Of course, the inflation story had not gone away. New data in the US and Australia pointed to slightly better inflation data – so what would the Fed do on March 22nd? Many suggested the Fed would not hike because of the SVB problems. In the end, the Fed hiked interest rates by 0.25% (25 bps) rather than the 0.50% or 50 bps, touted before the SVB collapse. However, Powell stunned some, including us, in his press conference.
Powell pointed out that there would be a tightening of credit resulting from the problems in the regional banks. He went on to say [paraphrased] that such tightening would act in the same direction as a rate hike and might amount to the equivalent of a 25 bps or maybe 50 bps or more hike. We cannot say with any precision!
So, what Powell has admitted to is a much bigger than anticipated effective policy tightening. That sounds like a recession is on its way to us (if it wasn’t before). The Fed’s 25 bps hike, plus another 25 or 50 (or more) bps from credit tightening spells trouble when we’ve already witnessed problems from the Fed’s prior hiking policy.
We have been arguing for some time that the US couldn’t avoid a recession (either later this year or next) but we think that has already been priced in by the market. That does not mean that share markets can’t go higher from here – with a little bit of volatility thrown in. In due course, we think the Fed will review its policy and go easier on interest rates.
We are (and have been) somewhat sceptical about the tight US interest rate policy for two reasons. First, the supply side problems in inflation (from the Ukraine invasion and the pandemic etc) do not respond to rate hikes. Secondly, because we all agree that interest rates – if they work at all – act with a ‘long and variable lag’. In other words, it might be too soon to know whether the first hikes that occurred in March 2022 in the US and May in Australia, have yet had any impact let alone the subsequent hikes!
But there is a possible lesson from Japanese actions (or lack thereof). Japan just released its inflation print of 3.1% (as expected) which was down from 4.2% the month before (a recent record). You might ask how high did they force rates up to get that effect. The answer is that their official cash interest rate is still 0.1% and the Bank of Japan hasn’t hiked since 2016. Go figure!
The market expects (has priced in) that the Fed will have to cut rates this year as ominous signs of a slowdown in economic growth start to build. However, the Fed is still clinging on to a policy of no cuts to the Federal Funds (Cash) interest rate in 2023!
To summarise – markets have recovered well following the dip after SVB failed. There hasn’t been a material impact on broker forecasts of company earnings as published by Refinitiv. But that could be because brokers do not yet know how to react to recent changes in macro effects.
There is no longer ‘no alternative’ to equities as both bond and cash yields have recovered so a portfolio containing both shares and bonds may have greater merit than in recent years.
The RBA looks like it might be ‘on hold’ after these events. Either way, Australia could dodge the bullet owing to having a smarter central bank and China’s nascent resurgence.
The ASX 200 didn’t have a good month – it was down 1.1% – but it has recovered from the mid-March low. Financials ( 5.1%) got hammered – probably because of the irrelevant knock-on fears from US regional bank woes. Property ( 6.9%) and Energy ( 4.8%) also saw losses.
We have the market as being slightly cheap and earnings forecasts are continuing to hold though we think the risk is, on balance, to the downside.
US equities were up on the month (S&P 500 rising 3.5%) after a big wobble in mid-March. Other international markets had a mixed month. It is too soon to see any new trend emerge but we are of the opinion that markets will work their way through a difficult March and beyond.
Bonds and Interest Rates
The US Fed did equities no favours in its about-face on interest rate hikes. There is a general consensus that the sharp rise in the Fed funds rate caused (at least in part) longer term Treasury yields to rise sharply. Those rises in yields directly caused big falls in the value of portfolios of supposedly safe bonds. Had investors been able to hold on to maturity, investors would have been rewarded but, in this mark-to-market world, assets of many financial institutions caused a mis-alignment between assets and liabilities.
The Fed and the RBA each hiked their base rate by 25 bps. The ECB, not to be outdone, went +50 bps. The Bank of Japan (BoJ) didn’t blink as it hasn’t for around seven years. Its rate is still 0.1% and its inflation rate fell from 4.2% to 3.1%.
The RBA is widely expected to be ‘on hold’ for a month but then go again.
The Bank of England (BoE) raised rates by 25 bps to 4.25% but their inflation rate rose to 10.4%.
The price of gold was well up on the month (8.2%) but that of oil was well down ( 5.5% for Brent). The prices of copper and iron ore each grew modestly.
The Australian dollar against the US dollar fell by 0.3%.
The VIX, an index that measures US equity market volatility, returned to a level below 20, a more normal level after a period of higher volatility recently. This gives an indication that investors seem to be getting more comfortable with the direction of the market.
Our unemployment rate dropped back to 3.5% from 3.7% and a bumper 64,600 new jobs were created in February. The number of full-time jobs increased by 74,000 while part-time jobs fell by 10,300. These are incredibly strong labour force figures and indicate a reasonably robust economy during the period.
While the RBA might have wished for weakness in this data as a sign that inflation might soon ease, it has only been 10 months since the tightening cycle started. If the RBA maintains a tight monetary stance, we fully expect the unemployment rate to shift higher quite quickly but at some unspecified future point in time. After a bout of higher unemployment, the rate usually returns to levels consistent with full employment rather slowly.
Our 2022, December quarter GDP growth came in at 0.5% for the quarter or 2.7% for the year. The more important figure from that statistical report was that the household savings ratio, it fell to 4.5% from 7.1%. This fall demonstrates that households are not adding to their savings – whether for retirement or consumer durables – as they do in general.
The Purchasing Managers Index (PMI) for manufacturing expectations came in at 52.6 at the start of March and 51.9 at the end, after having been as low as 47.0 at the beginning of the year. The re-opening of China’s economy after a three-year semi lock-down appears to be going well. The People’s Republic announced that it is targeting 5% or more growth in the coming period.
China seems to be committed to stimulus but with a focus oriented to a consumption led recovery as opposed to development as it has in the past. Evidence of its stimulatory approached was a cut to the Required Reserve Ratio (RRR) by 25 bps for banks, this enables them to lend a little easier.
Retail sales came in at 3.5% p.a. for January-February which was on expectations. Industrial output at 2.4% p.a. missed the expected 3.6% p.a. Fixed asset investment was 5.5% p.a.
The US recorded yet another bumper new jobs number of 311,000 – compared to a typical range of 200,000 to 250,000 in good times. The unemployment rate came in at 3.6% following the previous month’s 3.4%. Wage growth was moderate at 0.2% for the month.
CPI inflation came in at 0.4% for the month or 6.0% for the year. Core inflation – which strips out energy and food price inflation – came in at 0.5% for the month or 5.5% for the year.
Producer Price Index (PPI) inflation was actually negative at 0.1% for the month, 0.0% for the quarter and 4.6% for the year.
Personal Consumption Expenditure (PCE) inflation also showed nascent signs of recovery. The core version – which is the Fed-preferred measure of inflation – came in at 0.3% for the month against an expected 0.4% and 4.6% for the year. The headline rate was also 0.3% for the month but 5.0% for the year. While these data do not yet mark a victory for the Fed in its fight against inflation, it does seem to be getting close.
Since wages growth is now modest and PPI inflation shows input prices are not increasing, we expect consumer inflation (both CPI and PCE) to start falling to acceptable levels in the near future. Hence the Fed might soon pause and even consider cuts to its rate.
Both Powell and US Treasury Secretary Janet Yellen are reporting that banks have stabilised after the flurry of activity surrounding the SVB collapse. Fed data on its balance sheet reported at the end of March supported that view. There has been some outflow from banks of various sizes but they are largely offset by inflows to the money market. Some prefer to earn around 4% from the money market rather than close to zero in a bank deposit but the former is not insured as the latter is.
UK growth came in at 0.3% for Q4, 2022 when a negative result was widely expected. Its inflation rate jumped back up to 10.4% from 10.1% despite continued increases in the Bank of England interest rate from 4.0% to 4.25%.
The ECB vigorously addressed the inflation issue with a 50-bps hike to its interest rate even though banking problems had just come to light in the US and Switzerland.
Rest of the World
Japan’s rate of inflation fell from 4.2% to 3.1% while the Bank of Japan has kept its rate at 0.1% since 2016.