Jacqueline Barton

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

Key points:

• US Fed pauses interest rates in September but upsets markets with hawkishness commentary
• US economic data remains positive but further analysis indicates conditions are softening
• GDP data for Australia is showing mild growth but on a per capita basis we are in recession

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!

Asset Classes

Australian Equities

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.

International Equities

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%.

Other Assets

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.

Regional Review

Australia

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

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

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.

Europe

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.

After two months devoid of interest rate increases, home loan customers are getting comfortable with the repayments that will become the new normal. Initial indicators of ‘mortgage stress’ are up as households spend on average more than one third of the pre-tax earnings on home loan repayments.

The value of new housing finance fell for the second month in a row with July recording a 1.2% drop after a 1.6% drop in June. These are still well below the 5.8% drop in February which seems to coincide with the drop and then slight recovery that has been observed in house prices.

Owner Occupier lender seems to have suffered the largest drops, with a 1.9% drop vs a very slight 0.1% increase in Investment lending. Previously published drops in construction approvals are also flowing through to the home loan market as construction finance has dropped by 5.7% in the month.

Home loan borrowers are continuing to shop around for a good deal. Refinance activity in general jumped by 5.4% and totalled more than $21.5 billion – a record high. This is reflected in competition between the banks as interest rate pressures start to heat up now that cash-backs and other incentives have finished.

Banks and lenders continue to evolve their strategies, with a distinct shift towards retention of existing clients already on the book. Now is the time to look for a bargain in your own backyard – often the first step in getting a better rate is asking the question.

Are you saving for a new house or a holiday? Need some guidance with your budgeting? Finance calculators can be a great tool to help you make more informed financial decisions, so we’ve listed a range below that are both free and easy to use.

Home Loans – estimate your monthly payments and borrowing power to aid in your budgeting and decision-making throughout the homebuying process.

Home Loan Borrowing Power

Find out how much you could potentially borrow for your mortgage.

Mortgage Repayments Calculator

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Life Insurance Needs Calculator

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Income Protection Insurance

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Savings & Budget – set financial goals and track your income and expenses with these handy tools.

Savings Plan Calculator

Find out how much you will have in savings after a period of time based on what you deposit and the interest.

Budget Planning Calculator

A great way to help track your income and expenses and assist you with planning for future expenses.

Loans – Personal & Car – estimate your monthly payments based on factors like loan amount, loan term and interest rate.

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Car Loan Calculator

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Finance calculators can provide you with some more clarity as you navigate the world of loans, savings, budgets and more. It’s important to note that they’re not meant to be a source of complete accuracy, more so used as a guide to get you started.

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

Key points:

• The impact of interest rate increases is starting to appear in economic data
• China is struggling to reinvigorate its economy
• Equities take a breather

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

Backward looking inflation data, with most of the level being delivered in the early months of the data reporting window, has our current inflation rate at 4.9% annualised. However, if we take our guidance from more recent data (calculated on a rolling quarterly basis and then annualised) then we are seeing a level that is within the RBAs target band of 2%-3% p.a. The past three-monthly observations for this series being 2.4% p.a., 3.1% p.a. and 2.7% p.a. respectively.

On this basis the RBA should be encouraged that their monetary tightening policy is delivering the results intended and, save for a sudden inflation shock, be sufficient to tame inflation and not require further interest rate increases.

Further support for this position is evident through the latest retail sales data in Australia. The June quarterly result was ‑0.5% when measured in volume terms (i.e. removing inflation effects) and ‑1.4% for the year. The latest three quarterly results have all been negative.

Employment data was also softer as 15,000 jobs were lost in the latest month but that figure masks a worse outcome for full-time jobs which were down 24,000 because there was an offsetting gain in part-time positions. In July our unemployment rate went up from 3.5% to 3.7% indicating a deteriorating employment environment. The Westpac consumer confidence index also fell.

By taking a similar approach to observing US inflation data, its rate has also improved and looking contained, but there are so many alternative variants of that measure. Focusing on the measure that consumers actually face (CPI), and for the latest quarter and not the whole year, the latest read was 1.9% which is just under the Fed’s stated 2% target.

The US did record 185,000 new jobs in the latest month but three factors contribute to our view that this number was weak. First, it was 15,000 jobs less than expected. Second, 87,000 of those new jobs were in government and ‘health care & social assistance’ sectors which are typically not growth sectors. Third, the 209,000 new jobs for the prior month were revised downwards to 185,000.

During August, one of the big three ratings’ agencies, Fitch, downgraded US debt one notch to AA+ because of the debt default deliberations. Moody’s, another big ratings’ agency, down-graded 10 US banks and put six big banks on negative watch. Home affordability was reported to be the worst in 38 years, and the Fed just hiked its interest rate again in late July to the highest in 22 years.

The annual Fed-sponsored conference in Jackson Hole, Wyoming, was held at the end of August. Fed Chair, Jerome Powell, emphasised the need to keep policy restrictive and to be data dependent!

Is anybody winning? Well Japan hasn’t flinched yet still keeping its negative interest rate (‑0.1%) on hold since 2016. Its latest inflation read was 3.1% and its economic growth rate for the June quarter was 6.0% (annualised). However, there was some disturbing signs in their growth when we dig deeper. Consumption went backwards and imports were well below expectations. Offsetting this, retail sales were up an impressive 6.8% against an expectation of 5.4%.

We have often been able to point to China to lead the way for our economy – but so far, not this time. All China’s major economic statistics were weak and it is experiencing deflation rather than inflation. Deflation incentivises not spending now! We anticipate China will continue to try and find ways to stimulate its economy but what this looks like is not yet clear.

While there were several negatives during August, we are of the opinion that stock markets have largely factored in the state of the economies. Markets work on expectations of the future and not so much on past data. Our analysis of Refinitiv expectations of future company earnings remains positive overall.

After a bit of whiplash, US 10-year bond yields have settled down at just below 4.1%. Bonds are again a viable investment vehicle. Market volatility, as measured by the VIX Index, is at normal levels.

Asset Classes

Australian Equities

The ASX 200 fell 1.4% over August. A lot of the negativity appeared to arise from uncertainty about the Fed’s next move. Consumer Discretionary was the stand-out sector rising +4.6%. The year-to-date capital gain of +3.8% for the broader index is quite respectable given the long-term average of around 5%. August finished with a strong spell of daily gains. Moreover, our analysis of company earnings data, provided by Refinitiv, noted a modest increase in predicted gains over the next 12 months.

International Equities

The S&P 500 was also weaker over August, falling 1.8%. All of the other major global share indexes that we follow were also negative. However, the year-to-date gain for the S&P 500 is an impressive +17.4%. Japan’s Nikkei is even more impressive having risen 25.0% so far this year.

Bonds and Interest Rates

The Fed did not meet in August but it raised its cash interest rate at the end of July by 25 bps to a range of 5.25% to 5.50% (the highest in 22 years) in a widely telegraphed move. The probability of a further rate hike at the Fed’s September 20^th meeting has been priced at around 10% to 20% since the last hike. However, the odds only just favour no hike at the November 1^st meeting.

We agree that the Fed will likely pause interest rate increases this month despite Powell’s sabre-rattling talk of the prospect of further interest rate increases at the Jackson Hole conference in Wyoming of the world’s central bankers. We think there might be enough additional evidence in inflation, jobs, and growth data over September to convince the Fed to pause again at its November meeting.

By the final Fed meeting of the year on December 13^th, we think it likely that there is only a very minor chance the Fed would contemplate a further interest rate increase. We think the ‘interest rate cutting debate’ will start around that time as the earlier interest rate increases will have slowed the economy. We anticipate the conversation will turn to when stimulus measures (interest rate cuts) could begin in the first quarter and most likely before June 2024.

The RBA should be encouraged by the latest monthly Inflation data to hold off on increasing our interest rate further. The RBA interest rate tracker app on the ASX website prices in an interest rate increase at 0% in September and 14% for a rate cut. While we are certainly supportive of no further rate increases in the near term, we think October is also a bit too soon for a cut, only 18 days into the tenure of the new RBA governor Michele Bullock.

Without going through the details of what all of the other major central banks did and might do, it does seem that there is overwhelming support for global interest rates being at or near their peaks. Except for Japan and, to some extent, Switzerland whose economies have not followed the same path of rapid rises in inflation in recent years.

Other Assets

The price of oil was slightly up over August.

The price of iron ore rose 5.6%. The price of copper fell 4.0%. The price of gold was down fractionally. The Australian dollar depreciated 2.9% against the US dollar over August.

Regional Review

Australia

Cracks are starting to appear in the Australian economy. Growth in inflation-adjusted retail sales data have been negative for three successive quarters. Westpac’s consumer sentiment indicator has been hovering around a score of 80 (compared to 100 for a neutral reading) for about nine months. This read is worse than during the GFC but not quite as bad as that in the depths of the 1990/91 recession.

Even the jobs report has started to show weakness but, given the sampling error range associated with using a very limited data set, one month of weakness is insufficient to call it problematic yet. It is reasonable for businesses to hold on to workers longer than seemingly necessary because of the cost of re-hiring when the economy bounces back. And on the supply side, workers losing jobs in times of downturns might accept inferior positions to keep their cash flow going. However, history shows us that labour markets can then sour quite quickly.

The RBA is predicting 1.75% p.a. economic growth in 2024 and 2% in the following year. We see that scenario as being an optimistic one. Because of lags in the system, the full force of the high interest rates will not be felt until 2024.

Meanwhile, wages growth has not yet been a problem. Wages grew by 0.8% in the June quarter or 3.6% over the year. Workers are still playing catch up to the pandemic induced high inflation period during 2020 – 2022. As yet, there is no wage-push inflation (i.e. wages increase at a rate faster than productivity).

With China saving our economic bacon in 2008/9, we avoided a recession when the rest of the world went into what some called ‘the Great Recession’. This time China is struggling to manage its own economy. It is hard to see from where a silver bullet might be fired to stave off the effects of higher interest rates and inflation on the Australian economy.

China

Chinese data released in August were weak almost across the board. Retail sales, industrial output, and fixed asset investment were slow in absolute terms and all missed ‘weak’ expectations.

The purchasing managers index (PMI) for manufacturing was below the threshold ‘50’ level for the last five months but, at least, there were small improvements over the last three months. At 49.7 for August, the PMI easily beat the expectations of 49.4. We’re not talking about a collapse. It is just taking time for the economy to recover from the three-year shutdown. But there are signs of deep-seated debt problems arising in the property sector.

More disturbing is the deflation that appears to be underway in China. The broad inflation measure the Consumer Price Index (CPI) was ‑0.3% in the latest month when ‑0.4% had been expected. The Producer Price Index (PPI) was ‑4.4% against an expected ‑4.2%. Deflation is thought to be bad because it incentivises delaying purchases until those goods and services become cheaper.

US

US inflation statistics – and there were many variants published in August – were largely interpreted as showing that there was more work to be done before the fight against inflation can be considered won. Assessing US inflation with a measure that gives more weight to the most recent data, we concur with this assessment. Of course, we need to see this trend of softening inflation data confirmed in the coming months before we are comfortable enough to call a victory, but the trend has been for a steadily improving read over most of 2023.

The headline jobs number at 187,000 was big enough for many to conclude that the US economy is still strong however, what is concerning to us is that jobs in many of the growth sectors were small or negative and the data relies of government jobs for its overall level.

The June quarter GDP growth was revised downwards to 2.1% from 2.4%. The Fed considers 1.8% to be the neutral growth rate as far as inflation pressure is concerned, indicating an improving situation for inflation fighting – but still some work to do.

With credit ratings agency Moody’s downgrading credit worthiness for 16 US Banks (or putting issuers on negative watch) is disturbing. This change in ratings is no doubt the fall-out from the regional banking crisis that started in March. The combined credit tightening, the Fed interest rate well above its neutral rate, and the Quantitative Tightening programme (the Fed paying back on more maturing bonds than it is issuing new ones) appears to be building up to produce a downturn in the US economy. Whether this results in a recession and how deep that recession is, should it eventuate, remains to be seen.

Europe

The Bank of England (BoE) is still on a tightening cycle. Its latest 25 bps increase to 5.25% takes its cash interest rate to the highest in 15 years. CPI inflation stands at 6.8% over the year.

Britain has a different problem to that of Australia or the US, it reportedly took up the green energy challenge with more gusto than most – and found itself caught out by the supply-side energy price inflation. It is not easy to mitigate the impact of such a major policy shift.

EU inflation came down to 5.3% from 5.5% and its economic growth jumped back to positive territory after two consecutive quarters of negative growth. The first recession might be over but the next might not be far behind.

Rest of the World

Japan’s inflation declined further from its recent high to 3.1%. While Japan’s GDP growth came in at an impressive 6.0% (annualised) for the June quarter, the headline result masked the underlying compositional issues. Consumption growth was negative and capital expenditure was flat. However, retail sales jumped 6.8% (annualised) in July against an expected 5.4%.

Another hold decision from the RBA for the second month in a row is increasing confidence amongst economists and consumers that we have reached the end of the interest rate hiking cycle. This confidence is apparently having a flow-on effect on the property market with some suburbs showing accelerated median price growth compared to Australia as a whole.

Since February, dwelling prices have risen 4.1% across Australia, however, Sydney alone has risen 7.6%. Many potential sellers are under the belief that the current is not a good time to sell due to a soft price market, however, once the news travels that property prices are up and demand is low, a flood of properties will likely come to ease the price hikes.

Refinance activity, driven by fixed-rate expiry and general price hikes, is still continuing in earnest. Lender assessment times have slowed as credit assessment teams struggle to keep up with demand, and an influx of junior credit assessors means that assessment in general takes longer.

A shift in client retention strategy from the lenders is evident across the board as lenders adapt to higher interest rates (with higher margins for them) and also a lack of cash-back to entice borrowers. In general, some lenders seem to be offering significantly better interest rates via their retention team for those clients who do ask, or for the broker that regularly reviews their clients’ lending.

The cash-rate outlook has been changing readily over the past weeks. The general consensus is that this seems to be the end of the ‘tightening cycle’ however the board has previously indicated they will be driven by the data so if consumers keep spending, the rates will keep rising.

Savings and investments are both strategies that share a common financial goal – to grow your wealth. Despite this key similarity, there are a few differences between the two, and finding the right balance can assist you in building a more stable financial future.

Navigating the decision of when to save and when to invest can be challenging, so we’ve provided some tips below to help you decide.

Savings

As we know, savings form from setting aside a portion of your income into a low-risk savings account that can accrue interest over time… but when is it best to do so?

When to save:

• If you’ll require the money in the next few years – when working towards a goal that you know you’ll require funds for in the near future, a savings account offers enhanced liquidity and flexibility.
• If you haven’t already built up an emergency fund to cover unexpected expenses – it is often recommended to have an emergency fund set aside should something happen and you are unable to work. This is also useful before implementing an investment strategy, as it can help mitigate potential risk.
• If you have a low appetite for risk – if your risk tolerance is low, you may feel more comfortable putting your money into a savings account as opposed to investing which can be unpredictable and carries a higher level of risk.

Investments

Investments involve putting your money into assets with the expectation of generating returns over time and can include stocks, bonds, real estate, and more. As already mentioned, one of the key differences that set investments and savings apart is the level of risk, so consider the following scenarios before proceeding:

When to invest:

• If you don’t require the money for a longer period of time e.g., five years – investments take time and patience and are not typically intended as a short-term strategy. If you’re comfortable with not accessing your funds until the distant future, you may be ready to invest.
• If you have a cash emergency fund to help manage the risks of investing – no one can predict what the markets will do with 100% accuracy, so it’s recommended to have an emergency fund as a buffer against unforeseen events.
• If you’re comfortable with taking some risk to build your wealth – the world of investing is unpredictable, continuously changing, and at times, volatile. Understanding and accepting the level of risk before proceeding may instil you with more confidence throughout the process.

By striking the right balance between savings and investments, you can pave the way towards a more secure financial future. If you’d like to tailor a strategy that aligns with your goals, get in touch with your financial adviser.

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

Key points we cover:

• Inflation has undeniably come down but is higher than Central Banks’ preferred range
• Is there something different about this inflation and interest rate hiking cycle?
• The road ahead for the economy, inflation, interest rates, and markets

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 latest inflation data in Australia, the US, and indeed, many other economies is showing inflation has declined from their respective peaks. So the question is, how low does inflation need to be before the mindset of central banks transitions away from inflation-fighting and a bias to lower interest rate settings? And, assuming this transition occurs, the obvious question then becomes; when are they likely to start cutting interest rates?

We have previously documented the source of this bout of inflation. To recap, prices rose post-Covid as demand increased rapidly but, because of Covid lockdowns, the supply side e.g. shipments of manufactured goods from Asia was unable to respond to the sudden rise in demand. Consequently, competition for the limited supply available resulted in price rises which fed into a corresponding jump in inflation.

Central bankers, economists, and many others assessed that the drivers of this inflation were transitory. The rationale is that once the supply side responded to the Covid-created demand imbalance, prices would recede to ‘normal’ levels and inflation would return to manageable levels in the 2% to 3% p.a. range. That being the case, the need for interest rate policy tightening at that time was not required as the period of elevated inflation would indeed be temporary.

As a consequence of this assessment, central banks did not respond to the initial price surges. Dr Philip Lowe, Governor of the Reserve Bank of Australia (RBA), throughout much of 2021 said that rates would not rise until at least 2024. So why was there a change of heart?

There are a range of reasons, key among these were:

• The timing of the Russian invasion of Ukraine exacerbated inflationary pressures through food and energy price inflation as instability in the supply of these fundamental resources drove their prices higher.
• The general supply-demand imbalance lasted longer and remained more severe than anticipated as much of the developing world continued to grapple with Covid, long after the developed world had contained the pandemic as mass vaccination programs proved effective.
• Central banks saw inflation rising as they anticipated and, in keeping with their ‘transitory’ assessment, were unresponsive to interest rate policy. By the time inflation data confirmed that inflation was not as transitory as anticipated and that it had become more entrenched, they then had a well-documented change of heart.

The RBA first raised interest rates in May 2022 while the US Federal Reserve (Fed) started increasing US interest rates in March 2022. Fed chair, Jerome Powell, has since said he regretted ever using the word ‘temporary’. With the exception of Switzerland and Japan, most developed world economies have seen their central bankers walk a similar path.

Part of the problem has also been data dependency i.e. Central Bankers waiting for the data to confirm what was already known before responding with policy changes. The risk of this delay now is an economic recession. Some developed economies are already there.

A major risk is that, as central bankers delayed interest rate tightening on the way into this bout of inflation, they will be slow in cutting rates on the way out as they wait for longer timeframes of inflation data to confirm that it has indeed receded. Look back to the experience during the 1989 to 1991 period in Australia when there was the interest-rate-induced ‘recession we had to have’. The recession persisted even though the RBA was sharply cutting interest rates throughout that period!

But is this time different?

That phrase, or its affirmative variant, is used too often but there are some differences worth noting for the current cycle. Prior to this bout of inflation interest rates had been low and even negative in some countries for a very long period. That is extremely unusual!

In economics, there is a concept of a ‘neutral rate of interest’ – one which is neither expansionary nor contractionary. Economist consensus is that in Australia and the US, that neutral rate is about 2.5% to 3.0% p.a.

In the current cycle in Australia, the RBA cash interest rate did not get into ‘tightening’ mode until December 2022 i.e. RBA taking the cash interest rate above 3.0% – the first seven rate hikes from 0.1% to 3% merely reduced and then removed the existing ‘loose monetary policy’. One reason we haven’t seen economies falling into recession is that interest rate increases only became restrictive in the last 12 months. Using the same metric, the US monetary policy became restrictive i.e. higher than 3.0% p.a. in September 2022 after the Fed started hiking in March of that year. What is different this time is that tightening cycles do not usually start from such a low base.

There is also another important fact to consider. Fixed-rate mortgages don’t ‘exert any pain’ on borrowers until the loans roll over or a new loan is initiated. The so-called ‘mortgage cliff’ is just starting in Australia as borrowers on fixed interest rate loans move to variable interest rate loans. In the US, where fixed rate loan terms are much longer (up to 30 years) the effect of such a short sharp rates’ upswing is diluted even more.

In the current environment, the data is not all pointing to the same outcome. Some key data points indicate ongoing strength (upward inflationary pressure) which is adding to the complexity for Central Bankers trying to manage inflation back to preferred or neutral levels.

Key among these in both Australia and the US is the labour markets which are still holding strong but the same is not true for other inputs. The US has experienced several months of contraction in retail sales and Australia’s GDP, in the March quarter of 2023 (reported in June), was barely above zero (and was negative when population growth is taken into account). The recent June quarter 2023 estimate of growth for the US was an impressive 2.4%, but that includes a lot of fiscal stimulus (government spending) from the Biden administration, which is actually stimulatory and is fighting against the Fed policy.

The economic outlook remains opaque as we transition from tightening monetary policies through to a plateau phase (it feels like we are entering the plateau phase now), before interest rates decline to support economic growth/recovery post inflation returning to its neutral range.

The outlook for share markets is somewhat brighter even though earnings forecasts for companies were revised down for the June quarter in the US and the half-year ending June 30 in Australia. So, the current forecast for corporate earnings is not that high and, as a consequence, not that hard for companies to achieve.

Markets can look through the malaise and rise before a downturn in the economy is over, and, based on historical experience, often do. Refinitiv, one of our data providers, surveys hundreds of stock broker forecasts of company earnings for the three years ahead. The analysis of that data is, on average, supportive of current share market valuations and prices.

Asset Classes

Australian Equities

The Australian share market as measured by the ASX 200 Index was up +2.9% in July. The index of Energy shares led the way rising 8.8% whereas the Indices of Financial and IT companies rose 4.9% and 4.4% respectively. Good results all things considered. The indices for Staples and Healthcare went backward in July.

It would appear that equity investors have gradually moved to be more accepting of a ‘soft-landing’ scenario for the economy and are allocating capital back into shares as markets are trending more positively. While a ‘hard landing’ remains a risk for markets, data, particularly in the US, continues to support a ‘soft-landing’ outcome.

International Equities

The US S&P 500 Index of the largest 500 companies listed on the US share market had a strong July rising +3.1%.

Much attention continues to be paid to the magnificent 7 large-cap technology stocks listed in the US and, while they have performed well and largely carried the market to its loftier heights, the positive move in the market has been broader than these stocks alone. This broadening provides a degree of comfort in the general health of the share market.

Bonds and Interest Rates

In a widely telegraphed move, the Fed raised its cash interest rate by 0.25% to a range of 5.25% to 5.5% (the highest level in 22 years). The RBA, on the other hand, decided to leave our cash interest rate on hold at 4.1% p.a. at its meeting on August 1. The European Central Bank (ECB) took its base interest rate to a record-high level of 3.75% p.a. The Bank of Japan (BoJ) unsurprisingly stayed at ‑0.1% p.a. but it did adjust the allowed movement around its longer maturity bond rates (e.g. 10-year Government bond.

It appears that the mood across developed economies at least is that central banks are at or near their expected highs for interest rates. The US Fed has an estimated probability of 20% for one more interest rate increase to be announced at its next meeting on September 20^th. With inflation seemingly coming under control, there is a growing belief among many analysts that the Fed might already be ‘done’ raising rates.

The US 10-year Government bond rate has moved both up and down in recent months. The latest move was to briefly rise back above 4%. We note that after a period of volatility, the US bond market is stabilising somewhat.

Other Assets

The price of oil moved sharply higher in July (+14%) fuelling gains in the energy sector of the ASX 200.

The price of iron ore was down a little (‑1.9%). The price of copper was up +3.6%. The price of gold was up +2.7%. The Australian dollar appreciated 0.8% over July.

The VIX volatility index, a measure of share market volatility, closed in July at 13.6, a level that is in the normal range.

Regional Review

Australia

Our jobs report for June was strong with 33,600 new jobs being created and the unemployment rate at 3.5%. Of course, immigration is strong perhaps helping the increases in the demand for labour.

Dr Philip Lowe was not reappointed for a second term as RBA Governor. He is to be replaced by the current Deputy Governor, Michele Bullock, on September 17^th. We do not think that change will make a material difference to the conduct of monetary policy, particularly as inflation is now receding.

We do not think the RBA will start cutting interest rates any time soon unless, or until, more of a material slowdown in economic growth is observed. Retail sales fell by ‑0.8% over the last month but rose 2.3% on the year. In other words, the annual growth in retail sales at current prices is about the same as the general level of prices so inflation-adjusted retail sales have been flat.

China

China data are a little mixed. The latest GDP growth for the June quarter came in at 6.3%, 1% below the expected 7.3%. Both figures are well above the long-run expectation of a little over 5% p.a. because of the ‘base effect’ of coming out of the three-year-long lockdown. However, the quarterly growth was 0.8% against an expected 0.5%. That bodes well for the September quarter.

The usual monthly growth statistics of retail sales, industrial output, and fixed asset investment were at or above expectations but weaker than pre-pandemic rates. Exports and Imports both contracted in the latest month and were worse than expected. Youth unemployment was reported to stand at 22.3%! No doubt a concern for Chinese authorities.

China’s manufacturing PMI came in at 49.3 making it the fourth successive reading below 50 (a reading below 50 indicates contraction). However, the index has risen slightly in the last two months from a low of 48.8 in May.

US

US employment growth (non-farm payrolls) increased by 209,000 in June slightly missing the expected 225,000, but the unemployment rate fell from 3.7% to 3.6%. Importantly, around 150,000 of the jobs created were in government positions and lower-level healthcare. This change in the mix could be a sign of weaker job growth to come and, hence, to a softer monetary policy stance from the Fed.

The US has two more Consumer Price Indices (CPI) reports and two more employment reports before the next interest rate setting meeting on September 20^th. The Fed will also be hosting the Jackson Hole global conference for Central Bankers in late August. Should we expect a joint statement that the bulk of the work on inflation is over?

US June quarter GDP growth surprised to the upside at 2.4% when 2% had been expected. We recall that March quarter growth was 1.1% for the preliminary estimate reported in April which was then revised upwards to 1.3% and then 2% in June, indicating some resilience in the US economy.

US retail sales were weak at 0.2% for the month and industrial output went backward at ‑0.5%. Despite this, the mood continues to remain sanguine.

Europe

UK wage inflation grew the equal fastest on record in the three months to June 30 at 7.3%.

France’s GDP growth for the June quarter came in at 0.5% against a forecast of 0.1% and a previous reading of 0.1%. Inflation came in at 4.3% from a previous reading of 4.5%.

There is little in Europe data to give us much joy but they seem to be struggling through rather than collapsing. The latest European Union GDP growth data for the June quarter ended the run of two consecutive quarters of negative growth rates with a rate of 0.3% against an expected 0.2%.

Rest of the World

Japan’s inflation is off its recent high at 3.3% and core inflation was 4.2%. The Tokyo core inflation read was 3% which beat expectations. Japan retail sales came in at 5.9% above the expected 5.6%. However, industrial output at 2.0% was slightly below forecast.

Russia has reportedly ended the food corridor for ships carrying Ukrainian grain exports to pass freely through the Black Sea. There are many reports of Ukraine fighting back by firing missiles at Russian targets. There seems to be no peace in sight. There is an elevated chance of a hike in food and fertilizer prices from these recent moves but we do not see it as having the same effect as at the start of the invasion in February 2022. Alternative sources of supply have, to some extent, been found.

You’re about to enjoy a cappuccino from your local coffee shop, and you find yourself faced with an abundance of payment choices when the moment arrives to pay. Do you use your card? Cash? Your smart watch? Your phone? The chip embedded in your hand? (Just kidding).

This has become the reality with the rise of digital payments, with 98.9% of Australian customer banking interactions now taking place via apps or online, and cash being used for just 13% of payments (down from 70% in 2007).*

We’ve explored the growing trend of digital payments and outlined its benefits, challenges, how consumers and businesses can harness its full potential, and why cash still holds significance.

Benefits

• Convenience – the most obvious benefit that pops to mind is the convenience digital payments provide that not only allow us to make purchases swiftly, but reduces our reliance on physical cash and cards.
• Enhanced security – with advanced encryption and authentication measures, digital payments provide a secure way to protect financial information, reducing the risk of fraud and theft.
• Real time transactions – instant transfers and payments enable quicker access to funds and better visibility of financial status. For businesses, it also reduces the time staff need to spend handling, counting, reconciling and fixing errors that are associated with cash.
• Contactless – COVID may feel like a lifetime ago, but during that time, contactless payments gained popularity as a hygienic option for both customers and businesses.

Challenges

• Cyber security – where there is technology, there are cyber-attacks, so you need to be on alert when making online transactions. If you’re unfamiliar with a name or purchase on your account, it’s best to contact your bank to check.
• Connectivity – although most places we go have phone and internet coverage, this isn’t always the case, especially in regional areas and if connectivity is down.
• Data privacy – digital transactions require more personal data, which as we know, runs the risk of ending up in the wrong hands.

While the vast majority of consumers and businesses using digital payments appears to be the way of the future, cash still provides inclusivity for those without digital access, can be vital in emergencies, practical for small transactions, and provide people with a level of privacy. However, with more and more talk of Australia becoming a ‘cashless society’, the relevance of physical currency prompts us to reflect on our evolving financial landscape.

So, how will you be paying for that cappuccino?

* https://www.ausbanking.org.au/mobile-wallet-transactions-skyrocket-to-93-billion-as-98-9-of-bank-interactions-take-place-digitally/

The winter chill is in the air, and so too is the increased use of electricity to keep us toasty and warm. Dryers, heaters, electric blankets, heat lamps… the list goes on! With the cost-of-living pressures on the rise, we’ve listed a variety of practical ways to help you reduce your energy consumption.

Avoid the dryer when possible

Throwing clothes in the dryer can become a convenient default choice during the winter months, but can hurt our wallets as they’re notorious for sucking up energy. Try and take advantage of the sunshine when you can to dry them naturally outside or alternatively, use an indoor drying rack during rainy weather.

Heating the home

It may seem obvious, but only heating the room that you’re currently in is a simple way to keep energy costs down. Closing doors to unused rooms and blocking any drafts will also help you maintain a warm environment.

Let the light in

On those beautiful clear winter days, open up the curtains and blinds to use the natural light as an alternative to switching on the artificial ones.

Switch off and save

Even when appliances are on stand-by, they can still be consuming energy, so consider turning them off at the power point when not in use.

Shop around

It may help to put aside some time to research different energy providers to ensure you’re getting the best deal possible. You can find free comparison sites online who do most of the work for you such as Canstar, Energy Made Easy and Finder.

Rug up

Pull out the cosy socks, jumpers and blankets and layer up to avoid the temptation of reaching for the heater. Of course, there are times when the layers just won’t cut it, but have those winter woollies as a go-to when you can.

Slow cooker

Cold weather calls for comfort food, and slow cookers not only provide the convenience of cooking while you’re out and about, they also use less energy than ovens. If you’ve got a slow cooker, now is a great time to put it to use.

By adopting some of these small changes in your habits and home, you have the potential to save money on your energy bill over time.

It’s become almost impossible to watch, listen, or scroll recently without headlines about AI and ChatGPT infiltrating every aspect of our lives. From “ChatGPT wrote my fitness plan”, to “AI is taking over the world”, the general consensus seems to come down to one word – controversial.

A language model developed by the company ‘OpenAI’, ChatGPT is designed to generate human-like responses with impressive speed by scraping the internet for data. The system uses this information to respond to prompts provided by the user, that can range from answering simple questions to producing complex code for websites.

As the developments with this kind of technology evolve, so do the concerns about its role in our everyday lives and the industries it will continue to impact – with financial advice being no exception. Whether you’re for or against AI, there’s no doubt that it’s changing the way we do things. So, what could software like ChatGPT do for your investments?

The Financial Review tested this functionality[1], asking ChatGPT “How much tax is payable if you earn $250,000 a year with $40,000 tax deductions and should you make concessional super contributions?” In response, the software automatically applied Australian resident tax rules for 2022-23 (potentially learning this from previous prompts in the software) but calculated the marginal tax and concessional contribution cap incorrectly, applying one marginal tax rate to the entire net income, and stating $25,000 instead of $27,500 for the concessional contribution cap.

“Problematically, ChatGPT had no idea it was wrong. It gave these answers confidently – only someone who knew the correct answer could correct it. An investor relying on the data could be in trouble.” – Tim Mackay, Financial Review

However, when asked to provide the top 20 Australian Exchange-Traded Funds (ETFs) and links to their website, it was able to instantaneously provide the information (albeit, utilising some strategic prompts that asked the software to pretend it wasn’t actually ChatGPT to bypass its rules).

Although the software has the capacity to provide financial information in just seconds, it’s not always accurate, and this presents a unique set of challenges in an industry that so frequently changes and that faces such stringent regulations. Nevertheless, using ChatGPT for general enquiries, to improve financial literacy, to simplify complex information or even assist with budgeting plans, can provide an easily accessible and free tool to use in conjunction with a (human!) financial adviser.

It is also important to note that although some advisers may use the software for certain aspects of their financial planning process, it cannot account for unexpected events or changes in the market. Human expertise and judgement remain essential in adapting to these shifts.

[1] https://www.afr.com/wealth/personal-finance/what-chatgpt-can-do-for-your-investments-20230125-p5cfee