Economic Update

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

Key points:

– Central banks send mixed messages in their approach to addressing inflation

– Australian retail sales easily beat expectations indicating a level of consumer confidence

– Ukraine exports start to flow which is hoped will dampen food price inflation globally

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 us.

The Big Picture

The price of iceberg lettuce on the east coast of Australia just fell by 80% in a matter of weeks! Was this because the Reserve Bank of Australia (RBA) lifted its overnight borrowing rate from 0.1% to 1.85% this year with the prospect of more to come soon? No!

One doesn’t even need a high school education in economics to realise the iceberg problem was caused by extensive flooding and other adverse weather conditions in the east. Supply was crushed so farmers needed more per head for the smaller quantity they had to sell and some people were prepared to pay up to $13 a head for the privilege. For whatever reason, the supply of icebergs is back to normal – at least for the moment – and the price has returned to $2.49.

We are not trying to trivialise the current policies of various central banks but there is a strong parallel between this example and what some central bankers are saying.

Recently, the US Federal Reserve (Fed) chairman, Jerome Powell, made a strong statement at the annual global central bankers retreat at Jackson Hole, Wyoming. He went from being mild mannered earlier in August to a statement that pointed to the fact that ‘pain’ would be felt by many households and businesses as he kept increasing interest rates to rein in inflation and return it to within the 2% to 3% p.a. range. This, he said, was not a time to stop or pause the hiking cycle. Naturally, the S&P 500 on Wall Street fell over  3% that day and even further over the rest of the month!

We are not aware that the US has an iceberg lettuce problem but the world is suffering from high energy and general food prices partly caused by the Russian invasion of the Ukraine and supply-chain issues partly caused by China’s zero Covid policy.

None of these three supply disruptions will be cured by hiking interest rates. But there is a big difference between the price of lettuce and the price of food, energy or computer chips. Most, if not all households, can readily find a substitute for lettuce in their diets – or just forget about lettuce altogether. No one really needs to spend $13 on a lettuce! People around the globe are suffering big increases in energ¬y and food bills that they can’t afford and they can’t find a substitute for.

On top of the additional expenditure on fuel and food, any increases in interest rates – or holding them at high levels – to wait for general inflation levels to revert to normal causes corresponding hikes in mortgage and credit card repayments – and the cost of servicing business loans. That makes the pressure on the ability to pay for energy and food even greater.

What we have experienced in recent months are wild swings in economic data and a complete turnabout in the policy statements being issued by central banks. The 10-year bond rates in the US and Australia are going up and down in a wide range on these ‘news’ switches. That means households and businesses find it even harder to plan for what loans they can reasonably afford to take out – and that in turn affects the price of most goods and services and, in particular, housing.

To give a concrete example for Australia, at the start of August this year, the market was pricing in an RBA rate of 3.8% by the end of the year (from the then 1.35% rate) and a peak of 4.4% sometime during 2023. Just after the RBA board meeting on the first Tuesday of the month, the market priced in a reduced peak of only 3%. At the end of August, after the Jackson Hole meeting, that peak was raised back up to 4% from 3%. So, what should potential mortgagees and business owners do and what are the implications for investors?

Quite possibly, prudent, risk-averse people would allow for a higher rate than might or might not happen – or even being contemplated by the RBA behind closed doors – which means demand for housing goes down more than it needs and with it house prices. It is a commonly held view that falling equity in residential property from households not actually trading in property puts a dampener on their other retail expenditures.

As it happens, data on Australian retail sales for July just came in very strongly at +1.3% when only +0.3% had been expected. Also, for July, the unemployment rate even fell to a ‘tiny’ 3.4%. What will the changes in central bank ‘jawboning’ do to actual sales and unemployment during and after the August swings in sentiment? We can’t be sure but it is very unlikely that such behaviour by central bankers is helping to smooth the economic cycle.

Let’s also look at some relevant facts. And facts are relatively sparse in these debates. Unsubstantiated opinion counts for little. The Fed’s preferred measure of inflation is known as “core PCE”. Core refers to the fact that volatile energy and food price inflation is excluded from the calculation. PCE stands for Personal Consumption Expenditure. There is also a headline rate that does not exclude the volatile components. On top of that there are the core and headline CPI inflation results to which many other countries mostly relate.

The US usually relies on annual data for GDP growth and inflation that compares the current underlying figure for the level of GDP or the CPI with the corresponding period 12 months before. That means it takes 12 months for a big change in GDP or prices to work its way through the calculations. Of course, the US also produces monthly estimates for inflation and quarterly estimates for economic growth that do not suffer the overhang problem but these more regular data points are more likely to jump about a bit when underlying growth or inflation are not changing much.

As it happened, on the morning of Powell’s Jackson Hole speech, the PCE measures of inflation were released – only hours before he spoke – so he should have known that the latest headline monthly read was actually 0.0% and the core read was +0.1%. Hardly the stuff to inspire panic. Indeed, it is not possible to get a much better read as deflation (indicated by these numbers being negative) is, perhaps, even more scary than inflation!

Earlier in August the CPI reads came in. The headline monthly read was 0.0% and the core read was +0.5%. So, of the eight numbers produced on inflation each month, the Fed focuses on the big scary annual figures that include the overhang and not the benign monthly numbers we just quoted. And the month before (June) the statistics weren’t bad either – but not quite as good. There is building evidence that the worst of inflation may be behind us but it is not (yet) the time to celebrate its demise.

It’s not just the traditional measures of inflation that are giving us some hope. It was reported that US freight prices – one of the supply-chain issues fuelling general inflation because of a shortage of truck drivers amongst other factors – were up +28% on the year but actually down  2% on the month. And monthly house prices are down for the first time in three years. The Case-Shiller index is up 18% on the year but down  0.8% on the month.

So, from a monetary policy perspective we believe that central bankers are in general terms viewing their world, inflation and their respective economies through the following lens:

“All price inflation hurts all households but they (central bankers) cannot control all prices. Some increases are from so-called supply shocks such as the China chip shortage, the Russia energy supply rationing and the Ukraine grain export blockages. But those price increases, as well as some from other sources, are causing some ‘demand-side’ pressure through local wage increases and the like.

They will do what is needed to bring down demand-side inflation with interest rate policies but, after deciding what amount of inflation cannot yet be controlled, they will ease off this policy measure before they cause unnecessary damage to the economy.

They monitor inflation not just by looking at headline numbers but also components, month-by-month, taking care not to over-react to potential statistical blips.

Since households are hurt by prices that are higher from whatever source, governments need to be mindful of the upward pressure this in turn puts on wages. They cannot afford policy that leads to a wage price spiral, such as that which existed in the 1970s and 1980s when wage expectations fed off price increases that circled back into price rises”

At the latest report we have seen, 30 ships had left the Ukraine’s Black Sea ports loaded with grain and have made it to safe harbours in Turkey and beyond. The plan is apparently to increase this flow to 100 ships per month. If this occurs it should take some pressure off food prices – not just grain but, say, egg prices as they rely on the price of grain to feed the chickens.

Since 40% of Germany’s energy comes from Russia it will find a hard time trying to side-step that issue. But in the UK, which also has had major energy price surges, the incoming replacement for Boris Johnson is considering reversing some of the green initiatives regarding reliance on fossil fuel. It is all very well to want to switch to renewable energy but not until sufficient clean energy is available. There is a long, cold winter ahead and little tolerance for those who stopped all fossil fuel developments.

Despite the implications we here in Australia, the US and developed Europe are having in relation to inflation and interest rates, in other parts of the world the same situations exist but the effects and the policy responses are amplified significantly.

For example, Argentina has its cash rate at 69.5% and inflation is at 74%. On the other hand, Turkey has inflation running at 80% but it just cut its reserve rate from 14% to 13%. Japan, which glided through the 1970s and 1980s when most of the world suffered from stagflation (slow or negative economic growth and high inflation) without pursuing tight monetary policy is doing it again.

The Bank of Japan was again on hold in August; it is not falling into the trap of pushing up rates because that is the global trend!

It is difficult to know how to paint an economic picture for 2022/23 without knowing how far central banks will take monetary policy settings with respect to addressing inflation. If they push too hard a recession is likely – almost inevitable. If they ease soon, a recession might be avoided and inflation might come back if and when the supply pressures subside further. If they ease too soon, demand-side inflation might take hold as it did in the recent past. It is not easy being a central banker, particularly now. While the macroeconomic outlook is more uncertain than usual, it is important to remember that informed advice is also experiencing the same challenges but it is founded on proven principles that have been tested many times through history. This does not mean that financial pain will not be experienced, but hopefully that it is minimised.

Australian Equities 

During the first half of August, the ASX 200 continued the stellar run which began in July. Then, along with the S&P 500 and comments from the Fed, our index plunged sharply, recovered back to its August peak and the fell again to finish just about flat for the month.

The Energy and Materials sectors were the clear leaders in August. The Financials and Property sectors were among the worst performers most likely on the back of interest rate outlooks and property prices.

Although our earnings season is ‘on’ it hasn’t been grabbing the usual attention as bond market movements have taken centre stage. Our analysis of Refinitiv broker-forecasts indicate that capital gains prospects for the next 12 months are now a little softer than average but it is too soon to draw a strong conclusion. Brokers take different amounts of time to update their forecasts and company reports are spread out over many weeks.

International Equities 

The S&P 500 also extended its July run well into August but it faltered as the Fed raised rates, gave a hawkish outlook, and then finished August with Jerome Powell’s Jackson Hole speech.

Unlike the ASX 200, the S&P 500 was well down on the month – by more than 4%. The other major markets were quite mixed in the sizes of their capital gains.

The VIX ‘fear gauge’ almost returned to its normal operating range at the start of the month but rose sharply at the end of August.

Until we see how the Fed performs at its next meeting on September 21, it is hard to see there being any clear direction for Wall Street.

Bonds and Interest Rates

The Reserve Bank of Australia (RBA) again lifted its overnight borrowing rate by 50 bps this time to 1.85%. Other central banks including the Fed, the Bank of England (BoE) and the Reserve Bank of New Zealand (RBNZ) also lifted rates but, interestingly, the Bank of Japan was on hold at the last meeting and the Bank of Turkey actually cut its rate from 14% to 13% even though its inflation is running at 80%.

It is clear to many – not just us – that many central banks are implementing strategies that do not fully recognise that much of the inflation problems is the result of supply-side issues.

The CME Fedwatch tool, which is a standard when it comes to estimating what the market is pricing in for Fed rate hikes, had, until recently, a stable probability of there being a 50 bps or 75 bps hike in September with the latter being a bit more likely at 60%. The Jackson Hole speech by Powell on ‘pain’ from rate hikes has taken that latter probability to more like 72%.

The yield curve across the full range of government bond maturities is now clearly higher than a month earlier. Since most countries have not yet pushed cash interest rates above the neutral rate (2% to 3% p.a. here and in the US) and most real rates (i.e. allowing for inflation) are negative, the impact of higher rates is yet to have a material impact. A recession in the US or here is not our base case but something close to ‘no’ or ‘low’ growth might well occur – the so-called soft landing.

We believe that unless central banks soon pause their interest rate hiking strategies, an economic recession may well follow.

Other Assets 

The prices of Iron Ore and Oil fell in August while Copper was flat. Our currency against the $US softened by  1.5%.

Australia

For the first time in 2022, there were some mixed signals in the labour force data. The unemployment rate fell to 3.4% which is the lowest since the early seventies. But July witnessed the first fall in total employment this year – and it was by a sizable  40,900 jobs. On its own, there should be no alarm for one bad employment result from this small sample survey – but we will keep an eye on it next month. The total number of hours worked fell by  0.8%.

On the wages front, Australia recorded an annual increase of 2.6% including a 0.7% increase for the quarter. While that sits well with the long-term average, the latest CPI inflation read was 6.1% eclipsing the nominal wages read. Workers fell behind by  3.5% (= 2.6% – 6.1%) over the year in so-called real terms. That is the extent of the cost-of-living crisis.

The big data surprise for the month was the beat in retail sales. A rise of +0.3% was expected but the outcome for July was +1.3% and that is well ahead of what might be thought of as a monthly inflation read (Australia does not publish monthly inflation data like the US).

China 

China is highly unlikely to get anywhere near producing the official expectation for economic growth of 5.5% this year.

Retail sales limped across the line at 2.7% against an expected 5.0%. Industrial production fared a little better at 3.8% against the 3.9% of the previous month – but 4.6% had been expected. It is unusual for China data to miss expectations by so much.

Nancy Pelosi, the Speaker of the US House of Representatives, made an unusual visit to Taiwan at such a sensitive time. There were no scheduled official meetings but it drew the ire of China. Just before she departed the island, China flew 25 fighter jets over the area.

Since China is yet to abandon its zero-Covid policy, it is hard to see the supply chain issues – particularly around chips for cars and other machines – easing materially any time soon.

US

The US posted a massive nonfarm payrolls jobs number. 528,000 new jobs were created in July and the unemployment rate was again a very low 3.5%. The strength of this number caused the market to incorporate tighter monetary policy and so another month for share prices got off to a bad start.

The Inflation Reduction Act finally got passed into law. It is a policy concerning climate change, health care and taxation. It doesn’t seem to say a lot about inflation except in the name of the bill.

It has taken a long time for Biden to get his pet project through Congress. In the process, his approval rating has plummeted and the mid-term elections on the 8th of November are looming large.

A recent survey reported by the New York Times, found that only 17% of the population approves of the direction Biden is taking. A massive 77% disapprove of the direction in which the US is heading. That is a lot of unhappy people in a country of 330 million.

With a slim majority in the lower house and the Senate controlled by the casting vote of the Vice President, there is talk reported of needing a new Democratic candidate in two years to stand for President.

The US is also facing a new phase in its post-GFC recovery. From now, QT – or quantitative tightening – starts in earnest. QE – or quantitative easing – undoubtedly helped the economic recovery by lowering longer-term interest rates and increasing liquidity. After a period of pausing the bond buy-back policy, QT is getting underway by removing $95 bn per month from the government debt of $9 trillion. It is uncharted territory but we all probably remember the taper tantrums when QE was first eased – and now it is now being reversed!

We are arguing that there are some nascent signs of a recovery in US inflation. Retail sales came in flat for the month in line with expectations. Sales, excluding autos were up by 0.4% for the month possibly reflecting the chip shortage. There is a shortage of new cars forcing up the price of used cars.

Europe 

Europe is facing a cold, miserable winter unless something can be done about the energy supply from Russia. Germany takes 40% of its supply from that country.

The debate between the two candidates vying to replace Boris Johnson as PM have each flagged reversing some of its green policies. While it is laudable to want clean energy and a zero-carbon footprint, it makes little sense if people can’t afford the energy for heating and cooking.

The Bank of England (BoE) is forecasting inflation of 13.1% for October and the latest reading of 10.1% is the largest number in over 40 years. Interestingly, the BoE is predicting inflation returning to 2% by 2025. Perhaps they know something about Russia’s plans than we don’t.

Rest of the World

The Reserve Bank of NZ (RBNZ) raised its rate again by 50 bps to 3% well above our 1.85% at the same point in time. It is not clear that the NZ population is happy with its economic management.

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

Key points:

– Market volatility has been high driven by inflation and interest rate concerns, Stagflation seen as a risk

– US Fed and Australia’s RBA lift cash rates but bond rates ease from highs achieved early in May

– China is stimulating its economy as Covid case numbers decline

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 our team.

The Big Picture

We’ve had a turbulent couple of months on equity markets – to say the least! The new source of angst was from the Federal Reserve (“Fed”). Not only did they institute a big (0.50%) rate hike but they talked really aggressively about what might come next.

This policy aggression – or “hawkishness” – spooked bond markets. Yields on longer dated bonds e.g. 10 year Government bonds, jumped up sending the prices of high growth stocks – such as those of large mega-tech companies – tumbling in some cases. That took down the tech-based Nasdaq index to a level just shy of -30% from its December 2021 high, though there was a lesser impact on the S&P 500 because of its inclusion of all of the other industry sectors. The Dow (Jones Industrials index) was much less affected. For similar reasons our market falls were cushioned by our relative lack of a tech sector.

It is really important for investors to understand what is motivating the Fed and many market analysts. Some people have been talking about recession for some time but now the word “stagflation” has become more front of mind.

The term “stagflation” was coined in the mid-1960s in Britain by the then Chancellor of the Exchequer. It didn’t get mentioned again until 1970 and then became the word ‘du jour’ after the absolutely massive 1973 and 1979 OPEC oil price hikes. If you think recent oil price rises are big, check out what happened in 1973. Such a shock to the price system is called a “supply shock” because it is separate from the demand pressures that so often cause inflation.

Stagflation occurs when there is persistently high inflation coupled with sluggish (or worse) economic growth. The simplest explanation for those times and today is the following. A supply shock such as that caused to oil prices by OPEC in the 1970s or Russia in 2022, sparks high inflation. The central banks go out to quell inflation by hitting the monetary policy brakes – that is raising interest rates and possibly other measures.

If the cause of inflation cannot be cured by raising interest rates (as is the case for supply shocks), economic growth falls producing stagflation as inflation is largely impervious to the actions of central bank policy actions.

Conversely, when demand pressures are causing inflation, higher rates can cure an inflation problem. However, because of the long lags between raising rates and the real economy reacting, central banks can (and often do) cause recessions. It needs to be remembered that central bank monetary policy and Government fiscal policy (expressed through the budget) are blunt instruments hence policy mistakes are not unusual.

In the 1970s, when monetary policy supposedly came of age under the leadership of Nobel Laureate Milton Friedman, the lag between raising rates and economic response was thought to be 12 – 18 months. Since then, financial markets have become far more complex.

Many of us now rarely use cash for anything! Most of us didn’t have a credit card in 1970. There are now also complex derivatives in financial markets that allow the size of financial transactions to be scaled up enormously. We doubt if anyone currently has a good handle how long the monetary policy lag is, but we think it would at least be a few months and possibly a lot longer.

Few serious analysts would doubt that we have been experiencing supply shocks for a couple of years: oil price rises from OPEC activity; both energy and grain prices from the Russian invasion of the Ukraine; and the supply-chain problems largely coming out of China because of covid-related lockdowns. There is equally good reason to assume that these supply shocks will not respond to rate rises in the US or Australia.

Because of the past lockdowns in the US, Australia and Europe – and the change in work habits that followed – labour has been harder to find in some sectors as we strive to get back to normal. In a sense, a reduced post-covid-workforce could be thought of as a supply shock. But the wage increases we are seeing are in part demand related.

Workers are being bid away from home or other jobs and workers also want to be compensated for the higher prices they are undoubtedly facing. Higher rates make it more costly for business to raise capital and can put downward pressure on that part of the inflation problem.

For much of the first part of the supply shock inflation problem, the Fed chair, Jerome Powell, sensibly told everyone not to worry about it. But, as the problem got bigger, and seemingly some Fed members were playing political games by saying the Fed was behind the curve, Powell started to lose his nerve.

The Fed hiked a “double notch” of 0.50% points at the start of May but Fed Chair Powell said he was not considering bigger hikes going forward. Markets became volatile as different interpretations of the current regime took centre stage. There was a very big US CPI headline inflation read of 8.3% but the Fed prefers the so-called “core” inflation numbers that strip out volatile energy and food prices. The core read was a more acceptable 6.2% but still very much above the 2% Fed target.

The problem with the US inflation data is that they focus most attention on the annual read comparing say this April’s prices with those in April 2021. In normal times there is no real problem in doing this. Indeed, there can be advantages in smoothing out statistical noise.

But when a big blip of a few months’ duration comes along, it takes months and months to notice inflation has really gone up. Equally, it takes months and months for the annual inflation rate to fall back to normal as the blip passes through the 12-month data window.

The US does also publish monthly data. The latest read for April was 0.3% for the headline rate and 0.9% for the core variant. There are two really important observations to make here.

Firstly, the 0.3% headline rate was the equal lowest in 12 months. Now, it could just be a statistical blip. We won’t know for at least a month or two, maybe more. Second, and more importantly, the core value was above the headline number. This means the volatile energy and food prices actually deflated in April! Could this be indicating the situation already be self-correcting?

Along came another variant of inflation later in May – the so-called PCE (Personal Consumption Expenditure) measure. The Fed has long-held it prefers this variant. The headline PCE monthly rate came in at 0.2% from 0.9% in the previous month. The core version was 0.3% for the second month in a row. This result could be more evidence that the supply shock impact is subsiding.

Now, energy, food and other prices are still high, but inflation measures a relative change from one month to the next. For inflation to remain high, energy prices and the rest would have to keep rising.

We are not yet prepared to make the call that inflation will naturally fall over the course of this year but we, and presumably the Fed, will be monitoring its progress very closely.

The current Fed funds (cash) rate is a range: 0.75% to 1.00%. The commonly held belief is that the neutral rate is somewhere around 2.5% in the US and 2% to 3% in Australia. When rates are below the neutral rate, policy is said to be accommodative (supportive of economic growth). When the cash rate is above neutral, the policy is considered contractionary (restrictive for economic growth).

The Fed has forecast they will make at least another two 0.5% hikes to the Fed funds interest rate before they start slowing the economy down.  This is likely to occur at their next meeting in mid June and again in early August. By then it will be reasonably clear whether or not the inflation problem has started to self-correct and the modest hikes toward the ‘neutral’ interest rate may take some sting out of any demand-pull inflation.

The Reserve Bank of Australia (RBA) is well behind the US in raising it official cash rate. The RBA just lifted its rate from 0.1% to 0.35% in May. In its meeting minutes, it did say that it considered a bigger hike to 0.5% which would have brought its rate back to a scale calibrated in 0.25% increments which is has been historically.

Both the US and Australia have strong but not “hot” labour markets. We are cautiously optimistic that neither central bank will cause stagflation. They have stated that they are aware much of inflation is due to supply-side problems.

In the meantime, consumers are facing higher prices. When inflation runs ahead of wage inflation – which it is – consumers are becoming worse off and need to be compensated. The choice is between wage rises and temporary government payments. The latter might be preferable to locking in wage inflation expectations.

The Bank of England has stated that it thinks they will experience a recession in the UK starting this year. China has been cutting some rates and stimulating the economy to compensate for the Shanghai (and other industrial cities) Covid-lockdown.

The S&P 500 did temporarily enter bear-market territory in May by falling below 20% from the recent peak in early January. The ASX 200 didn’t quite fall 10% to mark a correction. Both indexes made substantial gains in the closing days of May. If inflation pans out as we think it might, both indexes could be well on the way to at least recovering some or all the drawdown experienced so far this year. Despite this more positive outlook there will still probably be a few big wobbles along the way as the Russian invasion of the Ukraine continues.

Bond yields have climbed over the year but even at their recent peak in early May they are not compelling competition for the dividend yields on stocks let alone the prospect of possible capital gains on equities.

Earnings forecasts collected by Refinitiv support the notion that the fundamentals of the underlying businesses of the companies comprising the S&P 500 and the ASX 200 remain strong.

Australian Equities 

The ASX 200 shed 3% in May despite the very strong two-day rally near the end of May. However, the index has only lost 3.1% over the year-to-date. Given that this index was down 9% at one point, the strength of the rally is encouraging for future gains.

The consumer staples ( 6.7%), IT ( 8.7%) and property sectors ( 8.7%) were the worst hit in May. No sector performed exceedingly well.

International Equities 

The S&P 500 was flat over May despite its turbulent day-to-day movements. Some other major indexes gained over the month, key examples are: England’s FTSE (+0.8%); Germany’s DAX (+2.1%) Japan’s Nikkei (+1.6%); and the Shanghai Composite (+4.6%). Interestingly, broader Emerging Markets ( 0.5%) lost a little ground.

Bonds and Interest Rates

The RBA lifted its overnight cash interest rate from 0.1% to 0.35% at its May meeting. It also said that it would start to reduce the total government debt by letting maturing bonds ‘run off’ in an organised fashion.

Since inflation in Australia is far from the problem it is in many other countries, there should be less temptation for the RBA to just keep hiking in an aggressive fashion.

The governor, Dr Philip Lowe, is particularly well educated in economics and he is of a conservative disposition. We think it will be some time before he will look to push up rates to the neutral rate of 2% to 3% (as recently stated by Dr Chris Kent of the RBA) let alone above that band.

The Fed has put out some seemingly contradictory statements about how US monetary policy might unwind this year. The market is expecting a total increase of more than 2.5% in the Fed funds cash rate in relatively short order and some are expecting this rate to be above 3% by the end of the year. The key to this for us is what happens to the monthly inflation read over the next three or four months. These rate expectations can turn on a pin head.

The US 10-yr government bond yield got above 3% at one time during May but it is now back to around 2.75%. The Australia 10-yr made it to over 3.5% before retreating a fraction to around 3.2% and then up slightly to close the month at 3.4%.

Other Assets 

Gold, iron ore and copper prices all retreated over May but in a measured way. Both West Texas Intermediate Crude and Brent Crude oil prices climbed close to 11% and are back to around the recent highs. Indeed, at the end of May, the EU decided to limit Russian oil imports which seems to be pushing prices even higher.

The Australian dollar was largely flat over May (+0.5%). The Volatility (VIX) fear index, measuring equity market volatility, fell markedly and almost back to the high end of normal levels.

Australia

Australia produced some very unexpected results in its Federal election on May 21. The Labor Party is able to form a majority government. The coalition lost its potential successor to Scott Morrison, Josh Frydenberg, leaving Peter Dutton to lead the coalition.

High profile former Labor Senator, Kristina Keneally, lost a healthy majority and more. She is now in the political wilderness. The “teals”, seemingly a mix of green/LNP independents, gained a number of seats taking the independent member total to 10 in the lower house.

The April labour force data released in May showed the unemployment rate held steady at 3.9%, a multi decade low, even though only 4,000 new jobs were created.

Wages rose by 2.3% for the year lagging far behind the latest CPI Inflation read.

China 

The China monthly data of retail sales, industrial production and fixed asset investment all missed expectations – some by a lot. Much of this negativity comes from the zero-covid policy that led to the shut-down of Shanghai – the commercial and industrial hub.

The China official manufacturing PMI (Purchasing Managers’ Index) came in at 49.6 at the end of May. While below the 50 mark that indicates contraction (above 50 indicates expansion), it was well up on the 47.4 recorded in the previous month.

It has been reported that the Shanghai lockdown has started to be eased – as from the first week of June. Easing should help these economic indicators improve substantially and rapidly.

On top of the easing of restrictions, China lowered a key mortgage rate in May and flagged a $US 21 bn stimulus package to help the economy recover. We think that if this amount turns out to be insufficient, China will not hesitate to keep turning on the tap until stability in growth returns.

The China zero-covid policy has been considered largely a disaster by the western economies. Economically, it will be important that China abandon or at least significantly ease this policy should other outbreaks occur in the future.

US

There were 428,000 new jobs created as reported in the latest monthly labour report and the unemployment rate remains at 3.6%.

The US economy has some room to move as the Fed raises interest rates through this hiking cycle. Fed Chair Powell has stated that he wouldn’t be worried if the unemployment rate went up a notch or two as a result of his rate hikes. Presumably he hopes that his own position wouldn’t contribute to that increase!

Europe 

Norway and Sweden flagged their intent to become members of NATO – a similar issue that possibly sparked the Russian invasion of the Ukraine when it moved to join NATO. However, there does not yet seem any extra hostility following Norway and Sweden’s stated intent.

EU inflation came in at 8.1% at the end of May.

Rest of the world

Oil from Russia to North West Europe has fallen about 80% since the start of the Russian invasion. The volume of oil “at sea” has nearly trebled as Russia goes in search of other, more distant markets such as India and China.