In this month’s update, we provide a snapshot of economic occurrences both nationally and from around the globe.
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
Our quarterly inflation read published in late October signalled a slight uptick which we addressed last month in our Economic Update. However, that was enough for the RBA to hike its overnight cash rate on Melbourne Cup Day, even though most of the other major central banks seem to be done. The odds for a hike – as priced by the market – were only 50% prior to the meeting.
Michele Bullock, the new RBA governor, inflamed the situation in a recent speech when she all but said we should hike again. Indeed, she singled out dentists and hairdressers, among a handful of services, as significant causes in the little inflation spike in August and September. That call was in our view unwarranted in that such a relatively tiny amount is spent on those two services.
We singled out the crude oil price spike, which has since faded and the depreciation of our currency as major contributors to the recent increase in inflation. Our dollar was appreciating back up to around 66c from under 63c almost as RBA governor Bullock was speaking.
To make matters worse, Philip Lowe, the outgoing RBA governor, fuelled the need to hike more. So, what happened to the monthly inflation read that came out at the end of November?
We calculate inflation (annualised) on a rolling quarterly basis using the monthly data series. Miraculously, the headline CPI (Consumer Price Index) came in at 3.0%, at the top of the RBA’s target range – and not above it. It was also down from the recent peak the month before. The Core variant of inflation that excludes such things as food, fuel and certain vacation spending was higher at 4.4%.
Aussie retail sales in current value terms fell by ?0.2% in October so, after, allowing for inflation and population changes, the retail picture is grim. Sales were up +1.2% for the year or about ?3.7% in volume terms. Population grew at around 2.6% so that is about a ?6.3% decline in volume per capita terms. And the RBA now under Bullock is maintaining a tightening bias which we believe is difficult to support based on our assessment of the available data.
Fortunately, the RBA and governor Bullock appeared to take onboard the view of the market and decided to leave official interest rates on hold at its meeting on December 5th, now all eyes are focused on the RBAs next interest rate policy setting meeting in February 2024.
In the US, the Federal Reserve Board (Fed) is backing away from hiking again and there is speculation that some Fed members are even talking of cuts soon. In support of this view the US CPI inflation came in at 0.0% for the month; the market loved it. Personal Consumption Expenditure (PCE) inflation which is weighted by what is actually being spent was also flat for the month!
In the space of about a month, the US 10-year Government Bond yield popped above 5% only to end November at around 4.3%. In terms of bond yields, that is a big move and it gave US equities a big boost.
The CME FedWatch tool, which uses bond yields/prices to predict future official interest rate movements, looks to be pricing in one or two interest rate cuts for the US by June next year and maybe four or five by the end of 2024. If the US Fed doesn’t cut interest rates and inflation continues to fall, the so-called real rate (being the difference between the headline yield and inflation) will be driven higher making monetary policy even more restrictive.
The US unemployment rate, released in early November, rose to 3.9% from a recent low of 3.4%. There is a ‘rule’ (the so-called SAHM rule after a former Fed staffer) that says if the (average over three months) rate climbs 0.5% or more above the recent low, that is a strong signal for a recession. The unemployment rate is a small move away triggering that rule.
Other aspects of the US labour report also showed weakness – as did retail sales and the outlook statements from some, but by no means all, US retailers.
Although we believe Australia is already in a ‘per capita’ recession and maybe heading for worse as past rate hikes work their way through the economy, companies’ earnings are not based on per capita consumption. Population growth can support the market through bad times and that is what our data is showing. So, markets can remain positive at times when the economy is weakening!
China even published some quite reasonable economic data during November and a strong China is always good for us. However, the end of November read of the China manufacturing activity index, the PMI, again came in below 50 at 49.4 from 49.5, a reading below 50 indicates contraction. A reading of 49.7 had been expected. However, The Materials sector of the ASX 200 and iron ore prices over November were both very strong countering the impact on the Australian share market of a China slow-down!
We are broadly positive about the share markets going forward into 2024. While bond yields might fall in line with expected changes in monetary policy, though we do not anticipate it is highly unlikely that the US Fed and RBA interest rates will fall to neutral levels (in the range of 2.5%p.a. to 3.0% p.a.). In this environment traditional approaches to portfolio construction which have been disrupted by the historically low interest rates following the Global Financial Crisis will make a return with defensive assets, such as bonds, potentially offsetting the volatility of equity markets and paying a more attractive yield.
The ASX 200 had a strong November with gains of 4.5% taking the year-to-date into positive territory at 0.7%.
The Healthcare and Property sectors produced double digit gains over the month. At the other end of the spectrum, gains in Telcos were flat and sharply negative for Utilities.
The S&P 500 had an extremely strong month, gaining 8.9% and 19.0% for the year-to-date. The German DAX and the Japanese Nikkei moved roughly in line with the S&P 500 over November but the FTSE was a laggard at 1.8%.
If the Fed starts to cut rates from the first quarter of 2024 as some expect, because inflation is falling and not because the economy is going into recession, we expect a stronger 2024 than otherwise. If a recession becomes apparent, we still expect some positive, but more modest returns. Markets are largely still off their recent all-time highs.
It seems reasonable to attribute some of the strength on Wall Street to long bond yields having settled down at well below 5%.
Bonds and Interest Rates
When we look back on history we may see November 2023 as the beginning of the return to less aggressive monetary policy – except possibly for Australia.
As a result of recent changes in sentiment, the price of US Treasury’s rose sharply forcing yields down. 10-year yields were down by about 0.7% points in November – a massive change indeed. Market indicators are pointing to an end in Fed rate hikes having already been achieved and for a reasonable chance of a cut in the first quarter, followed possibly by another in the second quarter. By the end of 2024, the modal rate is expected to be about a full 1% below the current rate.
The Fed chair is not yet acknowledging this breakthrough in expectations but there are rumours that some Fed members are openly discussing it.
The price of oil dropped sharply in November – around ?6% for WTI and ?5% for Brent. Gold prices rose 2% and copper nearly 4%.
The price of iron ore rose very strongly – at 8% –which helped the Materials sector on the ASX 200 achieve a monthly gain of 5%.
The Australian dollar – against the US dollar – appreciated by 4.8% which will help reduce import prices and, hence, domestic inflation in Australia.
On the surface, Australian employment growth was strong at +55,000 new jobs in October with the full-time / part-time split being +17,000 / +38,000. However, the unemployment rate rose to 3.7% from 3.6%.
When the strong population growth arising from immigration is taken into account, some of the shine is taken off these numbers. However, +9 million hours extra were worked in the latest month. That number cancels out the ?9 million from the previous month but still leaves ?8 million hours lost over the last three months – or about 50,000 full-time-equivalent jobs. The mix is changing making it harder to interpret these data.
Retail sales were unequivocally bad. In volume terms they fell ?1.7% over the year or about ?4.3% on a per capita basis.
The wage price index rose 4.0% on the year or just about in line with inflation. CPI went up 4.9% on the year when 5.2% had been expected and down from 5.6% the month earlier. Core CPI rose 5.1% for the year down from 5.5% from the month earlier. Recent data point to sharply lower levels of inflation.
The so-called cost of living crisis is only really a problem if wages do not keep up with price inflation – which they are not. The crisis is real and workers deserve pay rises at least to maintain living standards including catch-up where appropriate. Wage rises are not the culprit. The old enemies of supply-chain, oil prices, currency depreciation and flood damage were the main causes our inflation problem.
China’s retail sales bounced back at 7.6% against an expected 7.0% and industrial output rose 4.6% against an expected 4.4%. Not a bad set of numbers but China must address some very real issues in the property sector.
At the end of November, it was reported that there was a surge respiratory cases in China. Hospitals are struggling to cope and masks are back in play but, so far, there are no travel restrictions in place.
It would be devastating if this was the start of another ‘pandemic scale’ crisis but it could just be a typical seasonal health problem on a larger scale.
US inflation data released in November beat expectations. CPI inflation was 0.0% for the month or 3.2% for the year against expectations of 0.1% and 3.7%. Core CPI inflation was 0.2% for the month and 4.0% for the year against expectations of 0.3% and 4.1%. While these numbers were not big beats, it appears the psychological 0.0% for the month caused a big sigh of relief. Bond and equity markets rallied strongly. PCE inflation was also flat for the latest month.
On the wholesale front, PPI inflation came in at ?0.5% for the month and 1.3% for the year (against an expected 1.9%). Wages only grew modestly at 0.2% for the month. If this were a political election, we think inflation would have declared defeat.
150,000 new jobs were created which was well down on last month and expectations. On top of that, the composition of jobs created was skewed towards sectors that are not part of the growth economy. The unemployment rate at 3.9% is now 0.5% points above the recent minimum.
The BoE was on hold and its inflation rate dropped to 4.6%, a two-year low, from 6.7% in the prior month. Inflation was only 0.1% for the month! However, retail sales volume was down ?0.3% for the month of October.
The UK government announced several stimulus initiatives in the November budget. These stimuli will fight against the inflation story but are most needed to redress the pain that many households have suffered in the last few years.
EU growth was negative in the latest quarter – as was that for Germany. EU inflation was down sharply from 4.3% to 2.9% for the headline rate. The core rate, at 4.2% was down from 4.5%.
Rest of the World
Thankfully a cease-fire in the Gaza-Israel conflict allowed a number of hostages and prisoners to be exchanged and essential supplies to be trucked in by the UN. The Ukraine-Russia conflict still seems nowhere near resolution. Neither conflict appears to be having a major negative influence on markets.
Turkey predicted 2023 inflation to be 65% falling to 36% in 2024. It puts our inflation problem into perspective!
As this is our last economic update for calendar year 2023, we would take this opportunity to thank you for your many comments, feedback and discussion over the year. From all in the Research and Investment team, we hope you and your families have a very happy, healthy and safe Christmas and New Year.
We look forward to returning in 2024 to continue our observation and commentary on what is a very interesting period.