any major military escalation. But human suffering continues. However, social unrest is increasing across the world as each side levels criticisms at its opponents.

The Peru prime minister is apparently struggling with an approval rating of only 5%. It makes, Biden, Trump and Albanese look positively popular! And Trump was just found guilty on 34 charges relating to ‘altering the books’. Jail time is apparently unlikely. Trump’s supporters rushed to donate to his cause (anecdotally in excess of $70 million) in the seven hours after the decision was handed down.

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:

–  Recent inflation numbers suggesting that inflation remains ‘sticky’.

–  Central Bank interest rate increases are back on the table but still less likely than cuts.

–  US economic growth softens in the March quarter.

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 the team.

The Big Picture

If March was the month that central banks started to cut rates – or at least foreshadow cuts – April witnessed at least the US Federal Reserve (Fed) and the Reserve Bank of Australia (RBA), talking of pushing the timing of cuts back – and even introducing the chance of more interest rate increases. Market pricing moved the first Fed interest rate cut from June out to September at the start of the month. Even September is now looking uncertain unless clear new economic data come to hand that is sufficient to support the Fed to cut interest rates. One rate cut in December is becoming the dominant call priced into money markets.

By and large, new inflation data in the US and Australia were lower than in the previous month/quarter. So, what was the problem? The key word is ‘stickiness’.

Late last year there was lots of optimism of inflation rates making serious progress towards central bank inflation rate target zones.

We have done quite a bit of research into the reasons for this stickiness. In the US, we found that by far the main problem is with the ‘shelter’ component which comprises about 33% of the broad Consumer Price Index (CPI). Official US data of CPI excluding shelter makes it clear that the inflation problem has been solved in everything except shelter. This shelter excluded index was in the target zone (of 2% or less) for each month from May 2023 to February 2024. The latest reading of 2.3% can reasonably be accounted for by a slight blip in oil prices as a result of the ongoing Middle East conflict.

The US shelter index is based on actual rents plus ‘owner equivalent rents’ (OER) which provides a proxy for the cost of home ownership. Not only does the US use a rolling 12-month window to calculate the annual window, individual rental ‘prices’ are typically held constant over the term of the lease – say 12-months or more. This method of calculating inflation has the effect of locking in any big change for two years or more.

Rents however seem impervious to fed rate policy. Shelter inflation is largely due to the supply-demand imbalance during a period of strong immigration and dislocations through the reaction to the pandemic. The ‘formula’ for calculating shelter inflation means that it is highly unlikely that the shelter component will reach 2% by the end of the year – even if ‘underlying shelter’ inflation was fully solved in early 2023!

If the Fed cuts interest rates, it is not likely that shelter inflation will alter its course. Wages and input prices in the US are behaving quite well.

Many cite the strength of the US economy as a reason for not cutting yet. The preliminary estimate of US GDP growth for the March quarter (Q1) was 1.6% against an expected 2.4%. The previous two quarters’ growth rates were 1.2% and 0.8% with Q1 growth at 0.4%. There is a clear trend emerging!

While the latest US GDP data could just be a blip, it should at least put the Fed on ‘amber alert’. The June quarter (Q2) is already well underway and monetary policy takes about 12-18 months to work its way through the economy.

US monetary policy did not become ‘restrictive’ until September 2022 – when the Fed funds rate climbed above the ‘neutral rate’ of, say, 3%. That first restrictive hike has only just worked its way fully through the economy and there are 2.25% points of additional hikes still in the pipeline and yet to be fully felt.

US employment data have seemingly held up but it has been well supported by quite a lot of financial stimulus spending by the Biden administration. Even so, there have only been 34,000 new jobs created in US manufacturing since October 2022.

Many reputable commentators are questioning the appropriateness (or accuracy) of US labour data. Each month a very big chunk of new jobs is in the government, health care and social administration sectors. And how many jobs do they need to create to be able to accommodate immigration flows? We are living in a new era for understanding labour movements: work from home (WFH); gig economy; GenZ reluctance to work in the traditional model; early retirement, etc

We came across an interesting statistic about US interest rates this month. The average interest rate paid across all mortgages is 3.8% but the rate for new loans is 7.1%. Because of the very long fixed-term loans favoured in the US, typically 30 years, they have been cushioned from rate rises much more so than those borrowing in Australia (who typically borrow at a floating interest rate) – so long as they don’t move home!

Australia’s jobs data were all over the place from November through to February – we suspect due to statistical seasonal adjustment procedures that have a more marked impact over the summer student school leaver / holiday period.

Our latest change in total employment over a month was ?6,600! However, there were 27,900 new full-time jobs offset by a big loss in part-time employment. The unemployment rate was 3.8%.

Our economic situation can be effectively monitored through changes in retail sales. In March, retail sales fell ?0.4% for the month and was up 0.8% for the year. When we allow for inflation, sales (i.e. volumes) fell by ?0.8% for the month and ?2.8% for the year. If we also allow for population growth of about 2.5%, the volume of sales attributable to the average person has fallen by ?4.5% for the year.

The cumulative fall in retail sales (volume) is ?4.9% from September 2022 which increases to nearly ?10% when we account for population growth. The average person in Australia is consuming about 10% less ‘things’ than they were in September 2022 and this trend in foregone consumption has continued to build month after month.

The average Australian resident is also carrying a mortgage burden far greater than that held in any recent period. Australian consumers are hurting yet some ‘experts’ are calling for rate increases. How much more pain do they want to put on the consumer and, for what?

Our latest CPI data was a bit of a miss at 1.0% for the quarter against an expected 0.8% but we also have a shelter (or household) category that is causing some stickiness. Lower rates would make it more viable for developers to build more houses and apartments to alleviate the rental crisis. Higher interest rates are more likely to exacerbate the rental situation.

Markets – both bonds and equities – have been buffeted by reactions to higher than anticipated inflation data and central bank commentary. However, there have been many strong company earnings’ reports in the US that underpin the S&P 500 valuations.

China produced some mixed economic data. Q1 growth came in at a brisk 5.3% compared to a more modest expectation of 4.6%. However, both monthly retail sales and industrial output missed expectations.

Asset Classes

Australian Equities

While most of the major markets are well up on the year-to-date (y-t-d), the ASX 200 ended April y-t-d up only +1.0%. For the month, the ASX 200 was down ?2.9%.

Our analysis of LSEG broker forecasts for Australian listed companies’ earnings is strong, but some expected weak macro data along the way could make share markets jittery.

Most sectors on the ASX 200 – save for Materials (+0.6%) and Utilities (+4.9%) – were in negative territory in April.

The narrative of the RBA governor’s press conference on May 7^th could be key in guiding near-term movements in the index.

International Equities

The S&P 500 was down ?4.2% on the month but the London FTSE was up +2.4%. China’s Shanghai Composite (+2.1%) and Emerging Markets (+1.6%) also had gains in April.

The S&P 500 swirled over sessions during the month as news, which was difficult to interpret, was digested. Towards the end of April, some strong earnings data lifted investor spirits.

Bonds and Interest Rates

In our opinion, investors and traders are finding it difficult to interpret ‘new’ news. There is little doubt that inflation has been easing – at least in general – but the difficult (almost impossible) question is whether it is improving sufficiently quickly that central bankers will be moved to reduce interest rates.

Central bankers seemed to be worried that, if they start cutting interest rates too soon – and inflation returns (whether or not due to the policy change) then they will need to begin the inflation fight again by increasing interest rates, in an environment where they will have lost credibility.

For the reasons stated, we think the central bankers are being overly cautious. But when billionaire, and much revered banker, Jamie Dimon states that rates might have to go to 8% to quell inflation, it is hard for dissenters to be taken seriously.

Nevertheless, for the reasons given in the opening section, we are reasonably confident that the next move for interest rates should be down, not up. However, if interest rates are cut and then a new supply shock happens, like heightened military action or oil price shocks, inflation would come back – but not because of interest rate cuts. Interest rates have almost no impact on wars and oil prices.

There is little chance (as priced in by the fixed interest markets) that either the Fed on May 1^st, or the RBA on May 7^th will adjust interest rates.

The latest Fed ‘dot-plot’ chart (each dot is the interest rate forecast of a Fed board member) released in March showed three cuts in 2024. With the market now pricing in only one, or possibly two interest rate cuts, it will be interesting to see the Fed’s stance when the dot-plot is refreshed in June.

When analysing interest rate policies, there are two very separate questions. Firstly, what should the central bank do? Secondly, what will the central bank do?

The first question is much easier to answer. And the two answers could imply moves in opposite directions.

We think macro data – particularly in the USA and Australia – will present a much clearer picture over the next quarter or two. By then, all else being equal, that without central bank interest rate policy easing we could be closer to recession.

The ECB and the BoE are expected to cut their interest rates in June after some supportive (softening) inflation data.

Other Assets

Iron ore (+15.6%) and copper (+14.8%) prices jumped out of the gates in April. That backs a recovering China story.

Oil (+1.1%) and gold (3.7%) prices were up but by more modest amounts. The Australian dollar (?0.1%) was flat but the VIX (equity market ‘fear’ index) was well elevated earlier in April but started to retreat in the last week or so to 14.8 – or just above normal.

Regional Review

Australia

The federal budget will be handed down in mid-May. Some fiscal stimulus seems likely but, again, this is the government fighting the RBA and the latter seems uncertain as to what course to plot.

Because immigration has been so strong, the usual statistics do not show the extent of the economic pain that the average person is feeling.

Fortunately for investors, company earnings depend on total revenue and not on revenue per capita. Therefore, the ASX 200 can be resilient when the average consumer is not doing so well.

There were 27,900 new full-time jobs created in the latest month but that was offset by a loss of ?34,500 part-time jobs.

The headline CPI inflation rate was expected to come in at 0.8% for the quarter (Q1) or 3.4% for the year. The outcome was 1.0% for Q1 and 3.6% for the year. The market reacted negatively to these data and seemingly encouraged some to call for a return to interest rate rises. The RBA is set to announce its next rate decision on May 7^th. It is highly likely that the RBA will hold the interest rate at the current level but the fixed interest market is starting to price in a chance of a rate hike later in the year.

With the pipeline of past interest rate increases building up recessionary pressure, we might even soon see aggregate GDP (rather than per capita GDP) growth in negative territory.

Retail sales for March came in at ?0.4% for the month and up +0.8% for the 12 months. When adjusted for inflation, sales volume was down ?0.8% for the month and ?2.8% for the year. In inflation-adjusted terms, consumers are purchasing ?4.9% less than they were in September 2022. If we also account for population growth sales volume would be down by near ?10%. There is no demand pressure left for the RBA to quell!

China

Not long after the last People’s Congress had stated a target for growth of 5%, GDP data came in for Q1 at 5.3%, which was well above the 4.6% expected.

However, retail sales came in at 3.1% against an expected 4.6%. Industrial output also missed expectations at 4.5% against an expected 6.0%.

At the end of April, the Purchasing Managers’ Index (PMI) for manufacturing beat expectations at 50.4 when 50.3 had been expected but the index was 50.8 in the previous month (a level below 50 indicates contraction and a level above indicates expansion). The nonmanufacturing PMI was 51.2 against an expected 53.0. While these results are not strong, they are solid.

US

On the face of it, US jobs data were again good. There were 303,000 new jobs created against an expected 200,000. The wage growth importantly was only 0.3%. Producer price inflation was below expectations at 0.2% for the month against an expected 0.3%.

However, for the first time since the recovery from lockdowns, GDP growth disappointed; Q1 growth was well under expectations at 0.4%.

Retail sales surprised to the upside for the month. Growth of 0.4% had been expected but the outcome was 0.7%. However, the US statistical agency put a tolerance of ±0.5% on that estimate meaning that 0.7% isn’t statistically significantly different from the expectations. That didn’t stop the market from responding favourably to the sales data!

In our opinion the market started to react quite strongly to very small differences between expectations and outcomes – both up and down.

Europe

The UK just posted its second month of very small but positive GDP growth data. That could signal the end of the so-called ‘technical recession’. The Bank of England (BoE) held its interest rate steady at 4% in April but it is widely expected to start cutting interest rates from June.

EU and Germany inflation are starting to come close to target at 2.4% and 2.2%, respectively. The president of the European Central Bank (ECB) spent much of last year talking of the need to keep interest rates higher for longer. That stance seems to be softening.

The EU posted a gain in GDP in Q1 but the previous quarter was revised down to give two consecutive quarters of negative growth in the second half of 2023.

Rest of the World

Canada’s unemployment rate rose to 6.1% and its jobs’ creation was negative. Analysts are expecting the Bank of Canada to start cutting interest rates soon.

Japan inflation missed at 2.7% against an expected 2.8%. Core CPI was on expectations at 2.6%. Such is the skittishness of markets, the Nikkei opened down 3% following these data. We think the fall was more due to the general uncertainty about whether or not global monetary policy is working.

The US has passed legislation for US military aid to go to the Ukraine, Taiwan and Israel. Australia has also sent aid.

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 first developed world Central Bank implements the first interest rate cut.
– The USA economy is still aiming for an economic ‘soft landing’.
– Australia still in a ‘per capita’ recession but RBA still hedging its bet on official interest rates.

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

The mood among central bankers is changing. The Swiss National Bank (SNB) is the first major central bank to have cut in this easing cycle. The Bank of England (BoE) welcomed its lowest inflation read since 2021 but kept its rate on hold – then flagged that ‘a cut is in play’.

The Fed was also on hold in March but Chair Powell made some very interesting comments. He said ‘there is no sign of a recession’ – which we agree with but neither do we rule one out in the future. He did allude to the fact that he thought some early 2024 US inflation reads may have been distorted (upwards) by statistical adjustment procedures but that he ‘cannot just dismiss inconvenient data’. Smart man!

We take it that Powell thinks he can start to cut if subsequent inflation data confirm his data-distortion hypothesis. We think they will. The market-priced odds for a cut at the next (May 1st) Federal Open Market Committee (FOMC) meeting are only 4% but there is a 36% chance of one or more cuts priced in by the June 12th meeting. There is a 40% chance of three cuts by the end of 2024 with a 24% chance each for two or four cuts.

The FOMC produced its ‘dot plots’ chart with each dot expressing each FOMC member’s expectations for the Fed funds rate at the end of 2024 and the next two years. The FOMC reinforced its December expectation of three cuts in 2024. Nine members voted for two or fewer cuts while 10 voted for three or more cuts. Being a median, the representative expectation is, therefore, three cuts. At last, the Fed and the market are on the same page. Not so long ago the market had pencilled in six cuts!

The Fed’s expected growth forecast for 2024 was raised from 1.4% (published in December) to 2.1% now. The unemployment rate expectation was lowered to 4.0% from 4.1% over the same period. The current unemployment rate is 3.9% and the latest growth figure for the last quarter of 2023 is 3.4% p.a.

The Fed is looking as though it may have dodged a bullet and might steer the economy to a soft landing – meaning no recession. Given that the unemployment rate has already risen to within 0.1% points of the end of year expectation, while growth is expected to fall to 2.1% from 3.4%, doesn’t quite add up for us.

There is a lot of pent up tight monetary policy impact from previous hikes and US fiscal policy has possibly pushed out the effect of monetary policy more than usual. If we go with the commonly expressed lag of 12 – 18 months for changes in monetary policy to work themselves through, the full impact of last interest rate increase made in July 2023 will not be felt until the second half of this year. And, at a range of 5.25% to 5.50%, the Fed Funds interest rate is around nine hikes above the neutral rate that neither slows down nor speeds up the economy. We have not yet seen what the full impact of the tightening cycle will bring. And, interest rate cuts are thought to take a similar time to work their way through when the loosening cycle starts.

If the Fed doesn’t start cutting until June, it might be forced to make some 0.50% cuts in the second half of the year to play catch up.

The European Central Bank (ECB) was also on hold in March but, unlike the Fed, it lowered its expectations for growth. We think Europe is in for a lot more economic pain.

The Bank of Japan (BoJ) increased its rate but only to a range of 0.0% to 0.1% from a negative rate held since 2016. For decades, Japan wanted to engineer moderate inflation and it has only just had a positive response. It is hoping to ‘normalise policy’ meaning that they are aiming for a similar end-point as the Fed but from below rather than above the terminal rate.

The ‘odd one out’ in central bank activity to us is our own Reserve Bank of Australia (RBA). It was on hold in March as was widely anticipated but the data does not support this action. And, based on a response Governor Bullock made at the post RBA meeting media conference, that ‘she doesn’t know whether the next move will be up or down’ is problematic.

As we have reported before, here in Australia, unusually strong immigration is masking the weakness of the economy when population growth is not taken into account.
Our latest growth data for the last quarter of 2023 was only 0.2% for the quarter and 1.5% for the year. Per capita growth was  0.3% for the quarter and  1.0% for the year. The last four quarters of per capita growth were all negative – which is what many mean when they say we are in a ‘per capita recession’.

Even harsher is the impact on retail sales. When inflation is taken into account, the latest so-called ‘real’ retail sales came in at 4% below the level of the October 2022 peak. There has been a stable downward trend in real retail sales over this period.

Since mortgage payments are not included in retail sales, about one third of the population (those with mortgages) are also carrying the burden of much higher interest repayments. While a cut from the RBA would take some time (the 12 – 18 months) to work its way through to the real economy, relief from cuts to mortgage interest rates would probably be felt almost immediately.

Not only does the RBA seem to acknowledge the extent of the damage to the economy, it appears to be seriously misguided. The governor stated that people were hurting even when trying to buy necessities but she argued that demand pressures were forcing up prices in services.

She can’t have it both ways, unless she considers us to have a two-speed economy. The masses are struggling to put food on the table (with no demand pressure) but some are able to push prices up on some services. It doesn’t add up. She only has one rate at her disposal to vary. If she keeps rates up to quell any services inflation, she will have to unduly penalise those who are already struggling with necessities.

We have conducted detailed analysis of Australian CPI inflation to the highest academic standard. We have concluded that the standard (headline) CPI inflation, and the core variant that strips out volatile components, have, on average, been in the middle of the target range (of 2% to 3%) for the last three months.

We think that there was also ‘a game of chicken’ being played out by central bankers in not being the first to blink on rate cuts. The SNB has already cut but we think the RBA won’t go until the Fed does.

The previous RBA governor arguably wasn’t reappointed for a second term because he said that rates wouldn’t go up until 2024. As we have said before, there is always an implicit proviso in a forecast ‘unless something terrible happens’.

On former RBA governor Philip Lowe’s watch, he had to contend with the pandemic, China shutdown, supply chain blockages, and a Russian invasion of the Ukraine. Those were all supply shocks to global inflation which are not impacted by rate rises in any country, let alone in Australia. The impact of supply shocks has largely evaporated by now and too many central banks around the world are claiming success from their policies in fighting inflation while much of the victory should go to the supply side problems having diminished.

Since the Fed is unlikely to move until at least June 12th, we think the RBA will not move until at least the RBA board meeting in the middle of June. Our labour force data seems to have been badly affected by statistical anomalies and so we think we might see a swift jump up in unemployment from the middle of 2024. With headline growth at 0.2% in the latest quarter, negative quarters might start to appear even without allowing for population growth.

The accepted definition of a recession used by the prestigious National Bureau of Economic Research (NBER) think-tank in the US does not include comments on two consecutive quarters of negative growth. The full definition includes an assessment of the health of the consumer and employment prospects. We think we are already in recession in Australia and have been for over a year.

But a recession does not mean our stock market index need go down. A company’s profits are not based on per capita demand but total demand. While all forecasts are subject to risk, our analysis of survey data of broker-forecasts of company earnings and dividends are optimistic. There will be dips along the way, but at time of writing the trend is still up.

Asset Classes

Australian Equities 

The ASX 200 ended the first quarter with another all-time high. At 7,897, the Index is only a whisker away from breaching the 8,000 level! Capital gains in March were +2.6% and on a par with those of the S&P 500 in the USA. Gains were largely across all sectors but Property, at +9.6%, did lead the way. Gains on the broad Index in the first quarter were 4.0%.

International Equities

The S&P 500 was up +3.1% in March and +10.2% over the quarter. The UK FTSE, German DAX and Japan’s Nikkei share market Indices all grew between +2.6% and +4.6% but the Shanghai Composite was flat at  0.1%. Emerging Markets were in aggregate also solid at +2.4%.

Over the quarter, the Nikkei grew by +20.0% after its economy had ‘flirted’ with a recession in the second half of 2023.

Bonds and Interest Rates

After the March FOMC meeting, in which interest rates were kept in hold at 5.25% to 5.5%, Jerome Powell seemed confident there were no signs of a recession. On the basis of the data released to date, we agree with his assessment but, because of the inherent lags in conducting monetary policy, it is far too early to call a victory.

US 10-year Treasuries settled down with a yield of around 4.20%. After a big shift from the end of January 2024, the yield curve, tracing yield against a range of different maturing lengths, has been unusually stable between the ends of February and March.

The SNB made its first interest rate cut but the Swiss inflation rate was never much of a problem.

Turkey increased its interest rate in the hope of fighting off its woes of a depreciating currency.

All year, the BoJ has been positioning to start its ‘normalisation’ of monetary policy after more than three decades of seemingly being unable to rectify the problems of the excesses of its past.

The rise in the BoJ rate from  0.1% to a range of 0.0% to 0.1% was symbolic more than anything else. The interest rate had not been positive since 2016. With the market seemingly accepting of this initial move, we expect further interest rate increases but in a very measured way.

The BoE and ECB were each on hold in March. However, only the former has shown its hand with its future policies. Governor Andrew Baillie stated that ‘an interest rate cut is in play’. Christine Lagarde, the ECB president has been strongly opposed to slackening its tight monetary policy for a long time but the ECB has been forced to cut its growth forecasts.

Australia’s RBA was also on hold but it is not ruling in or out future interest rate increases or cuts. We think the evidence is not only strongly against future increases – and the market agrees – based on the data provided above we think the RBA should not have raised the official cash interest rate last November and quite possibly should have done the reverse and cut rates at this meeting. Indeed, time will tell.

Unlike in the US, where the common mortgage is based on a 30-year fixed interest rate, Australians are mainly facing variable interest rate loans. Therefore, Australians are facing the twin problem of higher mortgage costs and negative per capita growth. US residents are not (yet) really facing either unless they choose to, or need to, move home.

Other Assets

The price of oil was comfortably up over March with the price of Brent Crude closing at just under $US88 per/ barrel.

Copper was up +4.3% but iron ore was down -12.3% but the price still held above $US100 per tonne.

The price of gold was up strongly to finish at $US2,214.

The Australian dollar – against the US dollar – was almost flat, rising only +0.2%.

The VIX volatility index (a measure of US S&P 500 share index volatility) finished March at close to its low at 13.0 – which is around ‘normal’ levels in ‘normal’ times. This low reading implies that market participants, in aggregate, are not taking out extra insurance against expectations of future falls.

Regional Review

Australia

Australia’s GDP growth came in at 0.2% for the latest quarter but the labour force survey claimed 116,500 jobs were created. These data together don’t add up.

The Australian Bureau of Statistics (ABS) surveys a rolling sample of 26,000 households to determine, among other things, how many people are unemployed and how many are in work. From those data, they scale the numbers to be representative of the 27 million or so people in the country. That naturally introduces what statisticians call sampling error. The ABS is up front about this and gives an interval of ‘reasonableness’ around those scaled-up numbers.

The ABS is pretty good at doing this analysis. To reduce the interval of reasonableness by half would require increasing the sample size by a factor of four (a squared rule). It’s not worth the extra cost. The current data are accurate enough.

The ABS then transforms or adjusts these ‘original’ estimates to allow for ‘predictable seasonal effects’. It so happens employment in January in Australia is typically much lower than the months either side. Without the so-called seasonal adjustment, it is meaningless to compare employment in January with that of the months either side.

These adjustment procedures which are employed by relevant agencies and bodies around the world usually work well. But, when there is a change in seasonal patterns, the adjustment process goes awry.

Given the massive volatility of the change in the seasonally adjusted total employment over the last three months (-65k, +0.5k, +116k) – but there was a very reasonable aggregate three months (+23k per month) – it is pretty obvious the seasonal pattern just changed. No one can reasonably blame the ABS; we certainly don’t. So, until new patterns can be established, the best that we can suggest is that employment growth for the last three months has been +23k per month which was reasonable in years gone by but what should it be with a +2.6% increase in population?

Measuring unemployment rates is an easier task as the numerator (number of the working age population who seek work but are out of work) and the denominator (number in the workforce) are subject to the same seasonal adjustment procedure so most, but not all, of the problem cancels out.

The unemployment rate was +3.7% in February. Not bad, but what does being employed mean in this new post Covid world? Work from Home (WFH), GenZ apparently more comfortable with flexible work hours, Uber ride-share and deliveries etc, etc. We interpret current labour market moves apparent in the data with a lot more scepticism than in years gone by.

We think we get a clearer picture of how households are currently faring by looking at retail sales. What do people actually spend? All of the data point to the volume (i.e. after inflation adjustments) we buy is falling. We may be consuming less lamb chops or switching from lamb chops to beef mince, etc.

The ABS in analysing the national accounts commented that (after inflation) Australians spent less in cafes, restaurants, and hotels by -2.8% in the latest quarter than they did in the prior one. The ABS surmises that people are eating and drinking at home instead of going out to save money. We think that is logical given the data. While we don’t know what people are really doing, we do know they have less to spend and the future looks to be one of increased austerity based on recent consumer sentiment surveys, so the ABS hypothesis to us looks on the money.

The average wage is down about 7% from the 2020 peak when adjusted for inflation. Retail sales is down about 4% using the same metric.

With real wages down 7%, workers need big pay rises to get back to par and then they need to claw back the losses made over the last four years. We weren’t in an economic bubble when Covid struck. It is not unreasonable for Australians to aspire to recovering their pre-Covid standard of living.

China

China has had a rocky ride through the post 2019 era with extended lock downs and a crisis among its property developers leading to issues in its property market. Notwithstanding, China’s People’s Congress put out a target of +5.0% p.a. economic growth rate going forward.

The monthly Purchasing Manager’s Index (PMI) for manufacturing had not been above the 50 mark (a level that that separates expansion from contraction) for some time. The latest print for March was 50.8. The latest PMI for non-manufacturing was 53.0, up from 51.4.

There was also a glimmer of hope in the monthly economic data read. Retail sales grew by 5.5% which beat expectations. Industrial output at 7.0% blew away the 5.5% expectation.

There was also good news in China’s trade data. Exports grew by 7.1% easily beating the 1.9% expectation.

For Australia, there is nascent news that the massive tariff on our wine has been lifted. Elsewhere, the Materials sector of the ASX 200 which is dominated by our large iron ore miners was up +2.2% in March.

The really good news from China was that it just found some inflation! Deflation is the enemy of all because falling prices induce people to delay spending while prices fall – hoping to buy the same item for less, later. China’s inflation just came in at 0.7% for the month after months of deflation. China’s economy could be turning. If it is not, then it is too soon to write it off.

US

US jobs data were good. There were +275k new jobs created in February but the unemployment rate went up to +3.9% from +3.7%. We, along with many other analysts, wonder whether these data are as relevant as they once were? Regardless, they are all that we’ve got to work with.

GDP growth was revised up to +3.4% from +3.2% for the December quarter of 2023 but the +3.2% was a downward revision from the original 3.3%.

We think Fed Chair Powell is correct in saying that ‘there are no signs of a recession and that an economic soft landing is possible’. It will be wonderful if that is the case but, as the old saying goes, ‘there is many a slip twixt the cup and the lip’.

It takes ages for economies to respond fully to interest rate increases and then cuts. So far so good. And we will be better off if the US stays strong. But we would be foolish to stop worrying and then be caught out with a left-of-field event. Cautious optimism is the appropriate mindset.

There are so many variants of official measures of inflation a commentary on them all would dominate this narrative. So, let us summarise.

We have determined, reasonably, that the US CPI inflation data has been corrupted by their Owners’ Equivalent Rent (OER) measure for the shelter component. They include rents but they also include estimates of what owned properties could be rented for. This is a massive component – about one third of the CPI index – yet it is arguably the worst in estimation accuracy.

The details are long and boring but we are across the nuances. In essence, in the USA, rents are usually set when a new tenant is found. The rent is usually set for a leasing period of at least one year but landlords are reportedly reluctant to raise rents until there is a new tenant. On top of that, the statistical bureau only samples rents every six months for a given property.

We have also conducted a detailed analysis of the US CPI index. If we take official ‘CPI less shelter’ inflation data, it usually is less than 2% and, since June 2023, it has not once been above 2% – the Fed’s CPI inflation target level. The current official shelter inflation rate is +5.8% but private surveys put that number at more like +3.6%.

We think, and we suspect Powell thinks, that the inflation genie is back in the bottle and he is about to begin cutting interest rates before it destroys the US economy. We think it is line ball between the Fed getting its prized soft landing and having a mini recession. It doesn’t matter too much which it is. But, if some of the Fed members keeps bleating about maintaining higher interest rates for longer, and wins the argument to implement this, then the USA could get the recession that nobody needed.

Europe

The European economy has been in a bit of a mess since Putin invaded the Ukraine. The BoE – now disassociated with Europe – seems to be controlling inflation in the UK, and is ready to cut rates. Europe seems to be behind the eight ball i.e. inflation too high for the ECB to cut interest rates but economic growth slowing to the point where interest rate cuts are needed to stave off recession.

Rest of the World

Japan is seemingly about to start normalising monetary policy after three decades of interest rate controls and, latterly, negative interest rates. It skirted a recession (from the populist definition of a recession being two consecutive quarters of negative economic growth) by revising its latest growth estimate from -0.1% to +0.1%.

Not one Japanese person would know they are better off from such a small change in growth – but the stats look better. The revision says more about the populist definition of a recession than it does about the state of the Japan economy.

Infocus acknowledges 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:

– US inflation ticks up a little but downward trend remains intact, rate cuts further deferred
– Australian inflation close to being back in the RBA target range
– Australian cost-of-living crisis not yet improving

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 the team.

The Big Picture

Only one month ago, the bond market ascribed a 50% chance to a US Federal Reserve (Fed) interest rate cut in March and an 85% chance of two or more interest rate cuts by June. By the end of February, the chance of a rate cut in March was almost zero while only one cut is still deemed likely by June.

In essence, the market has come back closer to the Fed’s way of thinking as espoused at its December meeting. It now appears that three interest rate cuts in 2024 are more likely, rather than the six or even seven the market had toyed with as late as January this year.

The changes in the market’s expectations are due to updated inflation data and recent Fed commentary. Inflation data are ‘noisy’ (prone to short-term volatility) and are also impacted by such things as changes in the oil price. US Consumer Price Index (CPI) inflation data in January and early February were not quite as good (low) as expected but they were not bad or even poor. The Fed’s comments have leant towards their trying to avoid cutting interest rates too soon for fear of a resurgence of inflation that might then force the Fed to revert to a tightening bias from its current neutral or ‘on hold’ stance.

The Fed is important to Australia, not only in terms of the US being a major economic power, but also due to its apparent influence on our central bank, the RBA, which seems likely to wait for the Fed to move before it does. The RBA governor and the committee are new this year and they seem to be still feeling their way a bit.

We see the case for cutting sooner rather than later as being different in the two countries.

The US economic data to date have been much stronger than many had anticipated. Perhaps this is due to savings and government spending (fiscal) policies as having fought against the central bank ‘monetary’ policy in the tightening cycle. However, there are some cracks appearing in the data. US retail sales in value terms only rose by +0.6% over the last 12 months so, with inflation running at +3.1%, inflation-adjusted retail sales (i.e. volume) are going backwards at -2.5% p.a.

US jobs data largely look strong but, as a Bloomberg reporter noted in February, labour market data should be viewed with a ‘dollop’ of salt (rather than the proverbial pinch). Collecting meaningful data is difficult at the best of times. The pandemic has a lot to answer for; the ‘gig’ economy adds new challenges; and the response-rates to data collecting agencies around the world have been tested in recent times.

Here in Australia, massive immigration flows have masked the true state of the economy. When GDP growth is measured in per capita terms, growth in four of the last six quarters has been negative and, even without correcting for population growth, inflation-adjusted retail sales have also been negative in four of the last six quarters. We think that is more than enough evidence to call the Australian economy as, in recession.

On top of the observed aggregate data, we know that mortgage rates have increased rapidly in recent times and any relief from holding fixed-rate mortgages taken during the pandemic has largely dissipated as the ‘mortgage cliff’ rolled over. Contrast the US system that largely depends on mortgagees holding very long-term fixed rates – up to 30 years i.e. the negative cashflow effect of Australian fixed rate borrowers moving from fixed-mortgage rates of circa 2.0% to circa 6.0% as their low fixed-rate terms ended and they began paying the no much higher variable or new fixed rates, did not occur in the US as their mortgages are largely 30-year fixed rate loans.

While the US CPI inflation data released in mid-February was an improvement over the previous month, the data missed market forecasts. The Fed prefers the Personal Consumption Expenditure (PCE) measure because it does not depend on a fixed basket of goods. Rather, the weights in the PCE measure adjust to consumer preferences over time.

The latest PCE inflation read at the end of February was +0.3% for the month of January and +2.4% over the last 12 months. The core variant, that strips out volatile energy and food components, was +0.4% for the month and +2.8% for the year.

The latest wage data in the US, adjusted for inflation ran at +1.4% over the year. While this number might be a little above historical comfort levels, it is necessary for workers to play catch-up in recovering the substantial losses made in the early part of the inflation cycle. We do not see any material evidence for a wage price spiral. Measured inflation expectations in the US have been quite stable at a little above +2%.

Inflation-adjusted wages in Australia have fallen substantially since the onset of the pandemic. However, that fall has since been arrested and there is some evidence of catch-up starting to emerge. If and when inflation falls sustainably back to the 2% to 3% RBA target-band, that does not mean prices return to pre-pandemic levels. Only deflation (negative values of inflation) can restore prices to previous levels or wage increases above inflation for a sustained time are needed to restore cost of living standards.

The latest monthly Australian CPI data for January were released at the end of February. The coverage of this index is around 70% of the quarterly index and that 70% is skewed towards goods rather than services.

The headline rate was +3.4% for the year and +4.1% for the core variant that strips out certain volatile goods like food, energy and vacation travel. We also produce regular in-house measures that better keep track of recent changes in trends. Our latest headline rate was +3.0% and the core was +2.3%. Both were within the RBA target range. We update these estimates every month. Neither variant has been above the target range for the last three, monthly updates.

Australia labour force data posted a second poor monthly reading in a row. Only 500 net new jobs were created following a loss of 65,100 in the prior month. The unemployment rate rose to 4.1% from 3.9%.

Around the world, many countries are suffering relatively poor economic times. Britain and Japan both slipped into recession using the popular ‘two negative quarters of economic growth’ definition. Interestingly, both of their major stock market indexes posted strong gains following these data releases. This type of behaviour underpins our view that our market does not necessarily have to perform poorly if further economic weakness becomes apparent. Markets are based on expectations while most economic data is a view in the rear-vision mirror.

After about a year of Ukraine holding its own against Russia, a lack of decision-making in the US Congress has led to a disruption in military supplies. Probably as a result, a major Ukrainian city fell to Russian forces during February. There has not been much impact of this conflict on economies in the rest of the word. But, without renewed support from the US in particular, that could change.

The Israel-Palestine conflict shows little sign of abating. The human suffering has reportedly been immense. There seems little chance of a resolution any time soon. The Israel GDP fell 20% in the December quarter compared to an expected fall of ‘only’ 10%.

Bond markets have stabilised and Wall Street has powered on following healthy report cards from the AI-chip designer NVIDIA and some others from the so-called ‘Magnificent Seven’ mega tech stocks.

The S&P 500 reached record highs in February as did the ASX 200. Even the Nikkei posted an all-time high that had stood since 1989!

The investing outlook will largely depend on how central banks report conditions and prospects, as much the actual data themselves. But conditions can change rapidly. If they do, we expect heightened equity-market volatility but longer-run prospects seem average to above average for investors in the nearer term.

Asset Classes

Australian Equities

The ASX 200 made a new all-time high in February but finished the month almost flat. The performances of the sectors were polarised. Energy, Materials and Telcos all fell more than -5% over the month. Consumer Discretionary gained more than +5% and IT gained nearly +20%!

Companies reporting earnings in February produced a mixed bag of results and, as a result, the broker forecasts collected by LSEG that we analyse show a slight weaking in earnings expectations for the next 12 months. However, that expectation is still just above the historical average.

International Equities

The London FTSE was flat in February but all of the other major indexes we follow gained around +4% or more. The S&P 500 was up +5.2%.

A lot of the impetus in Wall Street appears to have come from the big beat of the AI-chip designer, NVIDIA, earnings and prospects. This behaviour gives us some faith in the continuance of the Magnificent Seven rally that started a year ago – although one or two of the ‘seven’ seem to have fallen away from the peloton somewhat.

Our analysis of the LSEG broker forecasts reveal that forward expectations have held up through the US reporting season.

Bonds and Interest Rates

After 1 February Federal Open Markets Committee (FOMC) meeting, in which rates were kept in hold at 5.25% to 5.5%, Fed Chair, Jerome Powell stated that they were ‘confident inflation is coming down’ but that ‘they are not confident enough to start cutting’ yet.

The CME Fedwatch tool is pricing in about a 2% chance of a 0.25% interest rate cut at the March meeting. There is a modest chance of a rate cut priced in by the May meeting but there is over a 60% chance of a cut at the June meeting of the FOMC. The median expected number of interest rate cuts by the end of the year is three, but four rate cuts have a broadly similar probability.

Official US inflation data have been steadily improving but the gains are sluggish arguably because of the manner in which the shelter component of the price index is calculated. Currently shelter inflation stands at +6% and its weight in the CPI is around one third. Most commentators believe that the true measure for shelter is more like +3%. Therefore, we expect a big correction of 1% point or more in the CPI when the measure catches up with reality.

The RBA kept rates ‘on hold’. In the first media conference in the new RBA board setting, the governor may have embarrassed the board by trying to walk away from the three cuts in 2024 contained in the notes. She said that these three cuts were not forecasts or expectations but ‘assumptions’ as though this was a new category in policy making. It would be illogical to use anything but expectations for assumptions unless the Board wanted to convey outcomes under clearly differentiated assumptions such as base, best case and worst case.

Australian inflation data measured over the trailing 12-months is still above the RBA target range of 2.0% to 3.0% but it is well within that range when a shorter time period is used. We think there is little to no evidence of wage inflation becoming a problem if rates are cut and the data measuring demand point to a struggling economy for the average Australian. However, very strong immigration flows mask the extent of this economic weakness in the aggregate data.

We believe that the RBA will try to wait for the Fed to cut interest rates first before it takes its own corrective action. Therefore, we see the overhang of tight monetary policy causing even further hardship. Market expectations data support no cuts in the near term.

If we are correct in our analysis of the true state of the Australian economy and its likely course in the short-run, the RBA might be forced to do bigger cuts of say 50 bps when it does start easing policy.

Japan’s inflation rate has pulled back sufficiently for some to suggest that it may at last be able to start returning its benchmark rate to above 0% for the first time since 2016!

Other Assets

The price of oil recovered even more ground in February resulting in Brent ending the month at $US84 per barrel (Brent Crude price). This level is far from the $US95 that caused such problems with our inflation at the end of the September quarter. That oil price spike was caused by the onset of the Israel-Palestine conflict.

The price of iron ore again fell around 10% but, at $US117 per tonne, it is still well above the $US100 level that it came close to in the second half of 2023.

The prices of copper and gold were largely flat over February.

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

Regional Review

Australia

Australian retail sales (in volume terms) rose +0.3% in the December quarter and fell -1.0% over 2023. Volume sales fell in four of the last six quarters. When population growth is taken into account, sales volumes fell by around -3.5% in 2023. This measure emphasises the extent of the very real cost-of-living crisis.

With the latest household savings ratio at 1.1% (compared to around 4% to 6% in normal times), growth for the December quarter – to be released in the first week of March – will slow appreciably from the +0.2% for the September quarter (+2.1% for the year) – or households will have been forced into no saving – or even dis-saving. A rate cut by the RBA, if passed on to mortgage holders would alleviate some of this burden in future quarters.

The labour force data were again very weak. Only 500 jobs were created in January but there was a switch of around 10,000 jobs from part-time to full-time. We previously reported that data for December were particularly grim but we attributed some of that apparent weakness to inappropriate statistical procedures designed to remove predictable seasonal patterns.

The unemployment rate is less susceptible to these adjustments as it is the ratio of two quantities, so adjusted. The latest unemployment rate is 4.1%, up from 3.9% the month before and 3.5% in June 2023. That makes the average unemployment rate equal to 4.0% for the last three months which is 0.5% above the low over the previous 12 months. A gap of that size is the basis of the Sahm-rule (named after the Fed member who devised the indicator) to predict a forthcoming recession.

The wage price index came in at +4.2% growth for 2023 which is above the +3.1% CPI inflation index over the same period. This 1.1% premium does not show wage demand is problematic. On average, wage growth should exceed price growth as workers are rewarded for productivity gains.

The current inflation-adjusted wage (or real wage) is 7% below its mid-2020 level. Workers are only able to buy 7% less in volume terms and there is the cumulative impact of this real wage-cut over time.

China 

China’s economic data continue to be weak but not so much as to jeopardise our exports of iron ore and other commodities from Australia. The latest official Purchasing Managers’ Index (PMI) for manufacturing was a slight beat at 49.1 but below the 50-level that separates contraction from expansion in expectations.

China did move in February to cut a key interest rate and it seems to be pursuing an expansionary policy, albeit more slowly and carefully than in recent times.

China must deal with the problems of debt levels in its property sector while only stimulating the non-property sectors.

US

US CPI headline inflation came in at +0.3% for January against an expected +0.2% and +3.1% for the year against an expected +2.9%. Core inflation was +0.4% for the month against an expected 0.3% and 3.9% for the year against an expected 3.7%. The actual data were quite good compared to recent history but economists had reduced their forecasts quite sharply. Thus, the outcomes were considered poor (higher inflation being bad) and the chance of an interest rate cut was deferred further.

Our rolling quarterly estimates (annualised) were +2.8% p.a. and +4.0% p.a. for the headline and core CPI variants, respectively. Both were higher than in the prior month.

However, the real issue is how the Bureau of Labour Statistics (BLS) calculates a key component – shelter. Bloomberg reported that the BLS sent out an email to some clients about the problems with this component and then retracted it causing ‘confusion’. It has been suggested that this data problem might take five months to work through the system.

The Fed’s preferred PCE inflation data painted an even better picture. The monthly headline rate was +0.3% while for the year it was +2.4%. It’s getting very close to the target 2%! The core monthly read was +0.4% and for the year it was +2.8%. Given the problems we are experiencing with the shelter component of the CPI data, we are relying more heavily on the PCE measure at this time in our analysis.

US jobs grew by an unexpected and very large 353,000 in January. The expected range was 120,000 to 300,000 showing the high degree of uncertainty in the labour market data. Past data were also revised sharply. The unemployment rate remains at a healthy level of 3.7%.

Retail sales came in at -0.8% for January (expected -0.3%) following a revised +0.4% for December. The annual figure was +0.6% which was well below inflation at +3.1%. In real terms, the consumer is not as strong as some would have us believe.

The December quarter GDP estimate was revised down slightly from +3.3% to +3.2%.

Europe

Britain went into a ‘technical recession’ with its latest growth data for the December quarter. However, its retail sales in value terms grew by 3.4% in January after a ‘grim’ December. These data are very much in line with the recent US sales values that showed January was up 1.1% following a December decline of -2.1%. In short, we firmly believe that traditional seasonal patterns are being disrupted by ‘Black Friday’ internet sales. The Bank of England had kept its interest rate on hold at 5.25%.

Rest of the World

Israel’s December quarter GDP growth plunged by -20% compared to an expected fall of -10%. With so many Israelis mobilised to enter the conflict in Gaza, it might take some time for the situation to get back to normal in both a human and an economic sense.

Russia has taken advantage of a disruption in US aid to take over a large Ukrainian city in their ongoing conflict.

Japan entered a ‘technical recession’ but there seem to be two favourable outcomes. Inflation has dropped leading to a possible return to normal monetary policy settings (rather than the -0.1% base rate that has been in place since 2016). Secondly, after 35 years, the Nikkei share price index reached a new all-time high.

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

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

Key points:
– The US Federal Reserve has pivoted from a tightening interest rate policy to an easing one
– Markets are looking at growth and inflation data points to estimate first interest rate cuts
– Economic indicators are softening but inflation is still at risk from the Middle East conflict

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 the team.

The Big Picture

The US Federal Reserve (Fed) chairman, Jerome Powell, started last December by pronouncing it was ‘premature to talk about rate cuts’. By the end of December, the Fed ‘pivot’ was locked in (and the Fed had changed from a tightening interest rate policy bias to an easing one). Even the Fed then expected three cuts in 2024 but the market wanted more, forecasting up to 6!

During January 2024 opinions settled into less diverse scenarios. Cuts are still very much on the table but the 31 January meeting was considered ‘dead’, i.e. no change to interest rates throughout the month. However, the market had ascribed about a 50% chance of a cut in March and an 85% chance of at least two cuts by June.

Powell did not disappoint by keeping rates on hold but he did upset the market by saying that ‘he didn’t see a cut in March’. He said he was confident that inflation has been on track over the last six months but that he was not sufficiently confident to start cutting interest rates by March.

After these comments by Powell, the market priced in a 35% change of an interest rate cut in March. But the market is still pricing in two or more cuts by June at around a 90% chance. The bond market is still pricing in six cuts this year but the S&P 500 lost steam after Powell’s post Fed meeting press conference losing -1.6% on the day.

Interestingly, a survey conducted by media company CNBC just prior to the January Fed meeting reported that only 9% of respondents expected a cut by March and 70% said the first cut would be in June! Economists and traders often disagree. Usually only the latter has real skin in the game.

Depending on how one looks at the data – in the US and Australia – one can see a serious slow down or, at the other extreme, a gentle ‘soft landing’. The deciding factor, as we see it, relates to how one interprets the factors that caused the recent slow-down in inflation across the major economies. Those who think it was the deft response of central banks harnessing demand-side inflation with rate cuts, fear letting monetary policy ease – in case inflation then consequently re-emerges. This is Powell’s stated position.

Those who think the source of the inflation, starting in 2020 from the Covid pandemic, largely resulted from the supply side (i.e. global production slowed because of lockdowns, likewise transportation of goods largely stopped and the price of available goods rose materially due to lack of local supply during, and after the Covid restrictions eased, this being further exacerbated by the Ukraine war) are of the view that interest rates could be cut without inflation being reignited because the supply side issues have ceased. This group includes some eminent people – bankers and academics and a Nobel Laureate.

While we subscribe to this view more recently, we agree that rates could be cut without material consequence at this juncture. Failure to cut interest rates from the current restrictive levels could see them rapidly start to bite and cause economies to slow more than anticipated or intended by Central Banks. However, we do not as yet advocate the respective interest rates should move to below the neutral rate of about 2.5% to 3% in this easing cycle and certainly, they should not reduce back to emergency levels.

It has only been a little over a year since monetary policy in Australia and the US has been tightened (above the neutral rate). With the long and variable lags (say, 12 to 18 months) of effect of monetary policy settings, we are only just starting to witness some slowing effects from the interest rate hikes. Fed chair Powell acknowledged this in his January press release.

Of course, the pandemic added its own idiosyncrasies into the mix. People were forced to save because of lack of opportunities to spend under lock downs and governments added stimulus payments to ease the crisis. Those excess savings sheltered economies from monetary policy tightening – for a while. This time was indeed different but those excess savings have now largely been depleted. We are back to normal conditions for assessing monetary policy effects.

The latest Australian labour force data (for December) revealed an apparent massive crack in the economy. Total employment went down by 65,100 but the full-time position loss was even worse. 106.600 full-time jobs were lost in a month while the population grew by 48,200.

The monthly data does jump around somewhat but we have only had six months of decreases in the last 24 and the next worst result was less than half of the December outcome.

The unemployment rate held up at 3.9% but only because of the discouraged-worker effect. People who left jobs and didn’t bother joining the unemployment queues!

Before we jump to a disturbing conclusion, it is important to note that data have regular seasonal patterns (e.g. temperature related demand). The ABS uses averaging techniques to remove the regular seasonal component so that month-to-month or quarter-to-quarter changes better reflect new directions rather than predictable seasonal patterns.

For many data series, the ABS also smooths the seasonal data to produce ‘trend data’ so that longer-run trends become more apparent. While these are useful for a cursory glance, we tend not to rely on trend data in research houses and create our own opinions of underlying movement.

So, in relation to employment the actual number of jobs (original data) went up by 18,400 and not down sharply in December by the seasonally-adjusted 65,100. It was the statistical process designed to smooth out the data that did the damage. What if the seasonal patterns have changed since last year? We have had a year of record immigration and December is a month when lots of students start to enter the workforce. The large loss could be due to a statistical anomaly.

Furthermore, the monthly official data are prone to bounce around as the figure for the population are extrapolated from a very small sample. In addition to the sampling issue, it has been noted in various countries that telephone surveys are becoming less reliable because younger folk are less likely to ‘pick up’ the phone call from a number not familiar to them.

We are not unnecessarily concerned over these employment data but we are on alert to look for more clues when the January data are released in mid-February.

The US jobs data seemed somewhat stronger. 216,000 jobs were created compared to the expected 170,000. The expected range of forecasts was quite wide: 100,000 to 250,000. Importantly, digging deeper, reflected new jobs yet again largely being created in less productive sectors. The three-month average of new jobs was 165,000 compared to 284,000 in the same period a year earlier. And these data have a strong tendency to be revised downwards in subsequent months.

The US labour market is slowing and possibly a little more quickly than the headline data appear to convey.

It seems to be generally agreed that inflation in the US and Australia is returning to target levels more quickly than many had anticipated. Our own calculations based on more timely measures indeed suggest inflation is all but back to target.

However, the big issue on the sidelines might be events starting to cause a second-round oil-price inflation problem like that at the onset of the Ukraine conflict.

We are not experts in analysing military conflicts and their evolution but a simple reading of respectable news sources leads us to note that the Israel-Palestine conflict has involved more countries and groups over the last couple of months.

Some oil tankers and container ships are reportedly being diverted away from the Red Sea route to Europe and the US (and the reverse) because of drone and other attacks. The route via the Cape of Good Hope adds much time and, hence, cost to traded goods.

Brent oil prices declined to about US$75 per barrel before the Middle East conflict after having been US$95 slightly earlier in 2023. Brent oil bounced back to US$85 and has settled to just below that level – so some new inflation pressures must be building.

We have no insight into how, or indeed if, the conflict will be resolved but it is apparent that some of the hard-fought gains in inflation control will be eroded. However, it is equally obvious that keeping interest rates higher for longer will do nothing to reduce oil-price inflation pressure.

Markets have largely performed well in January. The S&P 500 and the ASX 200 reached all-time highs during the month. Bond yields have retraced a little from the late 2023 fall but not alarmingly so.

With the December quarter reporting season in the US and second half reporting season in Australia getting underway, we have a great opportunity to understand better what 2024 has in store for us. Our analysis of LSEG (formerly Thomson Reuters) company earnings expectations suggests that the outlook for 2024 has, if anything, improved over January as brokers update their forecasts.

The early reporting results on Wall Street have produced a bit of a mixed bag of success and failure in the big tech space. United Parcel Service (UPS) is laying off lots of workers because it doesn’t see internet-created demand sustaining the old system. Big Tech might not perform anywhere are strongly as it did in 2023 but we are expecting above average gains in the broad index.

But with recent all-time highs on the US S&P 500 and the local ASX 200, and stable bond markets, 2024 does not look bad! We think the Fed will do what we expected and cut interest rates as it does not want to alarm markets by changing their monetary policy direction and settings too much and too quickly despite it now being characterised as a ‘pivot’.

Asset Classes

Australian Equities

The ASX 200 was modestly up in January (+1.2%), largely because the index started the month at an elevated level following the December rally, but that was not so for the individual sectors. Energy and Financials each grew about +5.0% but Materials (-4.8%) fell by a largely offsetting amount. The broader index closed January at an all-time high.

January and July often witness bigger changes in broker expectations about earnings as the new half-yearly reporting season sets to get underway (for February and August). We did not see much change this January but, if anything, expectations point to a slightly stronger year than we saw for 2024 at the end of 2023.

However, the consensus end of year (eoy) 2024 forecast we have gleaned from published reports (made at January 1st) from reputable houses was, for the ASX 200, 7,600 points or just below the closing value on 31 January (7,681). While we are not expecting a bumper 2024, our analysis suggests that this consensus forecast could be a little too pessimistic. Our expected capital gains in the ASX 200 look reasonable but when dividends and franking credits are factored in, this asset is worthy of serious consideration for 2024.

International Equities

Japan’s share market index, the Nikkei, had a particularly strong month (+8.4%) but the US S&P 500 (+1.6%) was only moderately strong – largely because of the big sell-off on the last day of January following the Fed’s press conference. China (-6.3%) and Emerging Markets (-3.1%) went backwards.

A lot might depend on whether the Artificial Intelligence (AI)-led rally of 2023 continues or, indeed, retraces. Without the so-called Magnificent Seven (big technology stocks), the S&P 500 index would not have been impressive at all in 2023.

However, the consensus eoy 2024 forecast we have gleaned for the S&P 500 from published reports (made at 1 January) was 5,000 points or just above the closing value on 31 January (4,846). While we are not expecting a bumper 2024, our analysis of broker forecasts suggests that this consensus is somewhat pessimistic.

Bonds and Interest Rates

At the end of January the Fed funds interest rate was on hold at a range 5.25% to 5.5%. The CME Fedwatch tool is pricing in about a 35% chance of a 0.25% interest rate cut at the Fed’s March meeting. The same source is predicting that there is only about a 10% chance of the Fed funds interest rate being unchanged by June. The prospect of two or three 0.25% interest rate cuts by June being about the same and collectively by far the most likely outcome.

The European Central Banks (ECB) and the Bank of England (BoE) also kept interest rates on hold in January in spite of their slightly improving inflation outlooks.

The RBA kept our interest rates ‘on hold’ on their meeting on the first Tuesday in February. In our opinion, there is evidence that the Australia economy is in need of some rate relief, as the surging immigration levels are masking the cost-of-living pressures on the average household.

Since company earnings from selling to Australians are determined by aggregate demand – and not by per capita (household) demand – the ASX 200 can grow while a per capita recession takes place.

The 10-year Treasury yield in the US fell from just on 5% in October to a recent low of 3.8%, since then it drifted up a fraction to 4.1%. After the latest Fed meeting this yield retraced to just under 4.0%. The Australian 10-year yield ended January at 4.01%.

We expect some more visibility on Australian monetary policy from the RBA from here onwards, as the new committee appears to be charged with the task of improving communications.

Other Assets

The price of oil bounced back sharply from December’s lows. Both West Texas Intermediate (WTI) and Brent Crude oil were up by about +8% largely on the impact of the Middle East conflict and more recently issues with shipping in the Red Sea.

The prices copper and gold were largely flat over January. The price of iron ore fell by -6.3%.

The Australian dollar – against the US dollar – depreciated by -3.9% which will not help our inflation cause through import prices increases.
Regional Review

Australia

Australian November retail sales (in value terms) published at the start of January surprised at +2.0% for the month – but they grew only +2.2% for the year. This growth becomes negative when inflation is taken into account. In addition, population growth running at about +2.5% p.a. suggests the average citizen was consuming a lot less in inflation and population-adjusted terms.

The monthly retail value data for December were published at the end of January. The seasonally adjusted monthly growth for December was  2.3% (not annualised) wiping out the November gain. But, just as with the change in employment data, retail sales as collected by the ABS were up +14.3% on the month in ‘original terms’. It was the seasonal adjustment process that converted +14.3% into -2.3%.

Non-specialists might ask if the ABS is competent at performing the task at hand. While we think the ABS is world class, their task is very difficult when seasonal patterns are changing. In due course, we believe that the data will be revised. They will still likely not be good but not as bad as we see at first sight.

There were also two reads on the monthly Consumer Price Index (CPI) inflation gauge published in January owing to the delay in reporting November data because of our holiday season.

Both the headline and the core monthly variants for November were +0.3%. The 12-month gains were +4.3% for the headline and +4.8% for the core variant that excludes volatile energy, food and holiday travel. Our rolling quarterly estimates which we produce each month was +3.0% p.a. for both the headline and core variants. That puts these inflation estimates at the top of the RBA target range.

At the end of January, quarterly CPI data were released. The monthly data, in order to be more timely, has only about 70% coverage of the quarterly basket of goods and services.

The official read for the Quarterly index series was +0.6% for the quarter and +4.1% for the year (expected +4.3%). Note that +0.6% for the quarter, if annualised, becomes +2.4% p.a. and is within the RBA target range.

The monthly series official reads over the year for December were +3.4% from +4.3% for the headline and +4.0% from +4.6% for the core. Our in-house rolling quarterly estimates (annualised) were +1.3% p.a. for the headline and +2.4% p.a. for the core. The RBA has over-achieved! +1.3% is below the target range.

The core measures over the last five months have been +5.5%, +5.1%, +4.1%, +2.7% and +2.4%. We think that is a stable downward trend and indicative of the RBA may have gone too far, and at a minimum, far enough, given the lags in the system for interest rate hikes to work through. With the RBA target range being 2-3% the RBA needs to act in a timely manner with rate cuts to prevent overshooting on core inflation.

The jobs data for December showed that the participation rate had fallen from 67.3% to 66.8% reflecting a strong discouraged worker effect. In essence, 41,400 full-time jobs were converted to part-time while, in addition, 65,100 full-time jobs were lost from the workforce. The unemployment rate remained at 3.9%.

China

China’s GDP growth came in at +5.2% against an expected +5.3% but the market seemed to interpret this result as being very weak. Retail sales also missed at +7.4% compared to +8.0% expected but industrial output at +6.8% beat the +6.6% forecast.

The Purchasing Managers Index (PMI) a measure of industrial demand was 49.0 for December which was down from the 49.4 read in November. At the end of January the PMI for January rose slightly to 49.2.

The big problem in China still relates to the debt burden mainly of property developers. The Hong Kong government recently ruled that Evergrande the formally very large mainland property developer should be placed into liquidation. The government is reportedly trying to ring-fence a few of the big developers to stop a spread of the problem. At the end of the January, China noted that it had merged ‘hundreds of rural banks’ to reduce risks of failure.

US

US CPI inflation came in at +0.3% for both the headline and the core variants of the measure.

Over the year, headline inflation has come down to +3.4% and the core to +3.9%. While these numbers are far from the Fed target of 2% the market seemed to breathe a sigh of relief that substantial progress had been made.

Our rolling quarterly estimates (annualised) were +1.8% p.a. and +3.3% p.a. for the headline and core variants, respectively. The headline rate was below the Fed target of 2%! There should be two more releases of the US CPI before the next Fed meeting to make the next interest rate call.

The Fed’s preferred Personal Consumption Expenditure (PCE) inflation data painted an even better picture. The monthly core and headline rates were each +0.2% while for the year they were +2.9% and +2.6% respectively.

The Fed fears a resurgence in inflation if it starts to cut too soon. Supply-side shocks such as higher oil prices and disrupted supply chains due to restricted access to the Suez Canal due to the conflict in the Middle East, are almost unpredictable and inflation expectations data do not support a demand-side surge in inflation.

The US consumer appeared to be somewhat resilient in January. Retail sales (for December) grew by +0.6% – well ahead of inflation. The December quarter GDP growth was +3.3% when only +2.0% had been expected. The household savings ratio fell to +4.0% from +4.2% indicating some pressure on budgets.

Over 2023, economic growth was +2.5% following +1.9% for the previous year. The University of Michigan consumer sentiment survey showed that 28% of Americans thought the economy is in excellent or good shape. The corresponding figure for April 2022 was only 19% but, in January 2020, just prior to the onset of the pandemic, the Michigan figure was 57%.

While some reported that the current 28% figure showed some resilience, we think it would at least be equally plausible to state that the consumer is not as pessimistic as they were but nowhere near as optimistic as they were before the interest rate-hiking cycle began.

Existing home sales were the lowest since 1995 but, that is to be expected when mortgage rates are historically high and expected to fall in the coming months.

Europe

German inflation rose to +3.8% while, for the eurozone, it was +2.9%. The UK recorded +4.6% inflation and its retail sales fell -3.2% when a fall of only -0.5% had been expected.

The Europe economy is clearly in a worse position than the US and it has been paying the price for once becoming so dependent on energy/fuel from Russia.

Rest of the World

The conflict in the Middle East has certainly escalated and the deaths of US soldiers has seen a retaliatory military action against specific targets in the region, in particular to stem the terrorist attacks from inside Yemen on ships in and around the Red Sea and other military targets. To date, the economic consequences of the conflict seem less than that from the Ukraine war as there is a simple, but costlier, option to avoid the Red Sea shipping lanes by diverting round the Cape of Good Hope in southern Africa to access Europe and the US particularly with crude oil sourced from the Middle East.