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 7th 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 14st, or the RBA on May 7th 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 7th. 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 non-manufacturing 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.
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