Economic Update June 2024 – Infocus Advisory

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

Key points:
– The US Fed gets back on track talking of ‘when’ for rate cuts as data continues to soften modestly
– RBA inflation data still on the high side but in per capita terms the situation is considerably weaker
– Markets, lead by AI stocks, remain positive and bond yields are likely to have seen cycle highs in 2024

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

Support for the rate hike scenario canvased by many for the US Federal Reserve Board (Fed) and the Reserve Bank of Australia (RBA) has all but vanished from the agenda. There had been a brief ‘wobble’ as people grew impatient waiting for the fruits of the higher-rates-for-longer programme.

The Fed remained on hold in May – as expected. It did however, slow down ‘the run-off of the balance sheet’. That is, the Fed is not performing QT (quantitative tightening) with as much zeal as it once was. Is that the first sign of the Fed thinking it might have over-tightened?

The RBA was also on hold but it again opted for the ‘can’t rule anything in or out’ explanation. Imagine if you presented at your GP with a condition that you were worried about. The GP replies, “I can’t rule in that I need to prescribe some serious course of action; and I can’t rule out that you are fine – so I’ll do nothing for the moment.’ Wouldn’t you, in horror, rush up the street to the next clinic?

In the GP analogy, it seems perfectly sensible for the GP to say something like, ‘you might have a touch of … so I’ll start you off with a low dose of …’ or ‘I think you are fine but if you get any signs of … in the next week or two come straight back.’

The Bank of England (BoE) was also on hold in May but they seem to be flagging a possible cut for June. The European Central Bank (ECB) is on a similar tack. The Bank of Japan (BoJ) is weighing up its options. It wants to go for a second hike of 0.1% points to steer monetary policy back to something looking a little more like normal. But it doesn’t want to move too hastily after 16 years of a -0.1% rate! The current BoJ rate is in a range of 0.0% to +0.1%.

The Bank of China has a much more complicated approach to enacting monetary policy but it is making moves to ease policy to cope with the property development debt crisis.
In short, global central banks reacted somewhat nervously to inflation, unemployment and growth data in May. While we saw no clear-cut signals in the major economies, we did note some nascent signs of weakness in the US and continued weakness in Australia. US jobs data were a fraction softer, retail sales were flat and wage growth was only 0.2% for the month.

Australia data still points to an ongoing recession. The unemployment rate jumped up to 4.1% and, on a per capita, inflation-adjusted basis, retail sales and economic growth have been going backwards for over a year. It is only the major inflow of migrants that masks the underlying problems for those unwilling to do a proper economic analysis. Aggregate GDP demand has been rising but more slowly than population growth.

The Australian Federal Budget was handed down in May. Apart from the stage 3 tax cuts (which are not really cuts but mere lip-service to tax indexation from bracket creep in the face of strong inflation), there was a little rent assistance for some and a $300 rebate for any household with an electricity bill! That’s less than a dollar a day for each household. Anything is better than nothing but we can’t expect much in the way of a stimulatory effect after inflation-adjusted wages have dropped to around 7% less than they were in mid-2022.

In our opinion, the real issue in managing monetary policy is dealing with the so-called perceived ‘stickiness’ of inflation. In the US, rents make up about 33% of the CPI. Official CPI less shelter data have been well-contained for a year. The average of the last 12 such monthly measures is only 1.8% (less than the 2% target) and the latest two numbers were 2.3% and 2.2%, respectively; not a problem!

Because of the way shelter inflation is calculated, it cannot react in a timely fashion to an improving situation as does inflation-for-everything-else. Shelter inflation peaked at 8.1% in the first quarter of 2023. It had inched down only to 5.5% by April 2024. Leases are usually written for 12-months or more and the statistical agency only samples rent every six months. There is a massive lag between actual inflation and measured inflation! A simple improvement in the calculation could remove the inflation problem in a trice!

The latest US CPI-less-shelter read was 2.2% and that for shelter was 5.5%. With a third weighting to shelter, the aggregate CPI is 3.4% = (1/3) 5.5% + (2/3) 2.2%. In our opinion, it is almost impossible for shelter inflation to get down to 2% until 2025 but only because of the method of calculation. So, aggregate inflation has almost no chance of dipping below 2% unless the whole economy collapses in a heap.

Even if one ignored the calculation issues with shelter inflation, what school of economic thought would advocate raising rates to reduce rents? The dominant factor in determining rents is the demand-supply imbalance of people who need shelter.

US March quarter GDP growth was revised downwards from 1.6% to 1.3%, or 0.3% for the quarter. This further sign of weakness causes us some discomfort but on the positive side, it could help the Fed to decide to start cutting rates.

US PCE inflation data were more or less on expectations. The headline rates were 0.3% and 2.7% (for the month and the year) while the core were 0.2% and 2.8%. We believe these estimates are biased in the same fashion as the CPI variants owing to the way shelter inflation is calculated.

The housing inflation component of the Australian CPI is calculated differently from that in the US and with different weights. There is a new-home sales component and a rent component in Australia. New home-sale inflation peaked at 22% in July 2022 and it has since fallen to 4.9%. Rent inflation was within the 2% to 3% band when new home inflation peaked in 2022. Rent inflation has since increased steadily, as rates were increased, and it has climbed to 7.5% in April with no real sign of relenting. Rents in Australia also have at least an 18-month lag in the formulae between measured rent inflation and the underlying cause.

The latest official headline and core monthly CPI reads were 3.6% and 4.1%, respectively. Alcohol and tobacco inflation came in at 6.9%. Other big-ticket items were insurance, 8.2%, auto fuel, 7.4%, and health, 6.1%. Our frustration with the RBA’s monetary policy management can be expressed through the question, which of these rates would fall if interests remained on hold or increased? The apparent answer is probably none, maybe a little on insurance.

CPI inflation less housing (our estimate) was 3.4%. While these data were above the RBA target band of 2% to 3%, they are not sufficiently high to cause us any material concern.

It is clear that the Australian data are significantly impacted by the immigration issue and not so much by higher interest rates. Indeed, if the RBA unwisely raised rates, it would further negatively impact home owners on variable-rate mortgages and do nothing for the renters. Indeed, higher rates might slow down development in building new apartments.

To be clear, immigration is not the problem. Australia was built on the concept. The problem is not planning – specifically for accommodation – this time around which has also been impacted by supply side aftershocks from Covid.

We only have to look to Australian retail sales volumes (i.e. inflation-adjusted) to understand the plight of the Australian consumer. The first quarter result was -0.4% for the quarter or -1.3% for the year. With population growing at over 2.5% pa, retail volumes on a per capita basis fell by nearly 4% over the year to 31 March. The RBA board say they can’t rule anything in or out! Our next GDP data for the March quarter are to be released on June 5th and we think that data will amplify this story.

There is a glimmer of hope in Europe. Economic growth in both the UK and the EU was positive in the March quarter reversing some of the negativities witnessed in 2023.

The China economic situation is never easy to read. Problems in the property sector abound but imports for the latest month were up 8.4% compared to an expected 4.8%. Exports were up 1.5%. There were mixed results in the monthly data releases.

As a general conclusion, we think there is no clear-cut path back to prosperity here, in the US or elsewhere. However, neither do we think we are on the precipice of disaster. Rather, we believe there are strong benefits to easing monetary policy now. Seemingly paradoxically, we think the ASX 200 index can do well in Australia while the consumer is languishing. Companies earn profits on aggregate sales, both at home and overseas, and not on the average individual’s economic health in Australia.

The so-called ‘AI bubble’ does not appear to be out of control. Nvidia reported well. Unlike in the dot.com boom when little was being built and the ‘dream’ was on sale, serious AI companies are making things – and selling them – that people will want. Of course, there will be speed bumps as technology interfaces with reality. We think the investing future is relatively bright in many markets.

Asset Classes

Australian Equities

The ASX 200 didn’t have a great month. It limped over the line at 0.5% because of a stellar run on the last day. Its gain over the year-to-date of 1.5% isn’t impressive either. Our index is lagging the big guns but our data are consistent with Australia being in a recession. The month’s gains of IT (5.4%) and Utilities (3.4%) certainly helped the ASX 200 to perform.

International Equities

In contrast to the ASX 200, the S&P 500 powered ahead in May with a gain of 4.8%. The London FTSE (1.6%) and the German DAX (3.2%) also did well.

Our regular update analysis of company earnings’ expectations suggest that the rally can continue but, of course, central banks may play a part and there is always the chance of a geopolitical event upsetting progress.

Bonds and Interest Rates

All the major central banks were on hold in May. But the BoE, ECB and BoJ seem to have their fingers on triggers for rate changes. The RBA is dithering.
The market pricing tools for expected central bank changes over the rest of the year have stabilised but the momentum for cuts has been substantially reduced since the beginning of the year. There is now about an 80% chance of one or two cuts in the Fed funds interest rate by the year’s end.

Other Assets

Iron ore prices proceeded in a tight range of US$114 – US$122 per ton over May.

The Saudis are reportedly controlling oil production to counter moves in US shale oil production which left oil prices down by over 5% over the month. Interestingly the geopolitical premium in the oil price appears to have diminished.

Gold and copper prices were relatively flat over May while the Australian dollar (against the US dollar) rallied by 1.7%.
Regional Review

Australia

The Federal Budget was largely considered a non-event by most economic commentators however, the government was in a bind. If it had produced the fiscal stimulus necessary to turn the economy around, it could have been accused of fuelling inflation.

Housing supply is the key issue but it takes a substantial time to move from housing approvals to completions. The job needed to have been started a couple of years ago when the gates to immigration were being re-opened following the pandemic.

There were 38,500 new jobs created in April but full-time jobs fell by 6,100. The unemployment rate rose to 4.1% following 3.9% in March and 3.7% in February. That is not a strong set of numbers.

The wage price index rose 0.8% in the March quarter and 4.1% over the year. While these reads were slightly ahead of price inflation, there are two years of ‘catch-up’ needed before workers can celebrate getting back on track.

The latest monthly read of retail sales (value) was 0.1% and 1.3% for the year. When adjusted for inflation, the numbers were -0.1% and -2.4%. And then there is the population effect to account for!

China

Retail sales came in at 2.3%, below the expected 3.8%, but industrial production exceeded the 5.5% expectation with a 6.7% outcome.
The bright light was China’s 8.4% growth in imports and, to a lesser extent, its 1.5% increase in exports.

China has agreed to re-open trade to all Australia beef exporters – except two – but lobster exports are still caught in the claws of policy intransigence.

At last, the US jobs data did not produce a mega number of new jobs. The market expected 240,000 new jobs but ‘only’ 175,000 were created. However, in times before the pandemic, 175,000 new jobs would have been considered a very strong result.

The US unemployment rate has climbed to 3.9% from a recent low of 3.4%. Wage growth was 0.2% for the month or 3.9% for the year. Neither cause us any concern for commencing a rate-cutting cycle. There is a big pipeline of ‘lost’ real wages to be rectified before wage inflation would be seen to be a problem.

Economists often look to participation rates (the percentage of the population to be in, or looking for, work) to understand the dynamics of the labour market. When participation rates fall, economists often ascribe the move to the ‘discouraged worker effect’.

The opposite has just happened, at least in regards to the female side of the equation. The female participation rate stands at the highest since 1948!

While there are positives accompanying this number – it is a positive if women are able to join the workforce, if they so choose. A darker side to this observation is that women may be feeling compelled to work to help support a household in times of economic stress. We do not yet have the data to choose between these alternative scenarios.

In a disturbing turn of events, the University of Michigan Consumer Sentiment index fell in a hole to 66.5 from 76.0 but then recovered slightly on revision to 68.8. If this index continues to reflect US residents’ feelings, worse spill-over effects may be on their way.

US retail sales came in at 0.0% for the month and +3.0% for the year but, on correcting for inflation, the figures were -0.3% for each of the month and the year. That does not reflect a strong consumer.

It is too soon to call the start of a weakening US economy, even though March quarter growth got revised downwards to 1.3%, but it does alert us to monitor the situation more closely. If the US economy does start to soften, it could do so rapidly. That is the often the pattern from the past.

Europe

The EU posted a positive economic growth figure in the March quarter but ruled off 2023 in a downwardly revised pair of negative growth statistics for the second half of 2023.

As EU growth came in at 0.3% for the quarter, the ECB is poised to start cutting rates. The latest EU inflation was 2.4% (headline) and 2.7% (core).

Germany’s March quarter growth was +0.2% for the quarter and -0.1% for the year. German inflation was 2.8% which was slightly above expectations and the prior month.

Reportedly, the ’blip’ was due to the removal of a price subsidy on rail travel.

The UK growth of the March quarter, 0.6%, was a big beat over the expected 0.4%. The BoE seems set to start its easing cycle in June.

The ruling UK Conservative party is going to the polls on July 4th and one of its policies is compulsory service in the army or organisations like the police or hospitals for 18-year-olds! We don’t think this will be overly popular with the folks impacted. What would happen to their ‘side hustles’? We’re not sure what the net impact would be for the economy but the social media comments should be informative!

Rest of the World

Japan registered its 24th successive monthly negative growth in real wages with the latest annual statistic being -2.5%. Its PPI inflation was +2.5% and its core variant was +2.2%. Japan’s household expenditure was up 1.2% in March but down -1.2% over the year against an expected loss of -2.4%. GDP in the March quarter was down -2% putting doubts on an imminent interest rate hike. That view was further compounded by April’s industrial output with a big miss at -0.1% when +0.9% had been expected for the month.

May also closed with Japan’s three, main monthly inflation indicators all coming in at less than 2%; below expectations; and, less than that in the prior month. We find it implausible to believe that the 0.1% interest rate hike a while back, following 16 years of negative interest rates, could be the cause of the softening in inflation but it looks more likely that the BoJ will now stay on hold a little bit longer.

The conflict in the Middle East seems no closer to resolution but, at least, there does not seem to be any major military escalation. But human suffering continues. However, social unrest is increasing across the world as each side levels criticisms at its opponents.

The Peru prime minister is apparently struggling with an approval rating of only 5%. It makes, Biden, Trump and Albanese look positively popular! And Trump was just found guilty on 34 charges relating to ‘altering the books’. Jail time is apparently unlikely. Trump’s supporters rushed to donate to his cause (anecdotally in excess of $70 million) in the seven hours after the decision was handed down.

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