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
So much data is released every month that it is nearly always possible to find a justification for a ‘good’ or ‘bad’ forecast/outlook, depending on one’s view or motivation. The responsibility of macroeconomic analysts is to deploy skill in their analysis and be able to step back and synthesise the information to present a cogent and balanced view.
We agree that both the US and Australian economies can currently be viewed through an optimistic lens. But we see some cracks beneath the surface getting bigger. The lion’s share of responsibility for managing the many stresses and forces operating in the global and national economies falls in no small part to governments and in particular, central banks.
At time of writing, this turns on how central banks increase their interest rate settings to hopefully return inflation to an acceptable range without causing economic growth to slow to the point where a deep economic recession is inevitable. In our view, the now restrictive interest rate policies have done the job and it is time for central banks to acknowledge the lagged effects of high interest rates, in order to ensure that economies do not unduly succumb.
A key economic measure/indicator is employment. At the start of September, US jobs data were seen by many as holding up while inflation data were showing some impressive gains i.e. falling. As a result, almost everyone expected the Fed to keep rates on hold at its 20 September 2023 meeting – and it did. Therefore, the immediate stock market reaction was positive – until the Fed chairman’s press conference which started half an hour later.
During that question time, the Fed chair, Jerome Powell, became increasingly hawkish – meaning that he was leaning towards more interest rate hikes, or, at least, the current hikes being held ‘higher for longer’. As a result, September proved to be a bad month for equity markets.
Our take on the US jobs data is that it went against the superficial media coverage. 170,000 jobs had been expected and 187,000 jobs were created. The unemployment rate was 3.8% and wages rose by 4.3% against an expected 4.4%. We can see why a cursory glance might lead one to view that the US labour market was strong.
What we also read was that the previous two months jobs’ data were revised down by 110,000 and that most of the jobs created in the latest month were in two non-growth sectors: health care & social assistance, and government. However, jobs in many of the important building blocks of growth went backwards by -28,300, which was a clear deterioration from prior months.
When viewed through that lens, interest rates may have been (and potentially should have been) cut in September! And 3.8% for an unemployment rate is a big kick up from the expectation of 3.5%. Some say a 0.5% increase in the unemployment rate is a sign of a slowdown.
US GDP data came in after the Fed meeting and showed that growth in the June quarter, at its customary second monthly revision each quarter, held steady at 2.1%. We can see how that could also be construed as good. The Fed thinks anything above 1.8% causes upward pressure on inflation and the like. But consumption, the big driver of the US economy (circa 67% of GDP growth), was revised downwards from an initial 1.7% to an unimpressive 0.8%, and that is an annual figure. That is unequivocally not good!
So how did GDP growth hold up then? It transpires that business investment was revised upwards and it compensated for the loss in consumption. That investment was fuelled by Biden’s push to onshore semiconductor production after the pandemic/ shutdown/China situation from 2020 to 2022. There is an old saying, ‘Never fight the Fed’. It seems the government is fighting the Fed and that in part explains why temporarily the economy is holding up a bit longer than some expected. Monetary and fiscal policy work better in unison.
And other headwinds are gathering in the US. It was reported that US consumers had accumulated $2.1 trillion in ‘excess savings’ from government Covid-related cheques and personal savings back in 2021. Those savings had dwindled to $190 billion by June and was thought now almost gone except the GDP report also suggests they found a little bit more savings in the revision. Consumers have been partly living off excess savings for two or three years and that well has almost run dry.
The market still thinks the Fed might not hike rates again this year – pricing in about a 35% chance of another hike – and cuts could start as early as the first half of 2024.
However, the Fed published its dot plots last meeting – a brilliant graphic to show what all the members (voting and non-voting) think the Fed rate will be at each of the end of this and the next few years. Since the dots are not attributed to each member, and not all members vote, it is not trivial to interpret the expectations of the voting Fed.
Since there are only two meetings to go this year (1 November and 13 December) there was reasonable cohesion among the Fed members (12 for a hike and 7 for on hold) for the end of 2023. For 2024 and beyond the dots are dispersed widely. Two members expect a higher rate in 2024 than now (1 or 3 hikes from here); 4 the same as now; and the rest for up to four cuts from here (or five if they hike again this year).
Given that there are accepted to be long and variable lags following interest rate changes before effect, knowing that they will need to cut quite a few times soon, it makes little sense to put in another hike to then try and cancel it quickly.
Here in Australia, the RBA looks more likely to be ‘done’ and interest rate cuts could start soon. Our CPI monthly inflation data were within the RBA’s target range for three consecutive months but petrol/fuel inflation burst the bubble in the latest month.
Our initial GDP data were released for the June quarter and, again at first sight, they looked fine. Growth was 0.4% for the quarter (not annualised) and 2.1% for the year. However, when our material immigration flow is accounted for, growth per capita was -0.3% for the June quarter following -0.3% for the previous quarter. We were in a per capita recession during the first half of 2023. On average, we were going backwards!
The September quarter has now finished but it will be nearly three months before we find out whether the ‘going backwards’ continued. The Organisation for Economic Cooperation and Development (OECD) is pulling no punches. It forecasts we (Australia) will be in a per capita recession for two years (2023 and 2024). So, the OECD assessment adds further weight to the argument for the RBA to not raise interest rates further and to be contemplating cutting rates sooner rather than later.
The Bank of England (BoE) has surprised in the opposite direction. It was widely expected to hike again this month but it didn’t. The BoE hinted that the inflation data released the day before turned its hand. For the record, the UK headline CPI came in at 6.7% down from 6.8% the month before and the core variant that strips out volatile items came in at 6.2% down from 6.9%. No matter which variant you use, US inflation is around 4% or better and they are talking about hiking. Clearly there is significant divergence between how various central banks choose to implement monetary policy and their strong reliance and dependency on data.
China is the real mystery in all of this. Of course, their economy is not hitting the higher growth rates of years gone by. That is the fate of all maturing economies. What is 5% growth now amounts to about the same extra output as 10% growth when China was half the size (not so long ago). The problem is to do with what is going on with property and property developers. There have been defaults and possibly more to come. But the third quinquennium (Chinese long-term economic plan) is just around the corner. Every five years China has a big conference and announces new policies and possibly stimulus. Perhaps during October, we will have a stronger picture to paint for our major trading partner!
The ASX 200 fell -3.5% in September in part due to the hawkish comments made by the US Fed and concerns over property in China. Energy (+1.3%) was the only one of the 11 sectors to make gains. Property (-8.7%) and IT (-8.0%) took by far the biggest tumbles.
For the nine months to the end of September, the ASX 200 is up by only +0.1%; the IT sector is up +22.5% and consumer discretionary by +12.2%.
When dividends are included (but not franking credits) the ASX 200 is up +3.7% for the nine months.
We still have consensus earnings forecasts, sourced from Refinitiv, pointing to a solid end to the year and the market is modestly under-priced by our assessment.
The S&P 500 was also down by -4.9% over September. In contrast, the London FTSE was up +2.3% but all the other major indices we follow fell by a similar quantum to the ASX 200 and S&P 500 for the month.
Over the year-to-date, the Japanese Nikkei has rocketed ahead by +22.1%; the S&P 500 (+11.7%) and the DAX (+10.5%) have made creditable gains. The other major indices are more or less flat over 2023 to date but, at least, showing small positive gains.
Bonds and Interest Rates
The Fed did not raise interest rates at their 20 September 2023 meeting but the chair, Jerome Powell, made a hawkish statement in the press conference that followed. The Fed dot plots chart, showing participants forecasts for the US cash interest rate for the end of this year and several following, show a broad divergence in opinion.
More members than not saw another hike in rates this year with the CME Fedwatch tool which measures the Feds interest rate changes that are implied by movements in the bond market, show only modest support for that view.
The US Government bond market has experienced some volatility with the 10-year bond yield closing at 4.57% being markedly ahead of the 4.10% at the end of August.
The RBA now has a new governor, Michele Bullock, and she has not ushered in a rate hike at her first meeting, especially as the market had not pricing one in. Indeed, the market had priced in a small chance of a cut!
We consider Australian inflation largely under control with some doubts about the strength of the economy. We are in a per capita recession and chinks are appearing in the labour market which until recently has proven to be quite resilient.
The Bank of England kept its interest rates on hold in September despite a market prediction of an increase and inflation coming in at over 6%.
The European Central Bank (ECB), Norway, and Sweden all raised their official cash rate by 0.25% and hinted at the prospect of more to come. Switzerland’s central bank held rates steady instead of increasing them, the first pause since March 2022.
Japan is still maintaining its negative interest rate of -0.1% although there is growing commentary about the need for the Bank of Japan (BoJ) to change its stance. Japan’s latest GDP growth is 4.8% (after a revision from 6.0%) and inflation is running at just over 3%.
The price of oil was up by nearly 10% in September following OPEC+ (essentially Saudia Arabia plus Russia) supply cuts.
The price of iron ore rose 2.1%. The prices of copper (-2.8%) and gold (-4.4%) were both weaker. The Australian Dollar depreciated fractionally (-0.4%) against the US Dollar over September.
The VIX (US Share market) volatility index rose to 17.7 at the end of September after being in the normal range (at around 13) for some time.
CPI inflation came in at 5.2% (for the year) from 4.9% the month before. Core inflation was reported to be 5.5% and down from the previous month of 5.8%. We also compute a quarterly (annualised) inflation rate to follow new trends in a timely fashion.
Our headline quarterly inflation rate was in the RBA’s target range (2% to 3%) for three consecutive months but then a massive increase in petrol/fuel prices in August took that measure to 6.4%. The core equivalent quarterly rate was falling steadily into June and close to the RBA’s target but drifted a little higher in the latest two months possibly on the back of a depreciating Australian dollar which makes imports more expensive.
GDP growth came in at 0.4% for the June quarter and 2.1% for the year. However, when population growth is taken into account, per capita GDP shrank by -0.3% in the June quarter following on from a -0.3% fall in the March quarter.
Although the definition of a recession in this country is usually ascribed in terms of GDP, and not per capita GDP, we cannot ignore that, on average, the Australian economy in a viable metric (per capital GDP) has been going backwards and the OECD predicts that behaviour to continue into 2024.
The household savings ratio fell modestly from 3.6% to 3.2% in the June quarter but this ratio is well below ‘normal’ levels. It seems unlikely that saving will fall much more making it less likely for consumption to maintain current levels unless consumers increasingly use debt facilities.
The ‘mortgage cliff’ is almost on our doorstep when hundreds of thousands of mortgages previously fixed on low interest rates in the unusually low interest rate era will need to be rolled over to interest rates significantly higher. However, data from Domain.com suggest that stress in the form of ‘forced sales’ has been falling after a very recent peak. Hopefully the worst of that sort of stress has passed.
At first sight, the latest jobs report seemed promising with 64,900 jobs created – about three times what would normally be considered good. However, only 2,800 of these were for full-time work – the rest being for part-time work. The unemployment rate was unchanged at 3.7% but the number of hours worked fell by 9 million. That loss is equivalent to losing about 60,000 full-time jobs, which is further evidence that the labour market is weakening.
Unsurprisingly, therefore, the Westpac MI consumer sentiment index fell to 79.7 (with 100 being the breakeven point between optimism and pessimism). The index has been around 80 for several months; this level is usually associated with a recession or at least a serious downturn. Business sentiment indices from NAB, however, were more positive. Both the confidence and conditions measures were marginally up and in positive territory.
China holds a major government conference, the quinquennium, every five years to realign policies and, possibly announce new stimulus. It is due to start on 16 October 2023.
There have been many reported problems within China’s property sector including the massive Country Garden failing to pay coupon payments on some of its debt securities on time. Other data have been more encouraging.
Retail sales were up 4.6% against an expectation of 3.0% and industrial output was up 4.5% against an expected 3.5%.
China is reviewing some of the tariffs applied to imports from Australia imposed in 2020 and several of them have already been lowered or removed.
US inflation statistics continued to improve. Indeed, the monthly rate of the Fed’s preferred ‘core PCE variant’ came in at 0.1% which is below the Fed target of 2% pa. That measure rose 3.9% over the year. Headline PCE inflation rose 0.4% for the month and 3.5% for the year.
US CPI headline inflation rose 0.6% for the month and 3.7% for the year. The core variant rose 0.2% for the month and 4.3% for the year.
In our view US inflation is nearly there but, if the Fed holds interest rates higher for longer, there is a big danger of overshooting i.e. a recession ensues due to restrictive interest rate policy settings.
The headline jobs number was good but, as our preceding analysis shows, there are cracks appearing as the composition of the numbers shows employment growth is occurring in government and care sectors which are less positive for economic growth.
The Bank of England (BoE) paused its interest rate tightening cycle. CPI inflation fell to 6.7% from 6.8% (over the year). Core inflation fell to 6.2% from 6.9%.
On the other hand, the ECB hiked 25 bps to 4.0%.
Rest of the World
The New Zealand economy bounced back with 0.9% growth for the latest quarter and 1.8% for the year. Only 1.2% growth had been expected.