Economic Update for September 2023
In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.
Key points:
- The impact of interest rate increases is starting to appear in economic data
- China is struggling to reinvigorate its economy
- Equities take a breather
We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please get in touch with the team.
The Big Picture
Backward looking inflation data, with most of the level being delivered in the early months of the data reporting window, has our current inflation rate at 4.9% annualised. However, if we take our guidance from more recent data (calculated on a rolling quarterly basis and then annualised) then we are seeing a level that is within the RBAs target band of 2%-3% p.a. The past three-monthly observations for this series being 2.4% p.a., 3.1% p.a. and 2.7% p.a. respectively.
On this basis the RBA should be encouraged that their monetary tightening policy is delivering the results intended and, save for a sudden inflation shock, be sufficient to tame inflation and not require further interest rate increases.
Further support for this position is evident through the latest retail sales data in Australia. The June quarterly result was -0.5% when measured in volume terms (i.e. removing inflation effects) and -1.4% for the year. The latest three quarterly results have all been negative.
Employment data was also softer as 15,000 jobs were lost in the latest month but that figure masks a worse outcome for full-time jobs which were down 24,000 because there was an offsetting gain in part-time positions. In July our unemployment rate went up from 3.5% to 3.7% indicating a deteriorating employment environment. The Westpac consumer confidence index also fell.
By taking a similar approach to observing US inflation data, its rate has also improved and looking contained, but there are so many alternative variants of that measure. Focusing on the measure that consumers actually face (CPI), and for the latest quarter and not the whole year, the latest read was 1.9% which is just under the Fed’s stated 2% target.
The US did record 185,000 new jobs in the latest month but three factors contribute to our view that this number was weak. First, it was 15,000 jobs less than expected. Second, 87,000 of those new jobs were in government and ‘health care & social assistance’ sectors which are typically not growth sectors. Third, the 209,000 new jobs for the prior month were revised downwards to 185,000.
During August, one of the big three ratings’ agencies, Fitch, downgraded US debt one notch to AA+ because of the debt default deliberations. Moody’s, another big ratings’ agency, down-graded 10 US banks and put six big banks on negative watch. Home affordability was reported to be the worst in 38 years, and the Fed just hiked its interest rate again in late July to the highest in 22 years.
The annual Fed-sponsored conference in Jackson Hole, Wyoming, was held at the end of August. Fed Chair, Jerome Powell, emphasised the need to keep policy restrictive and to be data dependent!
Is anybody winning? Well Japan hasn’t flinched yet still keeping its negative interest rate (-0.1%) on hold since 2016. Its latest inflation read was 3.1% and its economic growth rate for the June quarter was 6.0% (annualised). However, there was some disturbing signs in their growth when we dig deeper. Consumption went backwards and imports were well below expectations. Offsetting this, retail sales were up an impressive 6.8% against an expectation of 5.4%.
We have often been able to point to China to lead the way for our economy – but so far, not this time. All China’s major economic statistics were weak and it is experiencing deflation rather than inflation. Deflation incentivises not spending now! We anticipate China will continue to try and find ways to stimulate its economy but what this looks like is not yet clear.
While there were several negatives during August, we are of the opinion that stock markets have largely factored in the state of the economies. Markets work on expectations of the future and not so much on past data. Our analysis of Refinitiv expectations of future company earnings remains positive overall.
After a bit of whiplash, US 10-year bond yields have settled down at just below 4.1%. Bonds are again a viable investment vehicle. Market volatility, as measured by the VIX Index, is at normal levels.
Asset Classes
Australian Equities
The ASX 200 fell 1.4% over August. A lot of the negativity appeared to arise from uncertainty about the Fed’s next move. Consumer Discretionary was the stand-out sector rising +4.6%. The year-to-date capital gain of +3.8% for the broader index is quite respectable given the long-term average of around 5%. August finished with a strong spell of daily gains. Moreover, our analysis of company earnings data, provided by Refinitiv, noted a modest increase in predicted gains over the next 12 months.
International Equities
The S&P 500 was also weaker over August, falling 1.8%. All of the other major global share indexes that we follow were also negative. However, the year-to-date gain for the S&P 500 is an impressive +17.4%. Japan’s Nikkei is even more impressive having risen 25.0% so far this year.
Bonds and Interest Rates
The Fed did not meet in August but it raised its cash interest rate at the end of July by 25 bps to a range of 5.25% to 5.50% (the highest in 22 years) in a widely telegraphed move. The probability of a further rate hike at the Fed’s September 20th meeting has been priced at around 10% to 20% since the last hike. However, the odds only just favour no hike at the November 1st meeting.
We agree that the Fed will likely pause interest rate increases this month despite Powell’s sabre-rattling talk of the prospect of further interest rate increases at the Jackson Hole conference in Wyoming of the world’s central bankers. We think there might be enough additional evidence in inflation, jobs, and growth data over September to convince the Fed to pause again at its November meeting.
By the final Fed meeting of the year on December 13th, we think it likely that there is only a very minor chance the Fed would contemplate a further interest rate increase. We think the ‘interest rate cutting debate’ will start around that time as the earlier interest rate increases will have slowed the economy. We anticipate the conversation will turn to when stimulus measures (interest rate cuts) could begin in the first quarter and most likely before June 2024.
The RBA should be encouraged by the latest monthly Inflation data to hold off on increasing our interest rate further. The RBA interest rate tracker app on the ASX website prices in an interest rate increase at 0% in September and 14% for a rate cut. While we are certainly supportive of no further rate increases in the near term, we think October is also a bit too soon for a cut, only 18 days into the tenure of the new RBA governor Michele Bullock.
Without going through the details of what all of the other major central banks did and might do, it does seem that there is overwhelming support for global interest rates being at or near their peaks. Except for Japan and, to some extent, Switzerland whose economies have not followed the same path of rapid rises in inflation in recent years.
Other Assets
The price of oil was slightly up over August.
The price of iron ore rose 5.6%. The price of copper fell 4.0%. The price of gold was down fractionally. The Australian dollar depreciated 2.9% against the US dollar over August.
Regional Review
Australia
Cracks are starting to appear in the Australian economy. Growth in inflation-adjusted retail sales data have been negative for three successive quarters. Westpac’s consumer sentiment indicator has been hovering around a score of 80 (compared to 100 for a neutral reading) for about nine months. This read is worse than during the GFC but not quite as bad as that in the depths of the 1990/91 recession.
Even the jobs report has started to show weakness but, given the sampling error range associated with using a very limited data set, one month of weakness is insufficient to call it problematic yet. It is reasonable for businesses to hold on to workers longer than seemingly necessary because of the cost of re-hiring when the economy bounces back. And on the supply side, workers losing jobs in times of downturns might accept inferior positions to keep their cash flow going. However, history shows us that labour markets can then sour quite quickly.
The RBA is predicting 1.75% p.a. economic growth in 2024 and 2% in the following year. We see that scenario as being an optimistic one. Because of lags in the system, the full force of the high interest rates will not be felt until 2024.
Meanwhile, wages growth has not yet been a problem. Wages grew by 0.8% in the June quarter or 3.6% over the year. Workers are still playing catch up to the pandemic induced high inflation period during 2020 - 2022. As yet, there is no wage-push inflation (i.e. wages increase at a rate faster than productivity).
With China saving our economic bacon in 2008/9, we avoided a recession when the rest of the world went into what some called ‘the Great Recession’. This time China is struggling to manage its own economy. It is hard to see from where a silver bullet might be fired to stave off the effects of higher interest rates and inflation on the Australian economy.
China
Chinese data released in August were weak almost across the board. Retail sales, industrial output, and fixed asset investment were slow in absolute terms and all missed ‘weak’ expectations.
The purchasing managers index (PMI) for manufacturing was below the threshold ‘50’ level for the last five months but, at least, there were small improvements over the last three months. At 49.7 for August, the PMI easily beat the expectations of 49.4. We’re not talking about a collapse. It is just taking time for the economy to recover from the three-year shutdown. But there are signs of deep-seated debt problems arising in the property sector.
More disturbing is the deflation that appears to be underway in China. The broad inflation measure the Consumer Price Index (CPI) was -0.3% in the latest month when -0.4% had been expected. The Producer Price Index (PPI) was -4.4% against an expected -4.2%. Deflation is thought to be bad because it incentivises delaying purchases until those goods and services become cheaper.
US
US inflation statistics – and there were many variants published in August – were largely interpreted as showing that there was more work to be done before the fight against inflation can be considered won. Assessing US inflation with a measure that gives more weight to the most recent data, we concur with this assessment. Of course, we need to see this trend of softening inflation data confirmed in the coming months before we are comfortable enough to call a victory, but the trend has been for a steadily improving read over most of 2023.
The headline jobs number at 187,000 was big enough for many to conclude that the US economy is still strong however, what is concerning to us is that jobs in many of the growth sectors were small or negative and the data relies of government jobs for its overall level.
The June quarter GDP growth was revised downwards to 2.1% from 2.4%. The Fed considers 1.8% to be the neutral growth rate as far as inflation pressure is concerned, indicating an improving situation for inflation fighting - but still some work to do.
With credit ratings agency Moody’s downgrading credit worthiness for 16 US Banks (or putting issuers on negative watch) is disturbing. This change in ratings is no doubt the fall-out from the regional banking crisis that started in March. The combined credit tightening, the Fed interest rate well above its neutral rate, and the Quantitative Tightening programme (the Fed paying back on more maturing bonds than it is issuing new ones) appears to be building up to produce a downturn in the US economy. Whether this results in a recession and how deep that recession is, should it eventuate, remains to be seen.
Europe
The Bank of England (BoE) is still on a tightening cycle. Its latest 25 bps increase to 5.25% takes its cash interest rate to the highest in 15 years. CPI inflation stands at 6.8% over the year.
Britain has a different problem to that of Australia or the US, it reportedly took up the green energy challenge with more gusto than most – and found itself caught out by the supply-side energy price inflation. It is not easy to mitigate the impact of such a major policy shift.
EU inflation came down to 5.3% from 5.5% and its economic growth jumped back to positive territory after two consecutive quarters of negative growth. The first recession might be over but the next might not be far behind.
Rest of the World
Japan’s inflation declined further from its recent high to 3.1%. While Japan’s GDP growth came in at an impressive 6.0% (annualised) for the June quarter, the headline result masked the underlying compositional issues. Consumption growth was negative and capital expenditure was flat. However, retail sales jumped 6.8% (annualised) in July against an expected 5.4%.
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