Jacqueline Barton

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

Key points:

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

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

The Big Picture

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Asset Classes

Australian Equities

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

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

International Equities

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

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

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

Bonds and Interest Rates

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

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

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

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

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

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

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

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

Other Assets

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

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

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

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

Regional Review

Australia

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

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

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

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

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

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

China

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

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

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

US

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

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

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

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

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

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

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

Europe

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

Rest of the World

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

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

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

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

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

Key points:

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

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

The Big Picture

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Asset Classes

Australian Equities

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

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

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

International Equities

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

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

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

Bonds and Interest Rates

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

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

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

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

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

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

Other Assets

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

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

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

Regional Review

Australia

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

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

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

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

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

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

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

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

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

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

China

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

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

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

US

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

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

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

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

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

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

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

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

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

Europe

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

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

Rest of the World

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