Bonds and Interest Rates
The RBA lifted its overnight cash borrowing rate from 0.35% to 0.85% at its meeting in early June. Most market analysts seemed to have been expecting a ‘typical’ 0.25% increase or perhaps 0.4% to restore the historical scale of one which climbs in 0.25% increments. This surprise 0.50% increase did not seem to achieve any positive results and, indeed, reflected poorly on the RBA after all of the statements made by the bank in prior months.
The Fed, after saying at its previous meeting that it wouldn’t do more than a 0.5% hike, not only increased the Fed funds rate by 0.75% but flagged such an increase would also be considered at its July meeting.
The expected Fed rate at the end of calendar 2022 is now 3.4% which, in itself, cannot be considered high. 3.4% is about 1% over the estimated ‘neutral rate’ but it is much higher than had been expected a few months ago.
The ECB and the Bank of England also joined in the monetary policy aggression. Perhaps central banks feared being the last to hike ‘enough’ and, hence, be criticised if inflation becomes more entrenched than they anticipated.
10-year interest rates on government bonds unsurprisingly went through gyrations following these early June interest rate moves by central banks. It seems to be the consensus view that the long-bond yields caused the major volatility in equity markets.
Iron ore and copper prices retreated even further in June – each by falling by over 10% – putting them both into bear market territory having fallen by more than 20% from recent peaks. However, iron ore prices are still well above $100 / tonne.
Oil prices also slipped in June but not as much as the metals. Gold prices were stable but the Australian dollar was down 4.1% over June.
There have been many casualties in the crypto currency space.
Economic growth in the March quarter was strong at 0.8% or 3.3% for the year. Importantly, the household savings ratio fell to 11.4% after having been above 20% just a few quarters before. Households stored cash in the pandemic – either by choice or lack of options to spend – and this leaching back into the economy is supporting growth prospects. With a ‘normal’ savings ratio of around 7% just before the onset of the pandemic, there is room for further cash injections into consumer spending.
There were 60,600 new jobs reported for the month. This total included 69,400 new full-time jobs accompanied by a small loss in part-time jobs. The unemployment rate was steady at 3.9%.
We have also experienced an additional driver of inflation in Australia. Owing to the floods and frosts at the beginning of winter, and a shortage of seasonal workers, the prices of some produce – such as lettuces – have sky-rocketed. Iceberg lettuces have reportedly risen from around $3 – $4 to a peak of $12 a head. Presumably the people buying these lettuces didn’t first check the price!
Since our CPI inflation is well below that in many developed nations, and we have a large savings buffer, it is difficult to see the Australian economy struggling in the remainder of 2022. What happens in 2023 will depend to a large extent on the wage negotiations that are now underway. Workers have a reasonable expectation of maintaining real (or inflation-adjusted) wages but if the current round of wage negotiations, then gets baked into inflation expectations as in the 1970s and 1980s, we could have a longer-term economic problem with inflation. It took a major recession in 1990-1991 to put the inflation genie back in the bottle.
China continues to grapple with its zero Covid policy. While large numbers of people – even in Shanghai – are fully vaccinated, there are tens of millions of old people who are not.
There was some mild evidence of the Chinese economy bouncing back after the lockdown ended. However, a US-based ‘beige book’ survey rejects that notion.
Chinese retail sales came in at 6.7%, industrial production at +0.7% and fixed asset investment at +6.2%. While these statistics are poor on face value, they did beat expectations. The full effects of China’s new stimulus packages have not yet been felt to any great extent.
There were 390,000 new jobs created as reported in the latest monthly labour report and the unemployment rate remains at 3.6%. Since only 328,000 new jobs had been expected, the report card was seen as a positive.
Wage growth at 5.2% was far behind CPI inflation which came in at 8.6% for the year or 1.0% for the month. The core CPI inflation rates that strip out energy and price inflation came in at 6.0% for the year and 0.6% for the month. The 8.6% print was the biggest since 1981.
The University of Michigan consumer sentiment index came in at an historic low of 50 but there was a glimmer of hope on the expected inflation front i.e that it is beginning to soften.
The headline PCE measure of inflation came in at 6.3% for the year and 0.6% for the month. The core variant came in at 4.7% for the year an 0.3% for the month. The expected annual core reading was 4.8% and the pervious read was 4.9%.
The Atlanta Fed, which has a strong reputation for its forecasting ability, is predicting growth of 0.9% (annualised) for the June quarter but that is down from the 1.3% forecast made two weeks before. Since the previous growth read was 1.5% for the March quarter, two consecutive negative quarters (a technical recession) might be avoided but the Fed and many of the regional bank presidents continue to call for major increases in interest rates.
The noted Wharton School professor, Jeremy Siegel,recently said that the US might already be in a recession. He also noted that inflation might be cooling and he thinks the US stock markets are not overvalued.
The Fed’s own ‘dot plots’, which records present Fed members’ individual predictions for the cash rate, show that the consensus is pointing to the cash rate declining in 2024 following substantial increases in 2022 and a flattening in 2023. That might be enough to dodge the recession bullet.
The ECB has, at last, joined the monetary policy move to end the accommodative regime that has lasted for a very long time. Interestingly, it has been reported that the UK, which left the EU in “Brexit”, is performing similarly to continental Europe.
With Sweden and Norway close to joining NATO and NATO moves to increase troops and armaments in the region, Russian President Putin is not left with many options for success in Ukraine.
Rest of the world
The World Bank is predicting global growth to be 2.9% in 2022. Emerging markets growth usually keeps that growth forecast quite a bit higher. It will be interesting to see if NATOs push to improve the military support to Ukraine has any spill-over to the private sector economy.