Economic Update

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Asset Classes

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Regional Review

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Key points:
– Has the US and Australia finally reached a turning point in their interest rate cycles?
– Despite conjecture we think the RBA is done
– The US Federal Reserve has clearly changed its rates position but no cuts until September
– Stock markets finish July with a rally

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
So much new macro and company-specific data are released each month, it would be easy to lose sight of the big picture. Many analysts and commentators react on the same day as a data release; and another day’s data arrives before they can properly digest the previous set of numbers.

It is no wonder, therefore, that different analysts and commentators reach different conclusions from the same data. We think it is not possible to provide a balanced view without a very strong background in at least statistics, economics and finance. And then it still takes time to mull over the big issues.

This monthly is our attempt to take a step back and take stock of, not just of this month’s data and central bank comments, but also have a deeper reflection of previous months of such inputs.

And research, as opposed to commentary, often requires new methods and techniques to be developed to challenge the orthodoxy. Just because someone says raising interest rate quells inflation doesn’t mean that statement should be adopted without challenge. And often, qualifiers are needed to express fully how ‘things work’.

Our monthly investment committee is one forum we use to challenge current popular views. This month, we had a particularly lively interaction. This economic update benefits from the result of that interchange.

There is no doubt that the US Federal Reserve (Fed) chair, Jerome Powell, has modified his view on what monetary policy action is currently appropriate. And others from that institution have also recently changed tack.

In last month’s update we reported that Powell had at last acknowledged that there are serious problems in the way the US data agency calculates the rate of inflation in shelter (specifically rent). This component takes up about one third of the index so it is important to get it right. But Powell said he isn’t currently interested in changing his metrics. But he must now consider that the number he has been fed might be misleading! The official inflation rate prints are severely biased upwards and Powell acknowledged that similar agencies in other countries do a better job.

Next, Powell acknowledged the so-called “Sahm rule”, named after a former Fed economist, Dr Claudia Sahm, which is used to call an impending recession. The rule came close to triggering such a call at the start of July.

The rule is a simple. It measures the increase in unemployment over a year in a particular manner. The media has also picked on this rule and we all await a recession signal (and a recession?) following the August 2nd jobs data.

This indicator was not conceived until 2019 and it didn’t attract any significant attention until December last year. Sahm’s claim is that a recession followed every time the signal called one. While that analysis appears to be correct, it is only based on correlations and not causation – and it has not been tested on a new recession [what we call out-of-sample-testing in econometrics]. The 2022 splutter in the global economy was not a recession in the usual sense as it was caused by lock-downs in the face of the pandemic.

Interestingly, two members of our investment committee independently came up with a similar set of criticisms of the Sahm rule. One of the fundamental problems is that the nature of work has changed since the pandemic arrived. People now often work from home – or in hybrid form – and the proliferation of travel and delivery options from the likes of Uber means that it is so much easier to get part-time work now – even if it is only a temporary solution to pay bills and put food on the table. During the post-Federal Open Markets Committee (FOMC) media conference, at the end of July, Bloomberg reported that Sahm is aware of this issue.

We have no evidence that the Sahm rule will work this time if, indeed, it is triggered. But we agree we would be foolish to ignore it. The media thrives on simple rules, whether they make economic sense or not. If the market reacts to a signal that doesn’t have a strong academic pedigree, others still need to be aware of it. We only have to think back a few years to the false-positive from the inverted yield curve to amplify this point.

If the US unemployment rate goes up one 0.1% point to 4.2% (and there are no revisions to past data) on August 2nd (or later) many people will expect an impending recession (in 6 – 24 months) in the US – and that group looks like including current Fed chair Jerome Powell. We will watch from the side-lines not sure whether the rule needs some tweaking for the new economy. If it is triggered that will force Powell to bring it into his thinking.

Indeed, at his last appearance in Congress, he stressed that the Fed has a dual mandate of maximum employment and stable prices. We don’t recall the last time he stressed that by so much.

And, to complete the warning signals, Powell reiterated that there are long and variable lags between monetary policy changes and their effect on the real economy.

Importantly, William Dudley, a former Governor of the New York Federal Reserve, has flipped a 180 degree turn on policy. He had been one of the prominent ‘higher for longer’ advocates. Towards the end of July, he suddenly said that rates should be cut as soon as possible. There was an FOMC rates meeting on the last day of July. Almost everyone thought that was too soon. September looms large. Powell even said that if things go well, “a cut is on the table” for that meeting.

The probability of a US interest rate cut in September has risen to 87.5% for one cut and 100% for two cuts – as measured by the well-respected CME Fedwatch tool.  There is over a 70% chance of two or more cuts by November 7th and a 75% chance of three or four cuts by December 18th.

We think a rate cut would have been good but we didn’t expect one. September 18th is the date of the next FOMC meeting. Importantly, the annual central bank conference at Jackson Hole, Wyoming, is scheduled for August 22nd – 24th. This year’s agenda is titled “Reassessing the Effectiveness and Transmission of Monetary Policy” and it seems like an excellent opportunity to set the stage for a September cut. There are two jobs and two Consumer Price Index (CPI) inflation measure reports due by the September FOMC.

In the last month or so, the Swiss and Canadian central banks have cut interest rates twice and the list of one-cut-banks is long and growing: China, ECB, and Sweden. Britain seems almost set to cut in August.

Japan just made its second hike in this cycle. Japan is struggling to get back to normal behaviour but from a below-normal rate level.

Australia is the stand out. The RBA rate tracker tool on the ASX website puts the price of a rate increase (hike) on August 6th at 25% as recently as two weeks ago. While there are plenty of commentators supporting an interest rate increase because they think that a hike is needed to bring inflation down, we think they are incorrect in their thinking. The RBA at its meeting on August 6th determined to leave its official cash interest rate on hold at 4.35%.

It is a fact that the latest inflation rate (3.8%) is above the target 2% to 3% zone. But there are two well-argued causes of inflation – demand pull and cost push, or demand and supply causes.

All the big problems in the Australian CPI inflation are due to supply-side factors in: rents, insurance, education, electricity and the like.

The Federal Government did act to alleviate some pressure from electricity and rent inflation. Almost everyone expected the high read for Q2 inflation but, looking to Q3, Westpac has calculated that quarterly inflation will fall from 1.0% in Q2 to 0.1% after the government changes take effect. Westpac is not arguing that the fall in inflation is because of interest rates.

We mention in each of our recent monthly updates that Australia has been in a per capita (household) recession for over a year. Quarterly per capita GDP growth is repeatedly negative. Retail sales volumes (price-adjusted but not by population) just posted its 17th successive monthly negative annual growth rate.

But there is new, even more alarming data. ASIC reported that the number of companies going into administration in the 2024 financial year (FY24) was a third more than in the previous year. Indeed, the FY24 number was greater that the sum of the numbers in FY23 and FY22 combined. It has been reported that around a quarter of the companies in trouble are in the construction sector. That won’t help the rental crisis.

Australia is not alone with corporate difficulties. The US just reported that the number of first-half 2024 filings for bankruptcy and related difficulties was the highest half-year number since 2010!

When we were writing about long and variable lags quite a while ago, we suggested that monetary policy takes 12-18 months to work through the economy. That cumulative effect of rate hikes from 0% to 0.25% to the current 5.25% to 5.50% in the US is now taking its toll – and it will get worse. Australia should not ignore these issues. We believe the first interest rate cut in Australia is needed now and 0.5% would be a good start.

Although politics is outside our remit, we cannot ignore some of the events of July. An assassin got very close to killing former president, Donald Trump. Whatever your politics, there is no room for violence on the streets.

Markets did take a bit of a dive a few days after the shooting. Some say it was related but we don’t know. What we do know is that some markets shrugged off ‘these July blues’ and returned to solid gains. US small cap stocks had a brilliant month (over +10%) so it is not a case of analysts being shy of equities – it’s just a rotation from magnificent-7 (Artificial Intelligence and Technology) type stocks into the rest of the market. And the ASX 200 closed the month above 8,000 again.

The calls for President Biden to step aside from his own supporters eventually had the desired effect. Almost too swiftly, nearly all the major Democrat figures threw their weight behind Kamala Harris.

The betting odds (according to sports betting websites) are still firmly in favour of a Trump victory but there are endless media stories about how Harris has closed the gap. We don’t know if this is fact or wishful thinking. We will find out in November.

Providing all the central banks, including our own, start easing interest rates at a reasonable rate, the extent of any recessions might be contained.

There were some very poor company results filed to the US stock market from mega-cap tech-stocks – but also some good ones! What was refreshing is that, in the sell-off of some big names, the Russell 2000 index – representing small cap stocks – made some good gains (11.1%) during July – as did the ASX 200 (4.2%). Perhaps the market is broadening out rather than pausing.

Asset Classes

Australian Equities 
The ASX 200 climbed 4.2% during July and closed the month at a record 8,092. The utilities sector was down  2.9%; resources and IT were all but flat; there were strong gains across the other seven sectors which included the banks.

International Equities 
The S&P 500 was looking at a slightly down month in July but the FOMC-induced last day rally saw the index gain 1.1% over the month. Other markets were mixed and the World Index was flat at 0.1%.

Bonds and Interest Rates
The US Fed did what was expected of it and more at the July 31st FOMC. There was no change in interest rates but there was a distinct dovishness (easier or lower interest rate policy) in the statement and Powell’s media conference. There is a chance that a soft landing will have been engineered but, as Powell pointed out, there is a long and variable lag on the way down for rates too.

The Bank of Canada and the Bank of China cut rates in July. The Monetary Policy Committee of the Bank of England is divided over whether to cut in August or not. The ECB was on hold in July.

The RBA despite remaining on ‘hold’ has not ruled out the notion of hiking rates despite its twin mandate of full employment and price stability.
Since, in our opinion, the RBA is not appearing to heed the guidance being provided in publicly-available data, we find it difficult to predict what they will do. However, we can say that the longer they keep the overnight cash rate at its current (or a higher) level, the worse will be the impact on the Australian economy.

Other Assets 
Iron ore prices just held above $US 100 per tonne despite falling 4.5% over the month.

Brent Crude oil prices fell 9% over the month to under $US80 per barrel but, popped to $80.72 on the news that Iran’s leader has pledged retaliation against Israel’s attack.

Copper prices fell 6.5% but the price of gold jumped 4.1% over the month.

The Australian dollar against the US dollar depreciated by 2.0% in July.

The VIX index, being a proxy for the cost of an insurance policy against falls in the S&P 500, climbed from a ‘normal’ 12.4 at the beginning of July to 17.7 at the end of the month.

Regional Review

Australia
Employment rose by 50,200 in the latest report (for June) but in percentage terms, the growth was worrying. The annual growth in full-time employment has been falling over the past year and it is now 1.2% which is less than the natural rate of population growth in this country. However, part-time annual growth in employment has been above 6% for the past year, making total annual employment growth look respectable at 2.8% in June.

It has also been reported that the average working week in Australia is running at just over 32 hours compared with nearly 38 hours for the US and around 35 hours for the UK and Canada, such is our dependence on part-time work.

In a separate report, it has been noted that around half of our part-timers would rather be working full time. The current situation is not one of full employment even though the unemployment rate of 4.1% might seem low by historical standards. The world has changed since the pandemic and the RBA needs to be more cognisant of this.

Retail sales quarterly volume came in at  0.3% for the quarter and  0.6% for the year. That makes for seven of the last eight quarters being negative! And that does not allow for the effect of the 2.5+% population growth. Aussies are consuming less ‘things’.

The NAB and Westpac business and consumer sentiment indexes are at low levels but above those at the worst points in past economic cycles.

The monthly and quarterly CPI series were updated on the last day of July. As widely predicted, they were not going to be good but the problem is not excess demand – it is all about supply conditions. The RBA should cut interest rates but we don’t think they will in the near term.

China 
The China Purchasing Managers’ Index (PMI) for manufacturing was steady at 49.5 at the beginning of July. Below 50 is indicative of a weakening economy.

Imports unexpectedly fell by -4.9% but exports rose by 1.5%. Inflation as measured by CPI was 0.2% for the headline rate when 0.4% had been expected. The core inflation read, which strips out volatile items like food and fuel, rose by 0.6% when 0.7% was expected.

Probably because of this weaker data, the People’s Bank of China cut its key lending rate by 0.1% points to 3.35%. We expect further stimulus to follow.

US
The assassination attempt on former president Trump at a Republican rally was fortunately unsuccessful. Since the would-be assassin appears to be a young person who was attached to both the Republican and Democrat parties – and to no known extremist group – there is no reason for us to expect any further fallout. Apparently, the young man’s father (who has 20 guns at home) took him out to a shooting range to practice shortly before the assassination attempt. The US Constitution’s ‘Second Amendment’ (the right to bear arms) has a lot to answer for.

President Biden succumbed to extreme pressure from high-ranking members of his own party to step aside from the nomination for the November presidential election. Biden’s performance in the first presidential debate with Trump was seemingly the catalyst in starting the demand for an alternate nominee.

Perhaps too swiftly, Vice President Kamala Harris was endorsed by just about every major figure in the party. There are conflicting reports about the gap between Harris and Trump in the polls but it is accepted that, despite a strong bias to Trump, the gap (odds on betting sites) has closed since Harris became the Democratic party’s presumptive nominee.

US jobs data deteriorated a little in June. The unemployment rate rose to 4.1% which is just below the 4.2% trigger point for calling a recession under the Sahm rule. We expressed some reservations about using this largely untested rule elsewhere in this update. Since we believe others, possibly including the Fed, are more confident in the rule, it could play a major factor in affecting monetary policy and, as a result, market behaviour.

Economic growth as measured by the change in Gross domestic Product (GDP) jumped out of the blocks at 2.8% (for the year) in the June quarter when a more modest 2.0% had been expected. But retail sales volume over the year came in at -0.7%!

Of the many inflation rate indicators published each month, two seem to have given markets and the Fed some optimism. The CPI for the month was  0.1% (largely because gasoline price inflation was -3.8%); the Personal Consumption Expenditure (PCE) reading at the end of July was 0.1% (or 2.6% for the year).

As we repeatedly state, the shelter component is poorly estimated and distorts the CPI and PCE measures. In our opinion, the inflation rate of ‘everything but shelter’ has been contained for a year and is consistent with the Fed target of 2%. Since Powell clearly stated that he does not have to wait until the aggregate measure is 2%, we think he has opened the door for an imminent interest rate cut.

Europe 
The UK economy rebounded with a 0.4% GDP growth rate in May following 0.0% in April and 0.7% for the March quarter. Inflation came in at 2.0% but 1.9% had been expected.

The Bank of England and the European Central Bank (ECB) are behaving cautiously about relaxing monetary policy (reducing interest rates further).

A Labour government took office in the UK in a landslide victory in July. The Tories (Conservative party) had been in office for 14 years!

Rest of the World 
Japan missed on both its imports and exports predictions. These data were not enough to cause concern over its economy – but it does make us sit up and wait for the next numbers. The Bank of Japan (BoJ) increased interest rates for the second time in this cycle but only to 0.25%.

Canada’s interest rate cut in July was its second such cut in two months.

The conflicts in the Ukraine and the Middle East show little sign of an imminent resolution.

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

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

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

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

The Big Picture

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Without evidence to the contrary, we remain cautiously optimistic.

Asset Classes

Australian Equities

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

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

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

International Equities

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

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

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

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

Bonds and Interest Rates

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

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

Other Assets

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

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

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

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

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

Regional Review

Australia

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

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

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

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

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

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

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

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

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

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

China

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

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

US

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

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

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

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

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

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

Europe

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

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

Rest of the World

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

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

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

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

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

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

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

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

The Big Picture

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Asset Classes

Australian Equities

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

International Equities

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

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

Bonds and Interest Rates

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

Other Assets

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

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

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

Australia

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

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

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

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

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

China

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

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

US

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

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

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

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

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

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

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

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

Europe

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

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

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

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

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

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

Rest of the World

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

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

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

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

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

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

Key points:

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

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

–  US economic growth softens in the March quarter.

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

The Big Picture

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Asset Classes

Australian Equities

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

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

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

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

International Equities

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

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

Bonds and Interest Rates

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

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

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

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

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

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

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

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

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

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

Other Assets

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

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

Regional Review

Australia

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

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

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

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

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

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

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

China

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

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

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

US

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

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

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

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

Europe

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

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

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

Rest of the World

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

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

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

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

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

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

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

The Big Picture

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Asset Classes

Australian Equities 

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

International Equities

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

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

Bonds and Interest Rates

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

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

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

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

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

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

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

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

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

Other Assets

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

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

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

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

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

Regional Review

Australia

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

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

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

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

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

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

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

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

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

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

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

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

China

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

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

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

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

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

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

US

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

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

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

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

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

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

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

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

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

Europe

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

Rest of the World

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

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

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