Economic update – November 2023

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

Key points:
– The new RBA Governor, Michelle Bullock, increases the RBA Cash rate to 4.35%
– US Fed chooses not to increase the US Cash rate as data indicates some economic softening
– European and UK central banks hold interest rates steady as inflation and growth both ease

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact the team.

The Big Picture

We entered October with an air of positive expectancy about the outcome at the Melbourne Cup Day RBA Board meeting. Earlier in November, the market was flirting with a 14% chance of a possible rate cut in October. A cut did not eventuate and, by mid-October, the mood had shifted to being on hold with only a slight chance of a hike in November. On the back of the latest inflation read in late October, the odds turned the mood swiftly to a 50:50 split between the chance of a pause or a 0.25% interest rate rise according to the RBA Rate Tracker tool on the ASX website.

There is no doubt that the quarterly CPI read did jump from a modest 0.8% for the June quarter to 1.2% for the latest quarter resulting in a reading of 5.4% for the latest 12 months.

It is of extreme importance to recall that oil prices rose from just $72 / barrel earlier in the year to $97 largely based on supply changes orchestrated by OPEC+. That input-price-inflation ‘passed through’ to automotive fuel prices around the globe.

Oil prices swiftly fell to $84 in October before retracing to $87 by the end of the month. The fall was too late for the latest month or quarter’s inflation being measured. OPEC+ does not respond to RBA interest rates and it would be foolish to try to quell that component in the CPI with a rate hike in November.

The Australian Bureau of Statistics (ABS) also produces a monthly CPI series, albeit based on a slightly narrower coverage of goods and services. Our analysis of that data shows that the monthly CPI data peaked in August at 6.4% (following a succession of readings in the target range) before retreating to 5.8% for September – both months being within the September quarter.

It is most probably the case that several factors are at work in affecting our CPI inflation. Our $A depreciated from about $US0.70 to below $US0.63 over 2023. Such a depreciation causes import prices of many goods and services to rise. In response, CPI inflation is likely to have increased. Of course, oil prices, supply-chain disruptions and the rest are also in the mix.

It is difficult to point to the precise factors that caused the depreciation of our dollar but weakness in the China economy and rate movements in the US and here are likely to have been important. However, it is doubtful if a 0.25% increase in the RBA cash interest rate would redress a significant part of the depreciation.

Dr Luci Ellis, who only recently left the hierarchy of the RBA to become chief economist at Westpac, has been arguing that a rate hike is likely in November.

While Australia appears to be moving towards a renewed rate-hiking policy, the US has moved in the opposite direction. The November 1st Federal Open Markets Committee (FOMC) meeting had been thought to be leaning towards a pause but with a significant chance of a hike. However, by the time of the meeting markets were pricing in a 1.6% chance of a rate cut and a 0% chance of a hike hence the overwhelming expectation was for a pause, which is what was announced. At the time of writing, the fixed intertest market, as assessed through the CME Fedwatch tool, still has a 10% chance that the Fed could increase the cash interest rate again at its December 13th meeting. That said, what we have observed in past months is that the CME FedWatch tool varies in a wide range for the probabilities appended to the Feds next interest rate move and are very data dependent.

Across the Atlantic, the European Central Bank (ECB), Bank of England (BoE) and the Swiss National Bank (SNB) all kept their respective cash rates ‘on hold’ at their last meetings.

There is little doubt that the Australian economy is weaking: we have experienced two consecutive quarters of negative growth when expressed on a per capita basis; and the last three quarters of retail sales growth, when adjusted for inflation, have been negative. The last jobs report showed only 6,700 new jobs but there was an accompanying fall of 39,900 full-time jobs with the difference made up from new part-time jobs (replacing the full-time?). Eight million hours of work were reported as lost in the latest month (September) and nine million hours were lost in the month before. Those lost hours each equate to around 50,000 lost full-time jobs.

It is true that our unemployment rate is historically low at 3.6% – as is that of the US at 3.9%. In a revealing announcement at the end of October, Britain has abandoned its data collection survey method to compute unemployment because, reportedly, millennials and generation Z are reluctant to answer their phones, which impacts on the accuracy of the report!

Are US and Australian data also similarly affected? We do not know but serious questions about labour force data should be asked given how critical the assessment of the structure of the labour force is in the formation of both monetary (RBA) and fiscal (government) policy. There may well need to be changes in either the calculation of the rate or its interpretation following the social upheaval of the pandemic. When there are so many other signals of a weakening economy, it would be foolish to rely on a single part of the economy to guide the direction of monetary policy.

The US, however, reported an extremely strong labour market – at least at first glance. Two separate sources said the 336,000 new jobs reported in September – compared to an expected range of 90,000 to 250,000 – did not reflect that most of the new jobs were for lower paid, part-time positions. The sources proffered that it was more likely that these jobs were for second jobs to cope with the cost-of-living crisis rather than as an indicator of a strong market.

Some cite that there is ‘a strong US consumer’, particularly after the block-buster GDP growth of 4.9% for Q3. However, retail sales over the year – after adjusting for inflation – were flat. Recent data have been unduly affected by Covid related stimulus payments and people living off accumulated excess household savings.

The three-year US student debt forgiveness programme has just ended and excess savings are reportedly all but exhausted. So, from now on we will get to see how the economy fares when consumers now need to fund their lifestyles from their current earnings.

The savings ratio in the latest quarter fell from 5.2% to a low 3.8%. Households are saving less per quarter than their historical average which does not bode well for the future.

Because most US home mortgages have fixed interest rates for 30 years, many have not yet been affected by recent rate rises – unless they chose to, or needed to, move home. Many were smart enough to have locked in low rates for their fixed rate mortgages during the pandemic years.

The US 30-year fixed term mortgage rate just exceeded 8% – the highest since the year 2000 after climbing from a recent low of about 4% during the pandemic. That’s about double the interest repayments so it will obviously affect decisions of many to move. However, when rates do fall, people borrowing at 8% can typically refinance at the lower rate without penalty. The US is different from Australia in so many ways.

In mid-2023, many were calling no US recession – or, at most, a mild one. The majority now seem to be accepting of the notion that the US is heading towards a recession of some degree. But there is hope that any recession would be short-lived, providing that the Fed reacts quickly.

The third quarter US company earnings’ reporting season is now underway and many companies have posted strong earnings and have positive views of their earnings prospects in the quarters to come. With share markets having retreated substantially (of the order of 2% to 8% since the end of June) having bounced back from correction territory for some, markets could rally quickly if the central banks soon choose to make statements of likely cuts to interest rates to support their flagging economies.

Interest rate cuts are being priced into the US Fed funds rate in the first half of 2024 as assessed by the CME Fedwatch tool. Some central bankers, with the ‘higher for longer’ mantra, are still talking of no cuts in 2024 or even 2025. We find it difficult to see that happening.

While there has rightfully been much attention on equity markets, bond markets require some serious consideration. The yield of the US 10-year Government bond broke through 5% in the second half of October – the highest since 2007. When the price of a Bond falls the yield rises, and the longer the maturity of the bond, the larger the price impact. The mounting problem with the US is that the appetite to hold US debt was waned in recent times. Some bond auctions held by the US Treasury have not gone as well as expected which has caused some instability/volatility in the US bond market. In the long run, the US will have to address its significant level of Government debt.

As bond yields go up, they become more attractive – especially if they are held to maturity. Higher yields typically have a depressing impact on equity returns because the alternative to holding equities becomes more appealing as a result the relative attractiveness of equities declines

Of course, the Israel-Gaza conflict could adversely affect markets if the conflict escalates across the Middle East and beyond. From an economic perspective the risk to global oil supplies is particularly high.