Economic Update April 2024

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

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

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

The Big Picture

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Asset Classes

Australian Equities 

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

International Equities

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

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

Bonds and Interest Rates

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

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

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

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

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

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

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

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

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

Other Assets

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

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

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

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

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

Regional Review

Australia

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

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

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

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

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

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

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

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

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

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

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

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

China

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

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

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

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

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

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

US

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

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

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

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

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

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

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

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

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

Europe

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

Rest of the World

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

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

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