admin

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

Key points:

– The impact of interest rate increases is starting to appear in economic data
– China is struggling to reinvigorate its economy
– Equities take a breather

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

The Big Picture

Backward looking inflation data, with most of the level being delivered in the early months of the data reporting window, has our current inflation rate at 4.9% annualised. However, if we take our guidance from more recent data (calculated on a rolling quarterly basis and then annualised) then we are seeing a level that is within the RBAs target band of 2%-3% p.a. The past three-monthly observations for this series being 2.4% p.a., 3.1% p.a. and 2.7% p.a. respectively.

On this basis the RBA should be encouraged that their monetary tightening policy is delivering the results intended and, save for a sudden inflation shock, be sufficient to tame inflation and not require further interest rate increases.

Further support for this position is evident through the latest retail sales data in Australia. The June quarterly result was -0.5% when measured in volume terms (i.e. removing inflation effects) and -1.4% for the year. The latest three quarterly results have all been negative.

Employment data was also softer as 15,000 jobs were lost in the latest month but that figure masks a worse outcome for full-time jobs which were down 24,000 because there was an offsetting gain in part-time positions. In July our unemployment rate went up from 3.5% to 3.7% indicating a deteriorating employment environment. The Westpac consumer confidence index also fell.

By taking a similar approach to observing US inflation data, its rate has also improved and looking contained, but there are so many alternative variants of that measure. Focusing on the measure that consumers actually face (CPI), and for the latest quarter and not the whole year, the latest read was 1.9% which is just under the Fed’s stated 2% target.

The US did record 185,000 new jobs in the latest month but three factors contribute to our view that this number was weak. First, it was 15,000 jobs less than expected. Second, 87,000 of those new jobs were in government and ‘health care & social assistance’ sectors which are typically not growth sectors. Third, the 209,000 new jobs for the prior month were revised downwards to 185,000.

During August, one of the big three ratings’ agencies, Fitch, downgraded US debt one notch to AA+ because of the debt default deliberations. Moody’s, another big ratings’ agency, down-graded 10 US banks and put six big banks on negative watch. Home affordability was reported to be the worst in 38 years, and the Fed just hiked its interest rate again in late July to the highest in 22 years.

The annual Fed-sponsored conference in Jackson Hole, Wyoming, was held at the end of August. Fed Chair, Jerome Powell, emphasised the need to keep policy restrictive and to be data dependent!

Is anybody winning? Well Japan hasn’t flinched yet still keeping its negative interest rate (-0.1%) on hold since 2016. Its latest inflation read was 3.1% and its economic growth rate for the June quarter was 6.0% (annualised). However, there was some disturbing signs in their growth when we dig deeper. Consumption went backwards and imports were well below expectations. Offsetting this, retail sales were up an impressive 6.8% against an expectation of 5.4%.

We have often been able to point to China to lead the way for our economy – but so far, not this time. All China’s major economic statistics were weak and it is experiencing deflation rather than inflation. Deflation incentivises not spending now! We anticipate China will continue to try and find ways to stimulate its economy but what this looks like is not yet clear.

While there were several negatives during August, we are of the opinion that stock markets have largely factored in the state of the economies. Markets work on expectations of the future and not so much on past data. Our analysis of Refinitiv expectations of future company earnings remains positive overall.

After a bit of whiplash, US 10-year bond yields have settled down at just below 4.1%. Bonds are again a viable investment vehicle. Market volatility, as measured by the VIX Index, is at normal levels.

Asset Classes

Australian Equities 

The ASX 200 fell 1.4% over August. A lot of the negativity appeared to arise from uncertainty about the Fed’s next move. Consumer Discretionary was the stand-out sector rising +4.6%. The year-to-date capital gain of +3.8% for the broader index is quite respectable given the long-term average of around 5%. August finished with a strong spell of daily gains. Moreover, our analysis of company earnings data, provided by Refinitiv, noted a modest increase in predicted gains over the next 12 months.

International Equities 

The S&P 500 was also weaker over August, falling 1.8%. All of the other major global share indexes that we follow were also negative. However, the year-to-date gain for the S&P 500 is an impressive +17.4%. Japan’s Nikkei is even more impressive having risen 25.0% so far this year.

Bonds and Interest Rates

The Fed did not meet in August but it raised its cash interest rate at the end of July by 25 bps to a range of 5.25% to 5.50% (the highest in 22 years) in a widely telegraphed move. The probability of a further rate hike at the Fed’s September 20th meeting has been priced at around 10% to 20% since the last hike. However, the odds only just favour no hike at the November 1st meeting.

We agree that the Fed will likely pause interest rate increases this month despite Powell’s sabre-rattling talk of the prospect of further interest rate increases at the Jackson Hole conference in Wyoming of the world’s central bankers. We think there might be enough additional evidence in inflation, jobs, and growth data over September to convince the Fed to pause again at its November meeting.

By the final Fed meeting of the year on December 13th, we think it likely that there is only a very minor chance the Fed would contemplate a further interest rate increase. We think the ‘interest rate cutting debate’ will start around that time as the earlier interest rate increases will have slowed the economy. We anticipate the conversation will turn to when stimulus measures (interest rate cuts) could begin in the first quarter and most likely before June 2024.

The RBA should be encouraged by the latest monthly Inflation data to hold off on increasing our interest rate further. The RBA interest rate tracker app on the ASX website prices in an interest rate increase at 0% in September and 14% for a rate cut. While we are certainly supportive of no further rate increases in the near term, we think October is also a bit too soon for a cut, only 18 days into the tenure of the new RBA governor Michele Bullock.

Without going through the details of what all of the other major central banks did and might do, it does seem that there is overwhelming support for global interest rates being at or near their peaks. Except for Japan and, to some extent, Switzerland whose economies have not followed the same path of rapid rises in inflation in recent years.

Other Assets 

The price of oil was slightly up over August.

The price of iron ore rose 5.6%. The price of copper fell 4.0%. The price of gold was down fractionally. The Australian dollar depreciated 2.9% against the US dollar over August.

Regional Review

Australia

Cracks are starting to appear in the Australian economy. Growth in inflation-adjusted retail sales data have been negative for three successive quarters. Westpac’s consumer sentiment indicator has been hovering around a score of 80 (compared to 100 for a neutral reading) for about nine months. This read is worse than during the GFC but not quite as bad as that in the depths of the 1990/91 recession.

Even the jobs report has started to show weakness but, given the sampling error range associated with using a very limited data set, one month of weakness is insufficient to call it problematic yet. It is reasonable for businesses to hold on to workers longer than seemingly necessary because of the cost of re-hiring when the economy bounces back. And on the supply side, workers losing jobs in times of downturns might accept inferior positions to keep their cash flow going. However, history shows us that labour markets can then sour quite quickly.

The RBA is predicting 1.75% p.a. economic growth in 2024 and 2% in the following year. We see that scenario as being an optimistic one. Because of lags in the system, the full force of the high interest rates will not be felt until 2024.

Meanwhile, wages growth has not yet been a problem. Wages grew by 0.8% in the June quarter or 3.6% over the year. Workers are still playing catch up to the pandemic induced high inflation period during 2020 – 2022. As yet, there is no wage-push inflation (i.e. wages increase at a rate faster than productivity).

With China saving our economic bacon in 2008/9, we avoided a recession when the rest of the world went into what some called ‘the Great Recession’. This time China is struggling to manage its own economy. It is hard to see from where a silver bullet might be fired to stave off the effects of higher interest rates and inflation on the Australian economy.

China 

Chinese data released in August were weak almost across the board. Retail sales, industrial output, and fixed asset investment were slow in absolute terms and all missed ‘weak’ expectations.

The purchasing managers index (PMI) for manufacturing was below the threshold ‘50’ level for the last five months but, at least, there were small improvements over the last three months. At 49.7 for August, the PMI easily beat the expectations of 49.4. We’re not talking about a collapse. It is just taking time for the economy to recover from the three-year shutdown. But there are signs of deep-seated debt problems arising in the property sector.

More disturbing is the deflation that appears to be underway in China. The broad inflation measure the Consumer Price Index (CPI) was -0.3% in the latest month when -0.4% had been expected. The Producer Price Index (PPI) was -4.4% against an expected -4.2%. Deflation is thought to be bad because it incentivises delaying purchases until those goods and services become cheaper.

US

US inflation statistics – and there were many variants published in August – were largely interpreted as showing that there was more work to be done before the fight against inflation can be considered won. Assessing US inflation with a measure that gives more weight to the most recent data, we concur with this assessment. Of course, we need to see this trend of softening inflation data confirmed in the coming months before we are comfortable enough to call a victory, but the trend has been for a steadily improving read over most of 2023.

The headline jobs number at 187,000 was big enough for many to conclude that the US economy is still strong however, what is concerning to us is that jobs in many of the growth sectors were small or negative and the data relies of government jobs for its overall level.

The June quarter GDP growth was revised downwards to 2.1% from 2.4%. The Fed considers 1.8% to be the neutral growth rate as far as inflation pressure is concerned, indicating an improving situation for inflation fighting – but still some work to do.

With credit ratings agency Moody’s downgrading credit worthiness for 16 US Banks (or putting issuers on negative watch) is disturbing. This change in ratings is no doubt the fall-out from the regional banking crisis that started in March. The combined credit tightening, the Fed interest rate well above its neutral rate, and the Quantitative Tightening programme (the Fed paying back on more maturing bonds than it is issuing new ones) appears to be building up to produce a downturn in the US economy. Whether this results in a recession and how deep that recession is, should it eventuate, remains to be seen.

Europe 

The Bank of England (BoE) is still on a tightening cycle. Its latest 25 bps increase to 5.25% takes its cash interest rate to the highest in 15 years. CPI inflation stands at 6.8% over the year.

Britain has a different problem to that of Australia or the US, it reportedly took up the green energy challenge with more gusto than most – and found itself caught out by the supply-side energy price inflation. It is not easy to mitigate the impact of such a major policy shift.

EU inflation came down to 5.3% from 5.5% and its economic growth jumped back to positive territory after two consecutive quarters of negative growth. The first recession might be over but the next might not be far behind.

Rest of the World 

Japan’s inflation declined further from its recent high to 3.1%. While Japan’s GDP growth came in at an impressive 6.0% (annualised) for the June quarter, the headline result masked the underlying compositional issues. Consumption growth was negative and capital expenditure was flat. However, retail sales jumped 6.8% (annualised) in July against an expected 5.4%.

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

Key points:
– Inflation has undeniably come down but is higher than Central Banks’ preferred range
– Is there something different about this inflation and interest rate hiking cycle?
– The road ahead for the economy, inflation, interest rates and markets

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 latest inflation data in Australia, the US and indeed, many other economies is showing inflation has declined from their respective peaks. So the question is, how low does inflation need to be before the mindset of central banks transitions away from inflation fighting and a bias to lower interest rate settings? And, assuming this transition occurs, the obvious question then becomes; when are they likely to start cutting interest rates?

We have previously documented the source of this bout of inflation. To recap, prices rose post Covid as demand increased rapidly but, because of Covid lockdowns, the supply side e.g. shipments of manufactured goods from Asia, were unable to respond to the sudden rise in demand. Consequently, competition for the limited supply available resulted in price rises which fed into a corresponding jump in inflation.

Central bankers, economists and many others assessed that the drivers of this inflation were transitory. The rationale being that once the supply side responded to the Covid created demand imbalance, prices would recede to ‘normal’ levels and inflation would return to manageable levels in the 2% to 3% p.a. range. That being the case, the need for interest rate policy tightening at that time was not required as the period of elevated inflation would indeed be temporary.

As a consequence of this assessment central banks did not respond to the initial price surges. Dr Philip Lowe, Governor of the Reserve Bank of Australia (RBA), throughout much of 2021 said that rates would not rise until at least 2024. So why was there a change of heart?

There are a range of reasons, key among these were:

• The timing of the Russian invasion of the Ukraine exacerbated inflationary pressures through food and energy price inflation as instability in supply of these fundamental resources drove their prices higher.
• The general supply demand imbalance lasted longer and remained more severe than anticipated as much of the developing world continued to grapple with Covid, long after the developed world had contained the pandemic as mass vaccination programmes proved effective.
• Central banks saw inflation rising as they anticipated and, in keeping with their ‘transitory’ assessment, were unresponsive with interest rate policy. By the time inflation data confirmed that inflation was not as transitory as anticipated and that it had become more entrenched, they then had the well documented change of heart.

The RBA first raised interest rates in May 2022 while the US Federal Reserve (Fed) started increasing US interest rates in March 2022. Fed chair, Jerome Powell, has since said he regretted ever using the word ‘temporary’. With the exception of Switzerland and Japan, most developed world economies have seen their central bankers walk a similar path.

Part of the problem has also been data dependency i.e. Central Bankers waiting for the data to confirm what was already known before responding with policy changes. The risk of this delay now being an economic recession. Some developed economies are already there.

A major risk is that, as central bankers delayed interest rate tightening on the way in to this bout of inflation, they will be slow in cutting rates on the way out as they wait for longer timeframes of inflation data to confirm that it has indeed receded. Look back to the experience during the 1989 to 1991 period in Australia when there was the interest-rate-induced ‘recession we had to have’. The recession persisted even though the RBA were sharply cutting interest rates throughout that period!

But is this time different?

That phrase, or its affirmative variant, is used too often but there are some differences worth noting for the current cycle. Prior to this bout of inflation interest rates had been low and even negative in some countries for a very long period. That is extremely unusual!

In economics, there is a concept of a ‘neutral rate of interest’ – one which is neither expansionary nor contractionary. Economist consensus is that in Australia and the US, that neutral rate is about 2.5% to 3.0% p.a.

In the current cycle in Australia, the RBA cash interest rate did not get into ‘tightening’ mode until December 2022 i.e. RBA taking the cash interest rate above 3.0% – the first seven rate hikes from 0.1% to 3% merely reduced and then removed the existing ‘loose monetary policy’. One reason we haven’t seen economies falling into recession is that interest rate increases only became restrictive in the last 12 months. Using the same metric, the US monetary policy became restrictive i.e. higher than 3.0% p.a. in September 2022 after the Fed started hiking in March of that year. What is different this time is that tightening cycles do not usually start from such a low base.

There is also another important fact to consider. Fixed rate mortgages don’t ‘exert any pain’ on borrowers until the loans roll over or a new loan is initiated. The so-called ‘mortgage cliff’ is just starting in Australia as borrowers on fixed interest rate loans move to variable interest rate loans. In the US, where fixed rate loan terms are much longer (up to 30 years) the effect of such a short sharp rates’ upswing is diluted even more.

In the current environment the data is not all pointing to the same outcome. Some key data points indicate ongoing strength (upward inflationary pressure) which is adding to the complexity for Central Bankers trying to manage inflation back to preferred or neutral levels.

Key among these in both Australia and the US is the labour markets which are still holding strong but the same is not true for other inputs. The US has experienced several months of contraction in retail sales and Australia’s GDP, in the March quarter 2023 (reported in June), was barely above zero (and was negative when population growth is taken into account). The recent June quarter 2023 estimate of growth for the US was an impressive 2.4%, but that includes a lot of fiscal stimulus (government spending) from the Biden administration, which is actually stimulatory and is fighting against the Fed policy.

The economic outlook remains opaque as we transition from tightening monetary policies through to a plateau phase (it feels like we are entering the plateau phase now), before interest rates decline to support economic growth/recovery post inflation returning to its neutral range.

The outlook for share markets is somewhat brighter even though earnings’ forecasts for companies were revised down for the June quarter in the US and the half year ending June 30 in Australia. So, the current forecast for corporate earnings is not that high and, as a consequence, not that hard for companies to achieve.

Markets can look through the malaise and rise before a downturn in the economy is over, and, based on the historical experience, often do. Refinitiv, one of our data providers, surveys hundreds of stock broker forecasts of company earnings for to the three years ahead. The analysis of that data is, on average, supportive of current share market valuations and prices.

Asset Classes

Australian Equities

The Australian share market as measured by the ASX 200 Index was up +2.9% in July. The index of Energy shares led the way rising 8.8% whereas the Indices of Financial and IT companies rose 4.9% and 4.4% respectively. Good results all things considered. The indices for Staples and Healthcare went backwards in July.

It would appear that equity investors have gradually moved to be more accepting of a ‘soft-landing’ scenario for the economy and are allocating capital back into shares as markets are trending more positively. While a ‘hard landing’ remains a risk for markets, data, particularly in the US, continues to support a ‘soft-landing’ outcome.

International Equities

The US S&P 500 Index of the largest 500 companies listed on the US share market had a strong July rising +3.1%.

Much attention continues to be paid to the magnificent 7 large cap technology stocks listed in the US and, while they have performed well and largely carried the market to its loftier heights, the positive move in the market has been broader than these stocks alone. This broadening provides a degree of comfort in the general health of the share market.

Bonds and Interest Rates

In a widely telegraphed move the Fed raised its cash interest rate by 0.25% to a range 5.25% to 5.5% (the highest level in 22 years). The RBA, on the other hand, decided to leave our cash interest rate on hold at 4.1% p.a. at is meeting on August 1. The European Central Bank (ECB) took its base interest rate to a record high level of 3.75% p.a. The Bank of Japan (BoJ) unsurprisingly stayed at ?0.1% p.a. but it did adjust the allowed movement around its longer maturity bond rates (e.g. 10-year Government bond.

It appears that the mood across developed economies at least is that central banks are at or near their expected highs for interest rates. The US Fed has an estimated probability of 20% for one more interest rate increase to be announced at its next meeting on September 20^th. With inflation seemingly coming under control, there is a growing belief among many analysts that the Fed might already be ‘done’ raising rates.

The US 10-year Government bond rate has moved both up and down in recent months. The latest move was to briefly rise back above 4%. We note that after a period of volatility the US bond market is stabilising somewhat.

Other Assets

The price of oil moved sharply higher in July (+14%) fuelling gains in the energy sector of the ASX 200.

The price of iron ore was down a little (?1.9%). The price of copper was up +3.6%. The price of gold was up +2.7%. The Australian dollar appreciated 0.8% over July.

The VIX volatility index, a measure of share market volatility, closed July at 13.6, a level that is in the normal range.

Regional Review

Australia

Our jobs report for June was strong with 33,600 new jobs being created and the unemployment rate at 3.5%. Of course, immigration is strong perhaps helping the increases in the demand for labour.

Dr Philip Lowe was not reappointed for a second term as RBA Governor. He is to be replaced by the current Deputy Governor, Michele Bullock, on September 17^th. We do not think that change will make a material difference to the conduct of monetary policy, particularly as inflation is now receding.

We do not think the RBA will start cutting interest rates any time soon unless, or until, more of a material slowdown in economic growth is observed. Retail sales fell by ?0.8% over the last month but rose 2.3% on the year. In other words, the annual growth in retail sales at current prices is about the same as the general level of prices so inflation-adjusted retail sales have been flat.

China

China data are a little mixed. The latest GDP growth for the June quarter came in at 6.3%, 1% below the expected 7.3%. Both figures are well above the long run expectation of a little over 5% p.a. because of the ‘base effect’ of coming out of the three-year long lockdown. However, the quarterly growth was 0.8% against an expected 0.5%. That bodes well for the September quarter.

The usual monthly growth statistics of retail sales, industrial output and fixed asset investment were at or above expectations but weaker than pre-pandemic rates. Exports and Imports both contracted in the latest month and were worse than expected. Youth unemployment was reported to stand at 22.3%! No doubt a concern for Chinese authorities.

China manufacturing PMI came in at 49.3 making it the fourth successive reading below 50 (a reding below 50 indicates contraction). However, the index has risen slightly in the last two months from a low of 48.8 in May.

US

US employment growth (non-farm payrolls) increased by 209,000 in June slightly missing the expected 225,000, but the unemployment rate fell from 3.7% to 3.6%. Importantly, around 150,000 of the jobs created were in government positions and lower-level healthcare. This change in the mix could be a sign of weaker jobs growth to come and, hence, to a softer monetary policy stance from the Fed.

The US has two more Consumer Price Inces (CPI) reports and two more employment reports before the next interest rate setting meeting on September 20^th. The Fed will also be hosting the Jackson Hole global conference for Central Bankers in late August. Should we expect a joint statement that the bulk of the work on inflation is over?

US June quarter GDP growth surprised to the upside at 2.4% when 2% had been expected. We recall that March quarter growth was 1.1% for the preliminary estimate reported in April which was then revised upwards to 1.3% and then 2% in June, indicating some resilience in the US economy.

US retail sales were weak at 0.2% for the month and industrial output went backwards at ?0.5%. Despite this the mood continues to remain sanguine.

Europe

UK wage inflation grew the equal fastest on record in the three months to June 30 at 7.3%.

France’s GDP growth for the June quarter came in at 0.5% against a forecast of 0.1% and a previous reading of 0.1%. Inflation came in at 4.3% from a previous reading of 4.5%.

There is little in Europe data to give us much joy but they seem to be struggling through rather than collapsing. The latest European Union GDP growth data for the June quarter ended the run of two consecutive quarters of negative growth rates with a rate of 0.3% against an expected 0.2%.

Rest of the World

Japan’s inflation is off its recent high at 3.3% and core inflation was 4.2%. The Tokyo core inflation read was 3% which beat expectations. Japan retail sales came in at 5.9% above the expected 5.6%. However, industrial output at 2.0% was slightly below forecast.

Russia has reportedly ended the food corridor for ships carrying Ukrainian grain exports to pass freely though the Black Sea. There are many reports of the Ukraine fighting back by firing missiles at Russian targets. There seems to be no peace in sight. There is an elevated chance of a hike in food and fertilizer prices from these recent moves but we do not see it as having the same effect as at the start of the invasion in February 2022. Alternative sources of supply have, to some extent, been found.

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

Key points:

– Despite inflation peaking markets are pricing in more interest rate hikes in the US and Australia
– Share markets remain buoyant and to date showing little concern for the recession risk
– Artificial Intelligence (AI) popularised by ChatGPT has boosted the Tech sector, is it a bubble?

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

The Big Picture

As we start a new financial year it’s good to reflect on the year just past. Despite rising interest rates and the ongoing Ukraine war, returns on many major share markets have been well above average. We all noticed interest rates and bond yields rose sharply.

The start of the last financial year witnessed the early days of the interest rate hiking cycles by many central banks. We didn’t then know how high rates would go in the ‘fight against inflation’ but most would have been surprised by the size of the hikes that eventuated – and there may well be more hikes to come. This uncertainty around interest rates contributed to the share market low last October but need we go back there?

Depending on how you measure inflation, one could be satisfied by how it has fallen in the US. Oil prices are down by more than a third over the year after the spike partly caused by the Russian invasion of the Ukraine. Supply chain issues caused by Covid have largely dissipated.

It is interesting to observe that two developed countries, Switzerland and Japan, have had only a modest inflation problem. Switzerland only just hiked its rate to 1.75% and Japan’s central bank has kept its interest rates on hold since 2016 at -0.1%! Switzerland has a massive dependence on hydro power for electricity and both countries have well-regulated energy prices, which are in part a reason why they have lower inflation.

Swiss inflation stands at 2.3% compared to a recent peak of 3.2%. Japan’s core inflation stands at 3.2% which is down from 3.4%.

What this points to is that the mantra pervading most central banks – that “we must keep rates higher for longer to control inflation” – misses the point that other policy tools could have been employed in the fight against inflation. There is no simple relationship between interest rates and inflation so we believe that central banks are employing their largest and primary instrument, interest rates, and in the process are running the real risk of taking their economies into recession as a result of their inflation fighting approach. Deutsche Bank has assigned a 100% probability to the US going into recession. While we don’t think anything is certain, it is becoming increasingly difficult to make the argument that the US economy is not heading that way.

The Reserve Bank of Australia (RBA) had promised us that rates would not go up at least until 2024. They did have a brief pause in April this year having started hiking in May 2022, but followed that with two more hikes in this May and June. Many are predicting that there might be two more interest rate hikes in the pipeline.

We thought, at the start of 2023, that the RBA would not have hiked interest rates as much as they have. Had the RBA not been so aggressive with interest rate increases and China’s economy started bouncing back from the three-year Covid lockdown instead of the anaemic recovery it has had so far, we may well be better positioned to avoid a recession than it appears we are now.

We still think the RBA should have stopped hiking months ago. Our latest estimate of Australian inflation is 3.1% – almost within the RBA target band of 2% to 3%. Why didn’t you know this? The media is lazy.

Australia’s latest economic growth estimates came in at the start of June. Our economy grew by 0.2% in the March quarter. Not great, but positive. Over the whole year, growth was 2.3% which is not far off the historical average.

The problem comes when we adjust growth for population changes. Immigration is going gang-busters so the per capita growth in the March quarter was -0.2%. On average we went backwards!

The household savings ratio fell to 3.7% from 4.4%. It was nearly 20% in the early part of our Covid lockdowns because there was less available to spend income on, and probably because households wanted to put some extra aside for a rainy day – given the uncertainty created by the onset of Covid-19.

The current savings ratio of 3.7% is below what it was before the lockdowns. The stream of falls in savings ratios helped bolster the measured economic growth. That party is now likely to stop.

This savings data does not imply that people are spending more than they earn. They mean that they are not putting away as much for the future as they did before.

It would be remiss of us not to mention AI (artificial intelligence) and its effect on stock markets in the 2023 financial year. The US technology heavy Nasdaq index just experienced the best first half (January to June 2023) in four decades!

AI has been around for years but it only seemed to tantalise investors after ChatGTP was brought to our mainstream attention at the start of the year. Ordinary folk can now easily ask it questions and ask it to write an essay or computer program for us. This is big stuff and it is not going away. But let us be clear what it is.

AI has two major strands – both enabled by the massive increase in computing power in recent times. It can help us search very quickly from what already exists on the internet. That does raise questions of privacy and some are calling for AI development to be regulated.

The other component is image or pattern recognition. By taking, say, a digital photograph and changing each pixel into a number – say on a pantone colour score – one photo’s array of numbers can be compared to a massive number of other arrays. Western Australia just released a machine that can recognise feral cats from native animals and poison them.

Neither of these strands ‘think like a human’ – they just do what humans tell them to do, but extremely quickly!

Image recognition can help (and invade privacy?) identify people walking through immigration or a shopping centre. It can also be used to interrogate, say, aerial photos to work out who has a swimming pool or solar panel. Over time, this form of image recognition can monitor the effects of climate change, population movements and changes in traffic congestion. It will also drive cars without us!

AI has already made significant contributions to society, and it will continue to improve the efficiency of many tasks, but it can’t replace everyone’s jobs. It just doesn’t do that! It will put people with repetitive jobs in jeopardy but even this will take time.

Take the banking industry in Australia as an example. There has been a massive increase in employment at some major banks over the last decade – even as branches were being closed – owing to the switch to AI and a sub-branch of AI called machine learning (or generally data science). Computer models need to be designed, implemented, and monitored. This is a process that will takes years. Research never ends. There will always be a demand for people who can push computing power to its limits.

Many developed countries, including Australia and the US, are currently puzzled by the strength in their jobs markets. But should we be comparing unemployment rates today with those from years ago without adjusting for the types of work? Some restaurants claim they can’t organise home deliveries because they can’t get the workers! So, anyone who loses a ‘good job’ through AI or whatever can become say, an Uber driver or delivery person in a trice. Obviously, compensation and job satisfaction may not be the same in the two segments of the workforce. But unemployment data are not adjusted for happiness.

No one can reasonably assess what the impact of monetary policy has already had since the start of 2022 with any accuracy. Everyone in the profession is aware that monetary policy impacts the real economy ‘with long and variable lags.’ Central banks admit it but most say that rates should remain high until we see inflation back to a reasonable level.

The consensus view is that the lag length is 12 to 18 months. That means we may not even yet have seen the full impact in Australia of the first rate-hike of 0.25% point in May 2022 – let alone the cumulative impact of the next dozen or so hikes! If they wait until inflation returns to its target range, whatever that may be, there will be a dozen or more rate hikes still waiting to have their impacts – presumably then sending many economies into recession. Stopping interest rates hikes, or even cutting rates, will not reverse the economic declines quickly enough.

If the chance of a recession is already priced into share prices, markets can continue to grow as the real economy works its way through the recessionary impacts. Our analysis of broker expectations of company earnings suggests we might expect more of the same over FY24 – average to above average capital gains. A correction or bear market is not an obvious expectation unless one is worried about any ‘AI bubble’ bursting.

Over twenty years ago, we had the dotcom bubble and bust. The current situation is very different. The dotcom boom was based on dreams of making new products that never, in fact, ever got made. People invested in companies with no actual products and no revenue streams. The big US tech companies involved in AI today are already making good money and AI already exists. Of course, there could be new regulation that slows things down a bit but there will also be improvements in AI over time as innovation and development continue unabated.

Investing in share markets is always risky. There is always a possibility that one buys at too high a price. There is also the possibility that one misses out on a great opportunity of not buying now. Prudent investors manage these risks and expected rewards. And over, say, five-year periods, the timing of buying and selling become much less important.

The founder of modern portfolio theory, Nobel Laureate Dr Harry Markowitz, passed away at the end of June, aged 95. By and large, the same theory is as relevant today as it was when it was first published 70 years ago – just the investment products on offer have changed! Harry was reportedly a good, humble man. His contributions were massive. R.I.P.

Asset Classes

Australian Equities

The ASX 200 was up +1.6% for June and +9.7% for the 2023 financial year. When dividends are included, those (total) returns increase to +1.8% and +14.8%, respectively. Of course, many investors also have franking credits available to them making for a very solid FY23. All eleven sectors produced total returns in excess of 5% and three (Materials, Information Technology (IT) and Utilities) produced total returns in excess of 20% for FY23.

We currently have the broader index approximately priced as ‘fair value’ and broker forecasts are pointing towards capital gains of above the historical average for the 2024 financial year.

International Equities 

The S&P 500 had capital gains of 6.5% for June and 17.6% for the 2023 financial year. The gains were certainly not even across the component sectors. It was the top 10 companies on Wall Street that led the charge in the S&P 500 this year. The other 490 companies’ share prices didn’t do that much. The top 10 companies are largely mega-tech companies with some focus on AI.

The Russell 2000 index is commonly used to track where US small cap stocks are going. This index started to underperform the top 50 stocks from March when the Silicon Valley Bank and others went under and credit conditions tightened.

Emerging markets were flat over the 2023 financial year but they had a good June rising +2.6%.

Our analysis of the US company earnings forecasts points to another strong financial year but a lot will depend on the depth to which any recession hits the country – and the extent to which any bubble, assuming there is one, in AI bursts.

Bonds and Interest Rates

The US Federal Reserve (“Fed”) paused its hiking cycle for the first time in June. In a confusing press conference, Fed Chairperson Jerome Powell emphasised that this was a “pause” and not a “skip” (presumably meaning we shouldn’t automatically expect a hike in July). However, the dot plot forecasts of the members of the Federal Open Markets Committee (FOMC) clearly showed that the Fed expects two more hikes this year – with only four meetings to go. And that is two more hikes than they expected at the prior meeting!

The market is pricing in an 85% chance of an interest rate hike by the Fed in late July. Gone are the market expectations of three or four interest rate cuts this year – the market expects more rate hikes. Any rate cuts are a little unlikely with a market probability of 1.1%.

The RBA paused again at its July meeting and left the official cash rate unchanged at 4.10%. In the lead up to the decision market economists and pundits had been divided as to the outcome as data can be found to support either case.

With money market account interest rates having risen substantially the ‘there is no alternative’ (“TINA”) to equities is no longer the case. Share markets continue to have better long-term prospects than bonds or cash but a blend of these assets may well be appropriate for prudent investors who want to manage the risk of their asset allocations.

Other Assets 

The price of oil has fallen by more than a third over FY23 but they were up over 2% during June.

The price of iron ore was much the same at the end of the financial year ($112 / tonne) as it was at the beginning ($121 / tonne) but the range over that period was enormous ($80 to $133). During June, the price was up about 13% as China comes back out of the lockdowns.

The price of copper was flat over the 2023 financial year but up about 1% during June.

The price of gold was up 6% over the 2023 financial year but down 3% in June.

The Australian dollar appreciated 2.1% over June but was down about 4% over the 2023 financial year.

Regional Review

Australia

We again got a bumper monthly labour report. Two of the last three were extraordinarily strong. Because of sampling error in the way that the data are collected, we are comfortable to accept the middle month’s weak result as an anomaly.

76,000 new jobs were created in the latest month. The unemployment rate fell from 3.7% to 3.6% which is historically very low indeed.

GDP growth was a different story. The March quarter was weak and we were possibly saved from going negative by the cut to household savings. Per capita growth was negative at -0.2%! We cannot reasonably expect further falls in the savings ratio to support our growth estimates. However, strong immigration might keep headline growth positive.

In contrast, retail sales, that are not adjusted for inflation, came in strongly at 0.7% for the month or 4.2% over the year. However, we note that inflation was running at about 7% p.a. (April) (or 5.6% p.a. from the May monthly series) so real (i.e. adjusted for inflation) sales were down around 3% (or 1.4%), over the last 12-months.

We have been experiencing higher inflation than even the US. The Fair Work Commission gave a 5.75% wage increase to those on minimum wages. Owing to a technicality, that translates to about 8.5% for some.

Will this wage increase be inflationary? It certainly puts costs up and some or all of this increase will be passed on. However, the increase does not help those workers keep up with the inflation that has already occurred. Not to give such a wage hike might have slowed down inflation but at what human cost?

There is some evidence being presented that companies have been increasing profitability in this inflation round so hopefully such companies will be able to absorb some of the wage increases.

The latest quarterly inflation read (for the March quarter published in April) was 1.4% for the quarter or 7.0% for the year. Many think it was this number that prompted the RBA to hike interest rates again after their April 4th pause. There is a new official monthly, as opposed to quarterly, series that aims to provide a more timely view of price movements.

The May monthly inflation rate came in below expectations at 5.6% for the 12-month period published at the end of June. It was the lowest in 13 months but the new monthly series does not correspond very closely to the established quarterly series.

Our in-house analysis, in which we calculate a rolling quarterly inflation series – rather than the official rolling annual series – shows that the latest quarter came in at an annualised 3.1% (only just above the RBA’s inflation target range of 2% to 3%) but core inflation (that strips out the more volatile food and fuel prices) is still stubbornly high at 5.2%. We expect that the next quarterly inflation reads will continue to trend lower but the monthly data are a little volatile.

China 

China is struggling to get its economy back on track. It cut a couple of key interest rates in June and seems likely to do more to stimulate the economy.

China’s Consumer Price Index (CPI) inflation came in at 0.2% and the producer price variant was -4.6%. The government is trying to be selective in how it stimulates the economy. While some agencies are downgrading their forecasts of growth for 2023, estimates generally are still comfortably above 5%.

However, the manufacturing Purchasing Manufacturer’s Index (PMI) was below 50 (indicating a contraction) for the third month in a row showing that the stimulus packages have not yet filtered through to expectations that will take the economy back into a more sustained growth path. The latest read of 49.0 was better than the previous month’s read of 48.8 but below the April read of 49.2. In that sense, the economy is more likely struggling with getting back to stronger growth rather than falling into worsening conditions.

US

US jobs again impressed at 339,000 new jobs and an unemployment rate of 3.5%. Only 190,000 new jobs had been expected. Wage growth was 0.3% for the month or 4.4% for the year.

US GDP growth for the March quarter was revised upwards from 1.1% to 1.3% to 2.0% in each of the last two months.

When we calculate CPI inflation on a quarterly basis – as we do in Australia – the read was 2.2% (annualised) compared to the target 2% but the Fed seems very likely to hike again. And this low read was not a one off. Rolling quarterly reads have been drifting lower from 4% for several months. The problem is that the US focuses on a rolling 12- month inflation figure. At 4.0% for the headline rate and 5.3% for the core reading, the high inflation period up to the middle of 2022 is still biasing the annual estimates upwards.

The Fed prefers the Personal Consumption Expenditure (PCE) to the CPI variant of inflation because the weights attached to each expenditure segment evolve over time. The latest monthly headline read was only 0.1% or 3.8% for the year. The core variant that strips out the more volatile energy and food prices was 4.6% compared to an expected 4.7%.

US President Biden’s student debt forgiveness plan was not supported by the Supreme Court. Biden plans changes which he hopes will get the plan through but, for the moment that is an extra impost on spending power for those struggling with student debt. Add to that the effect of credit tightening and the repaying government debt programme (called quantitative tightening) and the economy has a lot to deal with without having more interest rate hikes.

Europe 

UK inflation was stuck at 8.7% and the Bank of England surprisingly hiked interest rates by 0.5% points rather than the expected 0.25%. Britain, along with Germany and the EU have had two consecutive quarters of negative growth. The ECB hiked by 0.25% to 3.5% but its President, Christine Lagarde, stressed that she wants rates to stay high until inflation, currently 5.5%, falls to 2%. She did not acknowledge the policy lag in her statement.

Rest of the World

Japan’s growth in the March quarter was revised upwards to 2.7% from 1.6%. Its core inflation read was 3.2% from 3.4% and the Bank of Japan interest rate is  0.1%.

New Zealand growth came in at -0.1% giving it claim to being in a recession after this second quarterly negative read.

The Royal Bank of Canada had paused after its January interest rate hike but proceeded to start hiking again in June with a 0.25% increase to 4.75%.

Turkey raised its rate by 6.5% from 8.5% to 15% in order to try and save its currency, the lira. The rate was 19% in the early phase of the pandemic and it was progressively cut to the previous month’s 8.5%.

In a puzzling state-of-affairs, the Wagner private army comprised mainly of former Russian soldiers marched on Moscow and got to within 300km before turning back. The leader, Prigozhin, cut a deal with Putin to stand down in exchange for safe passage to exile in Belarus. All of this happened over the weekend when markets were closed!

Wagner played a major role in the Ukraine offensive. Putin did not look good in this and it is not clear what the aim of the ‘mutiny’ was. Charges against the mercenaries have reportedly been dropped. Reportedly residents in Poland, Latvia and Lithuania are extremely worried by having these ‘serial killers’ in neighbouring Belarus. The army is not expected to return to fight in the Ukraine. However, the Pentagon claims some of the army is in the Ukraine.

Markets did not seemingly respond to this chain of events.

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

Key points:
– US debt ceiling deliberations coming to an end
– Central banks are still hiking rates despite agreeing that inflation peak now behind us
– China economy not yet out of the woods as indicators remain mixed

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

The Big Picture

It seems that every time there is a divided Congress in the US, like there is now, both sides engage in brinkmanship. They always come to a solution but is there a better way? It destabilises asset markets and causes consumers unnecessary angst.

President Biden announced that a deal had been reached with Republican leadership on the last weekend in May, and was finally ratified by the US Congress in the past week, ahead of the reported June 5th deadline after which the US government becomes at risk of defaulting on its debt. Despite the apparent risk the US Government does have some wiggle room before they would actually default e.g. public servants and the like get furloughed first, as has occurred previously in response to this issue.

As a result of this squabble, one of the big three ratings’ agencies, Fitch, put US Treasury Securities on ‘negative watch’ meaning that their AAA credit quality status was in jeopardy.

While we make light of the posturing for the TV cameras by the opposing political parties, a huge and very real problem is emerging. The total of US Government debt is now $31,000,000,000,000! (Trillion) As rates rise, the interest bill is becoming dangerously high unless some long-term deficit reduction solution is agreed upon. One day, US debt might become too risky for other nations to hold. What happens then when they’ve all but maxed out their credit card.

It is hard to unscramble all the influences on central banks and bond yields. It seems safe to ascribe a little of the recent uncertainty to the debt ceiling negotiations but a lot must also be due to central banks’ interpretation of the economic and inflation data that are landing on the news wires in rapid fire.

The Reserve Bank of Australia (RBA) surprised markets in May by increasing the official cash rate by 0.25% to 3.85% when the consensus was that they would leave rates on hold. At the June meeting the odds of a rate increase changed markedly during May from a minor chance of an increase in June to the point of ‘much more likely than not’ in the few days prior to the June meeting on Tuesday 6th of June. The RBA decided to go with the majority and increased the cash rate to 4.10%.

Our CPI inflation data did come in a bit high at 7% in the last week of April and that was backed up by 6.8% from a new monthly publication at the end of May. While that figure is well above the target rate of 2% to 3%, we have no real way of knowing what will be the delayed impact of all the previous interest rate hikes in the future.

Everyone agrees that the impact of rate hikes is felt with ‘a long and variable lag.’ So, if Central Banks wait for inflation to be reasonable before they pause or ‘pivot’ down, there is no doubt that some bad economic conditions will inevitably follow. Even swift rate cuts wouldn’t solve that problem as cuts also take time to work their way through the system.

In relation to the large swings in expectations of where Central Banks decide to take interest rate policy settings, when the probabilities change so much from day to day it makes little sense to take each number at face value. We prefer to interpret these probabilities and abrupt changes as evidence of confusion in the market. The next new number could be sufficient to flip expectations back to the RBA being on hold. We anticipate this volatility continuing for the near term at least.

The US Federal Reserve (Fed) also hiked rates by a quarter of a percent at the start of May to a target range of 5.0% to 5.25%. That means the current (average) Fed funds rate is about 5.1% or the figure the Fed forecast its rate would be at the end of 2023 – the so-called ‘terminal (peak) interest rate’. Therefore, any more hikes put them in a more aggressive stance than they were at the beginning of the year. But what has happened since? Most US news this year has been encouraging but the falls in inflation – and there have been some substantial falls – have not been as big as hoped for.

But on top of the Fed’s actions, the regional US banks bailouts have caused a credit tightening which has been acknowledged by the Fed and the market. Fed chair, Jerome Powell, said in a press conference that the credit tightening might be equivalent to one or maybe two hikes – or maybe even more. He claimed not to know.

Professor Jeremy Siegel, a particularly well-credentialed finance academic from the Wharton School (University of Pennsylvania) with both feet firmly on the ground thinks the credit tightening is worth about 0.75% to 1.0% in addition to the 5.1% Fed funds rate.

On top of that, Jamie Dimon, the high-profile CEO of JP Morgan, thinks the Fed rate will have to go to 6% or 7%. Putting all this analysis together, the US could easily be looking at an ‘effective’ Fed funds rate of 7% or maybe even 8% sometime this year. That might spell a big recession for the US. If that were to be the case then there is time to save the economy, but swift action could be necessary but it doesn’t look likely.

At the start of the year, the Fed was predicting a terminal or peak interest rate of 5.1% while the market’s prediction was a little under 5%. By March, the Fed hadn’t shifted its view but the market was then pricing in about 3.5% (due to the regional banking crisis). In the run-up to the June Fed meeting, the market was pricing in a terminal rate at around 5% – just like the Fed.

At one time, the market was pricing in three or four cuts this year. We didn’t see that happening and the chance of cuts is all but off the table. One cut is priced in unless they hike in June and then it will be two cuts!

The probability of a hike in June has gone from about 5% earlier last month to 71% near the end of May and then back down to 35% to close off the month. Again, these probabilities speak more to the difficulty to interpreting current data in this economic climate.

Our economic future in Australia looks a little brighter than that for the US but a lot is riding on how the China economy plays out. The last GDP reading for China was reasonable at 4.5% and the June quarter read could be very strong as opposed to the same quarter last year which was very weak. In recent data imports just came in at -7.9% for the month when 0% was expected; industrial profits were down -18% for April; but exports were on track at +8%.

Then, the Purchasing Manager’s Index (PMI) came in well below expectations for both manufacturing and services with the manufacturing variant indicating a contractionary sentiment at 48.8. However, this recent weakness could well cause a reaction from the Chinese government to stimulate the economy.

We are cautiously optimistic about China’s economy as it exits the pandemic lockdown but there could be some speed bumps along the way.

All-in-all, Financial Year (FY) 2023 looks like producing strong returns for the ASX 200 and the S&P 500. FY23-to-date capital gains are 8.0% and 10.4%, respectively. Dividends and franking credits in Australia put both returns well into double figures.
So far, surveys of company earnings’ expectations are looking moderately strong for FY24 but there are a lot of unknowns that could upset these expectations.

Asset Classes

Australian Equities

The ASX 200 had a bad end to the month on the back of the US debt ceiling deliberations, our inflation data and the patchy weakness in the Chinese economy. The broad index was down 3.0% in May making it all but flat for the calendar year to date. Except for the IT sector, there was little in May to celebrate on the ASX.

International Equities

US equities just managed to close May with a positive return which gives an 8.9% calendar year to date capital gain.

Japan’s Nikkei index had a spectacular month rising +7.0% but Emerging markets were flat. The German DAX, UK FTSE and China’s Shanghai Composite Indices were well down.

Bonds and Interest Rates

The market has now capitulated on its stance against the Fed’s ‘higher for longer’ position. Gone are the expectations of three or four cuts this year.

The market thinks it is more likely than not that the Fed will pause in June after having leant towards a hike for much of May.

The ECB is on a tear to keep hiking rates to fight inflation despite its largest economy, Germany, falling into recession in the March quarter on the back of a downward revision to growth.

The Bank of England (BoE) at last got some slightly good news as UK inflation fell from 10.1% to 8.7% in one month. Now at 4.5%, the latest quarter point increase took its interest rate well above the ECB’s 3.25%.

Perhaps the biggest danger in the Fixed Interest sector is the possibility of increased defaults in corporate credit.

Other Assets 

OPEC has just opened the door to allow Iran back into the club after sanctions are removed. The price of oil has been a little volatile of late but it is well down on the prices that caused much of the global inflation spike. Brent Crude oil was well over US$100 per barrel a year ago and is now just over US$70.

The price of iron ore has also retreated from around US$130 per tonne a year ago to close on US$100 today.

Over the month of May, the prices of copper, iron ore and oil were all well down but gold was only down by -1.0%.

The Australian dollar against the US dollar fell by -1.7% in May to US$0.65 cents.

Regional Review

Australia

On the face of it, our jobs report looked weak but it followed an extremely strong prior month. Taken together, the labour market seems to be holding up against higher rates.

Our unemployment rate jumped from 3.5% to 3.7%. Total jobs fell 4,300 but part-time jobs rose 22,800 reversing the big switch to full-time work in the prior month. Wages grew modestly at 0.8% for the quarter and 3.7% for the year.

Retail sales volumes again fell in the March quarter making for two consecutive quarters of negative growth: -0.3% and -0.6%.

While the Federal Budget made attempts to redress the cost-of-living crisis there wasn’t a lot for economists to agree or disagree with.

China

The China trade balance improved sharply as exports met strong targets but imports fell well short. The economy seems to be quite patchy with some areas of strength – mainly in services – but industrial profits falling by 18% in April did attract attention.

The manufacturing PMI came in at 48.8 at the end of May which was a big miss compared to the expected 49.2. However, the services PMI was well in expansionary territory at 54.5 – although that statistic did mark the second month of decline. It is quite possible that this weak manufacturing outcome will push the government into an expansionary policy phase.

China inflation came in light at 0.7% from 2.8%. The Producer Price Index (PPI) inflation was -3.6%, less than the -3.2% expectation.

US

The forecast for US new jobs to be reported at the start of May was 180,000 with a range of 95,000 to 265,000. The outcome, at 253,000, was at the top of the range. The anticipated weakness in the labour market is yet to appear. Wages growth was quite strong at 4.2%. The unemployment rate fell from 3.6% to 3.5%.

Nevertheless, the New York Fed calculator estimates that there is a 68% chance of a recession in the US.

Core inflation is above the headline variant as energy and food prices that are stripped from the headline measures are currently falling. Our calculation of quarterly CPI inflation at 3.2% (annualised) is not that far from the 2% target but the annual figure, as represented in official data, is stubbornly high because of the hangover effect of the high mid-2022 inflation spike. That should pass through the data measurement ‘window’ in a few months.

Europe 

The Bank of England is still intent on trying to suppress inflation with interest rate hikes. There is some slight evidence that it is winning.

Now that Germany is in recession it is not bringing any confidence to those who thought EU inflation could be supressed with interest rate hikes without causing a hard landing.

Rest of the World

Japan’s inflation was a little higher than expected at 3.4% and that is the highest inflation has been there since 1981. After the ‘lost decade’ and beyond characterised by deflation, Japan’s experience may have swung the other way. However, as Japan’s central bank has not meddled with interest rates – which are unchanged since 2016 at -0.1% – growth is doing moderately well.

Japan’s growth in the March quarter came in at 0.4% and 1.6% for the year when 0.2% and 0.7%, respectively, had been expected.

Japan’s industrial output fell by -0.5% while +1.5% had been expected. Retail sales grew strongly at +5.0% but missed the +7.0% expectation.
The Tokyo CPI inflation index pointed to inflation falling to 3.2% from 3.5% when 3.3% had been expected.

With a new governor at the Bank of Japan, we await a clear signal of a possible change in interest rate (monetary) policy.

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

Key points:
– Peak inflation now appears to be behind us
– US economic growth showing some resilience but is weakening
– Inflation is declining as higher interest rates start to bite on household spending
– Interest rates in Australia look close to peaking this cycle but appear to be data dependent

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

There are signs that the US economy is softening but, following the anticipated 0.25% rate increase early this month, will this be enough to cause the US Federal Reserve (Fed) to now pause its interest rate hiking cycle? At the time of writing, the market-based probability of a pause at the Fed’s June 14 meeting is 100%, notwithstanding, expectations of Central Bank interest rate movements are more volatile in the current environment of elevated uncertainty. Again, and at time of writing, markets are forecasting that the Fed will have cut interest rates at least once by the end of the year which is at odds with the Fed’s view that they won’t. This divergence of views, in part, makes it somewhat easier to reconcile the market reaction to the Fed’s decision to raise interest rates this month when confronted with a softening economy and knowledge of a potential recession. We note the European Central Bank (ECB) followed the Fed and increased their cash rate by 0.25%.

It can take quite a while – many say about 12 to 18 months – for interest rates to work their way through to the ‘real economy’ (like jobs and growth). Nobody has a good handle on what impact the interest rate hikes of the past year have already done to the economy. In the US, the market expected a modest 2% GDP growth (annualised) for the March quarter of 2023 and it came in at about half of that at 1.1%. The latest monthly US retail sales fell by -0.9% against an expected -0.5% for the month. The annual figure was -3.1%. Usually, when a recession hits, it generally occurs quite quickly.

Many economists expect a US recession to start this year. Any recession might be expected to get worse the more interest rates are hiked – or held at too high a level for too long.

A recession need not have a negative impact on the share market going forward. The US March quarter reporting season has already produced a few stellar results among the large tech companies. Of those companies that have reported so far (approximately 50%), 80% have delivered better than expected earnings for March quarter after earnings expectations had previously been marked down. We think a mild recession has been priced in and this seems reasonable unless the Fed blindly institutes further interest rate rises beyond what is already factored in for May.

Annual US inflation rates are still high owing to the double-digit supply (input price) induced inflation of nearly a year ago. Recent monthly data are now more promising. The Fed’s preferred inflation measures, the Consumer Price Index (CPI) and Private Consumption Expenditure (PCE) indices both came in at only 0.1% for the month of March.

The economic picture here is quite different from that in the US. The month of April ended with an estimated 100% chance of the Reserve Bank of Australia (RBA) being ‘on hold’ in May. The markets were taken by surprise on Tuesday 2nd of May when the RBA increased the cash rate by 0.25% to 3.85% citing concerns of residual strength in inflation as the reason. The RBA press release announced this change also opens the way for further rate increases should the RBA deem them as necessary to contain inflation and return it to the target band of 2% to 3% by mid-2025. Ahead of the rate increase a number of banks had already started cutting some of their mortgage rates!

Our labour force data published in April was particularly strong. The unemployment rate was steady at near a multi-decade low of 3.5%, 72,000 new full-time jobs were created and 19,000 part time jobs were lost. Retail sales were soft, up 0.2% for the month but 6.4% for the year, indicating a slowing in trend growth.

Australian inflation is still a little elevated at 1.4% for the March quarter but the RBA’s preferred variant came in at 1.2%. The annual rate was 7% which is down from the 7.8% recorded in the December quarter of 2022.

A review of the RBA by an independent panel was completed. They recommend a specialist committee be formed to consider interest rate changes and for it to meet only 8 times per year rather the current 11. The changes could actually improve monetary policy implementation and decision making.

The best economic news of the month came in the publishing of China’s economic growth data which came in at 4.5% p.a. when only 4.0% p.a. had been expected. The December 2022 quarter was 2.9% p.a. and the official forecast for 2023 is 5.0% p.a. China’s inflation is also well contained. We see the resurgence of the Chinese economy after the pandemic lockdowns as being a big positive factor in Australia being able to avoid a recession.

The European economy continues to languish with the latest estimate for March quarter growth at 0.1%, narrowly avoiding a technical recession marked by two successive quarters of negative growth. EU inflation was the lowest in a year at 6.9% but the UK is still struggling with inflation at 10.1%.

The ‘banking crisis’ that started in the US regional banks over a month ago does not appear to be spreading materially although there have been a couple of subsequent failures noting that depositors’ funds were protected. We do not think this is the beginning of a systemic issue in the banking system but do note that it is a clear indication that stress and vulnerabilities exist which could lead to isolated issues with other regional banks.

Sadly, the situation in the Ukraine does not seem to be improving. However, the economic consequences for the global economy anticipated at the outbreak of the conflict have not occurred to the extent expected. Food prices are still elevated but their rate of change has settled down and some falls have been recorded. Shipping costs of containers and the like are down over 82% from the pandemic peak and the Covid lockdown in China is largely behind us.

As our base case, we see modest capital gains in the US (S&P 500) and in Australia (ASX 200) to the end of the year and government bond markets have settled down. The worst of inflation is most likely behind us and the annual calculation of inflation rates will soon improve markedly as the previous higher monthly data points fall out of the calculation window.

Asset Classes

Australian Equities 

The ASX 200 bounced back +1.8% in April after a -1.1% decline in March. All industry sectors, except Materials, were firmly in positive territory. The index is up +3.8% for the year to date and +11.3% since July 1 of 2022 (financial year to date).

International Equities 

US equities (S&P 500) rose 1.5% in April and other major developed world indexes were up similarly.  In contrast, Emerging Markets were down  0.9%.

For the year-to-date there are some impressive performances from foreign equities: S&P 500 +8.6%; London FTSE +5.6%; German DAX +14.4%; Japan Nikkei +10.6%; Shanghai Composite +7.6%; Emerging Markets +2.4%; and the World +9.0%.

Bonds and Interest Rates

The US Fed is thought to be on pause now after the 0.25% interest rate increase early in May. However, the ‘CME Fedwatch tool’ which uses current data from the bond market to arrive at an estimate for the US cash interest rate, is reporting a forecast that the most likely interest rate is 4.25% at year-end (48% chance). We caution that these forecasts are very fluid and have fluctuated significantly recently. Our expectation is that this will continue and the Fed responds to subsequent economic data. This current market view is divergent from the view of the US Federal Reserve Board member median view, which forecasts a rate of 5.1% for the cash rate at year end.

Closer to home, following the RBA’s surprise interest rate increase in May, the prospect of further increases is low and will be data dependent. More broadly our expectation is that the RBA will likely pause again in June.

Other Assets 

The price of iron ore was well down over April (-16.9%) but the price is still above $100 per tonne. The prices of oil and gold were largely flat and copper also was down -4.7%.

The Australian dollar fell by -1.5% against the US dollar in April.

The VIX volatility index (a measure of US share market volatility) is now back to almost the ‘normal’ levels at 15.8. Investors seem to be getting more comfortable with the direction of the share markets and appear to be of the view that inflation is heading down and interest rates rises are at or nearing an end.

Regional Review

Australia

Our unemployment rate stayed at a very low 3.5% and net 53,000 new jobs were created (+72,200 full-time and  19,200 part-time) made up the total jobs figure. This composition of the job’s growth data (more full time than part time) is positive for economic growth and shows continuing strong demand for labour.

Retail sales were a bit soft at +0.2% for the month or 6.4% on the year.

The 1.4% quarterly CPI inflation figure was buoyed by a +5.3% education component.

The Federal Budget will be handed down on May 9th. It is widely expected that the government will make some improvements to healthcare.

China 

As the impact of China’s pandemic lockdown subsides, economic growth is bouncing back. March quarter growth came in at 4.5% (annualised) which is not far short of the 5% targeted by the government for 2023.

China CPI came in at  -0.3% for the month and 0.7% for the year. The market expected 1.0% for the annual figure. The producer price index (PPI) came in on expectations at -2.5% for the year.

US

The US recorded 236,000 new jobs which was only just below the 238,000 expected. However, news of big job cuts, particularly in big tech companies is concerning. The unemployment rate was still quite strong at 3.5% and slightly better than expected.

Wage growth at 4.4% p.a. was the lowest for the past year.  CPI headline inflation was 0.1% for the month or 5.0% for the year. The core CPI data were 0.4% for the month and 5.6% for the year as the energy and food prices that are stripped from the headline rate made negative contributions.

The Personal Consumption Expenditure (PCE) measure of inflation, which is preferred by the Fed, was 0.1% for the month and 4.2% for the year in the headline form and 0.3% for the month and 4.6% for the year in their ‘core’ state. The peak PCE rate was 7.0% in June 2021 and that was the highest since 1981.
There was some weakness in economic growth at only 1.1% for March quarter (annualised) against an expected 2.0%. Retail sales were a big disappointment at -0.9% against an expected -0.5% with the annual change now being -3.1%.

As the delayed impact of past interest rates hikes works its way through the economy, we expect growth and sales to remain soft. Jobs maybe resilient for somewhat longer.

Europe 

EU growth was negative in the December quarter of 2022 but backed that up with +0.1% in March quarter of 2023 thus avoiding a technical recession – for now!
Inflation for the region was 6.9% but 10.1% for the UK where 9.8% had been expected, the previous reading was 10.4%.

Rest of the World 

Japan’s core rate of inflation was unchanged at 3.1%. The last time Japanese inflation was higher was 41 years ago.

OPEC+ (+ includes Russia) cut supply by 1.2 million barrels per day and this had an immediate impact on oil prices – which rose 6% to 7% for that day.

The International Monetary Fund (IMF) shaved 0.2% points from its January global growth forecast for 2023 of 3.0% to 2.8%. The 2024 forecast is currently 3.0%

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

Key points:
– What impact has the banking crisis had on interest rates and markets?
– Who/what caused some of the failures in the US regional banks?
– Economy showing resilience – key employment data still strong in US and Australia
– Inflation still above objectives but growing evidence that the high point is in the past

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

There is a lot going on in the world of finance and to make some sense of it, we will do our best to walk you through it in a calm and rational manner.
Cutting to our conclusion, we do not think we are in a crisis – like in 2008 – or anything like it. Yes – some did/will get hurt but the problem is well-contained – at least until the next ‘crisis’ emerges.

Going back to our previous Economic Update of March 1st, no one was talking about banking crises. Indeed, the month started calmly with our growth data release and the RBA decision to increase the cash rate seemingly just as we all expected.

Indeed, the first nine days of March were largely ‘business as usual’. Then, unbeknown to us at the time, a moderately-sized bank in California, called Silicon Valley Bank (SVB) had a $42bn run on its deposits in only one day – a record of sorts. Still unbeknown to us at the time, the next morning, SVB contacted the regulator that it had about $100 bn more of requests to withdraw deposits and it couldn’t make them good. The bank was shut down and events escalated quickly.

Before we get into the details, it is important to refresh our understanding of how banks work. Around the 1960s, life was a lot simpler in terms of financial products and technology. Depending on the jurisdiction, a bank would accept deposits and establish customer accounts then allow customers to transact on them to facilitate their lives and businesses. The bank would only hold about 10% of those deposits in cash (when cash really was cash – i.e. notes and coins) and lend out, or invest, the other 90% often in the form of loans to businesses, home loans and personal loans.

Cash could usually be withdrawn at call (i.e. immediately, when the bank was open – no 24 hour internet banking!) but the loans usually had fixed, much longer investment terms. If depositors suddenly demanded their money back, the first 10% of assets could be offset against the cash holding. 10% then was thought to be a reasonable buffer to withstand the whims and needs of depositors. If more funds were to be withdrawn, there was a problem as the longer-term loans could not usually be reversed at will.

Banks exist for many important reasons. We couldn’t have an efficient society without them. They make their profits on the difference between the interest paid out on deposits and that received on longer term loans. Banks compete with one another on both deposit rates and loan rates to make the system work efficiently.

As we all know, depositors don’t get much interest on simple deposits but they pay quite a bit on home loans and the like. The bank pockets the difference and this is called the ‘net interest rate margin’ (NIM). What happens to fresh deposits that have not yet been lent out in the traditional way? They would usually be parked in safe assets such as long-term government bonds and the like until prudent loans could be made to clients.

Under normal conditions, long-term bonds have a higher yield than short-term bonds and deposits. All is then good for the banks. However, from time to time, particularly when a central bank is trying to slow down its economy, a central bank might force up short-term rates such that there is a so-called ‘inverted yield curve’. That is, short-term yields are higher than long term ones. When this happens, part of the traditional banking model doesn’t work. Such inversions are usually short-lived and there are complex financial products that allow banks to deal with the inverted situations.

Because a bank exists on this model that does not keep 100% of deposits on call, if a situation arises where depositors lose confidence in the bank and are concerned for the safety of their money, they collectively and actively withdraw their capital. This results in a ‘run on the bank’. In the ’old days’ this might have amounted to a queue at a cashier’s counter to take out bundles of notes and coins. Runs do not require logic or fact. Older readers might recall John Laws, the one-time famed Sydney radio announcer, started a run on a bank from some slack comments he made on his show and he got into trouble for it.

Dialling forward many decades and deposits can be removed electronically and moved directly to another financial institution – within seconds or less. No queues; no notes; and no coins!

Let’s return to the SVB case in particular. It has been reported in mainstream media that SVB was ultra successful in attracting new customers. Indeed, they specialised in ‘tech start-ups’ and the like, and some of the venture capitalists who funded these start-ups located around Silicon Valley, even insisted that they use SVB as their bank. As a result, the SVB client base was not diversified in any reasonable sense and the clients were largely very well educated and very well connected (including via social media and other rapid contact methods). Some have suggested SVB was more of a hedge fund than a bank in this regard.
That SVB was particularly successful in attracting deposits was arguably its downfall. It attracted deposits so rapidly that it couldn’t match those assets quickly enough with sound loans so they parked these large amounts of excess assets in seemingly safe long-term US Treasuries – often thought of as the safest assets on the planet.

Let’s now introduce the US Federal Reserve (The Fed). Whether rightly or wrongly, the Fed has been on a mission since March 2022 to raise the Fed Funds rate (short-term interest rate) to bring down price inflation which has undoubtedly been above its policy objective of 2% – 3%.
For many years before, the Fed rate was low and often close to zero. The rapid rise in its rate from just above zero to nearly 5% in less than a year caused the yield curve to ‘invert’. That is, the yield on short bonds became substantially higher than those of long-term bonds. That was a deliberate action to (hopefully) control inflation.

Let’s get back to SVB. It had a rapid run on its deposits for whatever reason. It was rapid because the depositors were sophisticated and well-connected. We saw analysis from reputable experts on CNBC saying that the deposits withdrawn did not go to cash or anything like it. The deposits largely went to the bigger well-known banks or the money market to earn higher returns on savings. This was not a run on ‘the banks’ as a whole, but simply reflected clients making a choice of which bank or institution to deal with.

We have noted evidence to suggest that SVB was not squeaky clean in a number of regards but it also got caught out on the presumption that US Treasuries are all but riskless. If a Treasury is held to maturity (like holding a 10-year bond for 10 years), the holder will reasonably expect to get all of their money back and all of the yield payments along the way. Corporate bonds might well have quite different probabilities of default. However, if a Treasury is not held to maturity, its (mark-to-market) price fluctuates on a daily basis responding intraday to changes in interest rate expectations.

SVB, when faced with a run on its deposits, would have needed to sell its long-term Treasuries at an unexpected loss (on a mark-to-market basis) because the price of a Treasury is inversely related to its yield and yields were being forced sharply upward. As the Fed forced up yields, they forced down the value of SVB’s (and others) Treasuries and the gap was enormous because of the aggression of the Fed policy. Selling a Treasury early can always result in a profit or a loss on capital.

To start a run, it wasn’t necessary for SVB to actually crystalise a loss through selling the long- dated bonds it owned at a loss. Any qualified financial analysts could view the SVB portfolio and realise the increased risk that SVB was facing.

Some have suggested that SVB should have been subjected to the same stress tests that bigger banks faced after the GFC – and that would have prevented the problem. Seemingly expert analysts on CNBC suggested that SVB would have passed such stress tests because the existing stress test was about how a bank could deal with falling rates. There was no stress test for rising rates. Whose fault is that?

So where does this leave us? Several smaller banks have been subjected to runs. That is no different in substance in Australia from people and businesses moving deposits from small banks to the big four or five. We may not like it, but that is business.

Contrast that to 2008 or so when there were complex financial products that no one seemingly fully understood and who owed how much to whom. In the panic most financial institutions then stopped lending to each other – called a credit freeze. Central banks freed up liquidity from the end of 2008 and commercial banks then got back on track. This time around, government agencies merely ‘insured’ the deposits over the traditional $250,000 limit. Problem solved!

This run on SVB and a few regional banks was not nice but it will not knock the global economy off track – or at least that is what we think.

Having hopefully dealt with the ‘banking crisis’ let us focus on analysing market behaviour and possible projections – including any ongoing implications from the ‘crisis’.

At the start of March, Australian GDP growth came in at a respectable, but not stellar, 0.5% for the quarter or 2.7% for the year. The RBA hiked its rate by 25 bps to 3.6% and foreshadowed more hikes to come. This action was largely anticipated.

China surprised a little with some strong economic data and policy objectives.

The US then reported its very strong labour market data which followed an even stronger prior month.

Even the UK dodged the recession bullet with positive growth in Q4, 2022 rather than the expected pull-back and the start of a recession.

Before the SVB collapse, Fed chair, Jerome Powell, was talking about maybe returning to a 50-bps hike at the March 22nd meeting following the smaller 25- bps hike in February. The market started pricing in an e o y 2023 Fed rate even higher than the Fed’s projection of 5.1%. Back in January, the market thought 4.4% was the level. Expectations were swirling; then the story about SVB broke!

Market expectations for the e-o-y Fed rate were rising to the point in time of the SVB collapse but then fell from a high of 5.84% to 3.44% in a week. Panic was permeating the markets. In normal times a small fraction of that change would have been considered big.

US regulators moved swiftly to insure (guarantee) all necessary bank deposits so that depositors were insulated from the collapses. Moves were initiated for bigger banks to absorb some of the stricken smaller peers. Credit Suisse also got into financial trouble but for different reasons. The European Central Bank (ECB) reportedly ‘leant on’ the other big international Swiss bank, UBS, to buy Credit Suisse out and absorb much of its losses. Another problem solved!

Of course, the inflation story had not gone away. New data in the US and Australia pointed to slightly better inflation data – so what would the Fed do on March 22nd? Many suggested the Fed would not hike because of the SVB problems. In the end, the Fed hiked interest rates by 0.25% (25 bps) rather than the 0.50% or 50 bps, touted before the SVB collapse. However, Powell stunned some, including us, in his press conference.

Powell pointed out that there would be a tightening of credit resulting from the problems in the regional banks. He went on to say [paraphrased] that such tightening would act in the same direction as a rate hike and might amount to the equivalent of a 25 bps or maybe 50 bps or more hike. We cannot say with any precision!

So, what Powell has admitted to is a much bigger than anticipated effective policy tightening. That sounds like a recession is on its way to us (if it wasn’t before). The Fed’s 25 bps hike, plus another 25 or 50 (or more) bps from credit tightening spells trouble when we’ve already witnessed problems from the Fed’s prior hiking policy.

We have been arguing for some time that the US couldn’t avoid a recession (either later this year or next) but we think that has already been priced in by the market. That does not mean that share markets can’t go higher from here – with a little bit of volatility thrown in. In due course, we think the Fed will review its policy and go easier on interest rates.

We are (and have been) somewhat sceptical about the tight US interest rate policy for two reasons. First, the supply side problems in inflation (from the Ukraine invasion and the pandemic etc) do not respond to rate hikes. Secondly, because we all agree that interest rates – if they work at all – act with a ‘long and variable lag’. In other words, it might be too soon to know whether the first hikes that occurred in March 2022 in the US and May in Australia, have yet had any impact let alone the subsequent hikes!

But there is a possible lesson from Japanese actions (or lack thereof). Japan just released its inflation print of 3.1% (as expected) which was down from 4.2% the month before (a recent record). You might ask how high did they force rates up to get that effect. The answer is that their official cash interest rate is still  0.1% and the Bank of Japan hasn’t hiked since 2016. Go figure!

The market expects (has priced in) that the Fed will have to cut rates this year as ominous signs of a slowdown in economic growth start to build. However, the Fed is still clinging on to a policy of no cuts to the Federal Funds (Cash) interest rate in 2023!

To summarise – markets have recovered well following the dip after SVB failed. There hasn’t been a material impact on broker forecasts of company earnings as published by Refinitiv. But that could be because brokers do not yet know how to react to recent changes in macro effects.

There is no longer ‘no alternative’ to equities as both bond and cash yields have recovered so a portfolio containing both shares and bonds may have greater merit than in recent years.

The RBA looks like it might be ‘on hold’ after these events. Either way, Australia could dodge the bullet owing to having a smarter central bank and China’s nascent resurgence.

Asset Classes

Australian Equities 

The ASX 200 didn’t have a good month – it was down  1.1% – but it has recovered from the mid-March low. Financials ( 5.1%) got hammered – probably because of the irrelevant knock-on fears from US regional bank woes. Property ( 6.9%) and Energy ( 4.8%) also saw losses.
We have the market as being slightly cheap and earnings forecasts are continuing to hold though we think the risk is, on balance, to the downside.

International Equities 

US equities were up on the month (S&P 500 rising 3.5%) after a big wobble in mid-March. Other international markets had a mixed month. It is too soon to see any new trend emerge but we are of the opinion that markets will work their way through a difficult March and beyond.

Bonds and Interest Rates

The US Fed did equities no favours in its about-face on interest rate hikes. There is a general consensus that the sharp rise in the Fed funds rate caused (at least in part) longer term Treasury yields to rise sharply. Those rises in yields directly caused big falls in the value of portfolios of supposedly safe bonds. Had investors been able to hold on to maturity, investors would have been rewarded but, in this mark-to-market world, assets of many financial institutions caused a mis-alignment between assets and liabilities.

The Fed and the RBA each hiked their base rate by 25 bps. The ECB, not to be outdone, went +50 bps. The Bank of Japan (BoJ) didn’t blink as it hasn’t for around seven years. Its rate is still  0.1% and its inflation rate fell from 4.2% to 3.1%.

The RBA is widely expected to be ‘on hold’ for a month but then go again.

The Bank of England (BoE) raised rates by 25 bps to 4.25% but their inflation rate rose to 10.4%.

Other Assets 

The price of gold was well up on the month (8.2%) but that of oil was well down ( 5.5% for Brent). The prices of copper and iron ore each grew modestly.

The Australian dollar against the US dollar fell by  0.3%.

The VIX, an index that measures US equity market volatility, returned to a level below 20, a more normal level after a period of higher volatility recently. This gives an indication that investors seem to be getting more comfortable with the direction of the market.

Regional Review

Australia

Our unemployment rate dropped back to 3.5% from 3.7% and a bumper 64,600 new jobs were created in February. The number of full-time jobs increased by 74,000 while part-time jobs fell by 10,300. These are incredibly strong labour force figures and indicate a reasonably robust economy during the period.

While the RBA might have wished for weakness in this data as a sign that inflation might soon ease, it has only been 10 months since the tightening cycle started. If the RBA maintains a tight monetary stance, we fully expect the unemployment rate to shift higher quite quickly but at some unspecified future point in time. After a bout of higher unemployment, the rate usually returns to levels consistent with full employment rather slowly.

Our 2022, December quarter GDP growth came in at 0.5% for the quarter or 2.7% for the year. The more important figure from that statistical report was that the household savings ratio, it fell to 4.5% from 7.1%. This fall demonstrates that households are not adding to their savings – whether for retirement or consumer durables – as they do in general.

China 

The Purchasing Managers Index (PMI) for manufacturing expectations came in at 52.6 at the start of March and 51.9 at the end, after having been as low as 47.0 at the beginning of the year. The re-opening of China’s economy after a three-year semi lock-down appears to be going well. The People’s Republic announced that it is targeting 5% or more growth in the coming period.

China seems to be committed to stimulus but with a focus oriented to a consumption led recovery as opposed to development as it has in the past. Evidence of its stimulatory approached was a cut to the Required Reserve Ratio (RRR) by 25 bps for banks, this enables them to lend a little easier.

Retail sales came in at 3.5% p.a. for January-February which was on expectations. Industrial output at 2.4% p.a. missed the expected 3.6% p.a. Fixed asset investment was 5.5% p.a.

US

The US recorded yet another bumper new jobs number of 311,000 – compared to a typical range of 200,000 to 250,000 in good times. The unemployment rate came in at 3.6% following the previous month’s 3.4%. Wage growth was moderate at 0.2% for the month.

CPI inflation came in at 0.4% for the month or 6.0% for the year. Core inflation – which strips out energy and food price inflation – came in at 0.5% for the month or 5.5% for the year.

Producer Price Index (PPI) inflation was actually negative at  0.1% for the month, 0.0% for the quarter and 4.6% for the year.

Personal Consumption Expenditure (PCE) inflation also showed nascent signs of recovery. The core version – which is the Fed-preferred measure of inflation – came in at 0.3% for the month against an expected 0.4% and 4.6% for the year. The headline rate was also 0.3% for the month but 5.0% for the year. While these data do not yet mark a victory for the Fed in its fight against inflation, it does seem to be getting close.

Since wages growth is now modest and PPI inflation shows input prices are not increasing, we expect consumer inflation (both CPI and PCE) to start falling to acceptable levels in the near future. Hence the Fed might soon pause and even consider cuts to its rate.

Both Powell and US Treasury Secretary Janet Yellen are reporting that banks have stabilised after the flurry of activity surrounding the SVB collapse. Fed data on its balance sheet reported at the end of March supported that view. There has been some outflow from banks of various sizes but they are largely offset by inflows to the money market. Some prefer to earn around 4% from the money market rather than close to zero in a bank deposit but the former is not insured as the latter is.

Europe 

UK growth came in at 0.3% for Q4, 2022 when a negative result was widely expected. Its inflation rate jumped back up to 10.4% from 10.1% despite continued increases in the Bank of England interest rate from 4.0% to 4.25%.

The ECB vigorously addressed the inflation issue with a 50-bps hike to its interest rate even though banking problems had just come to light in the US and Switzerland.

Rest of the World

Japan’s rate of inflation fell from 4.2% to 3.1% while the Bank of Japan has kept its rate at  0.1% since 2016.