Bonds and Interest Rates
The US yield curve has moved quite a lot over the last month or two. After a rapid rise in the 10-year Treasuries yield, it fell into mid-August but it has since rebounded a fraction to 1.31%. The Australian 10-year yield has been below that of the US with consequences for the Australian dollar (against the US) in the near term, particularly prior to the Afghan withdrawal.
The Jackson Hole meeting in August did not offer much in the way of specifics about US Fed policy. After all, it is a global, annual meeting of central banks.
At the last minute, the meeting was switched to virtual which made some think that rising concerns over COVID might stop the Fed from getting serious about tapering.
Nevertheless, Powell gave a calm, reasoned address which allayed market fears. The next Fed’s FOMC meeting is in September. It looks highly likely that Powell will back up his Jackson Hole comment and set an agenda for tapering to start just before the end of the year. Few seem to think that the US economy is weak enough to need any increase to the current level of Fed bond buy-backs.
Because of the way the market handled the Jackson Hole address by Fed chair Jerome Powell, we do not now think there will be much in the way of an adverse reaction to tapering when it is formally announced or started.
The RBA unsurprisingly kept rates on hold at its August meeting. No increases are expected in the foreseeable future. However, South Korea became the first developed economy to raise rates. It did so in August and it is expected to hike again before the end of 2021.
The steep fall in the price of iron ore was reversed somewhat towards the end of August. There are conflicting reports of China’s needs in coming years but it does seem likely that China is trying to move away from its dependence on Australian iron ore.
The prices of copper and oil made losses over August while the price of gold was largely flat. Despite the fall in oil prices over August, oil prices are up over 40% on the year-to-date. The price of copper is up over 20% on the year-to-date but iron ore prices are largely flat over the same period.
The Australian dollar recovered from a low of US$ 0.7133 during August to a range in the mid-73 cents, possibly more a case of the $US weakening on the back of the Afghan withdrawal than economic fundamentals.
Consumers and businesses are much less optimistic according to the NAB and Westpac sentiment indexes. Any further extension in the Sydney lockdowns will not help that pessimism. There is still disarray in public health policy but the government is borrowing 500,000 doses of Pfizer from Singapore for a few months to try to speed up the vaccination programme this year.
Australian unemployment fell to 4.6% from 4.9% in July with a strong increase in employment. However, the impact of the current lockdown has not yet been fully felt in these data series.
A major problem in confidence and the shutdowns is the perceived disparity between how the different state and territory leaders are handling the pandemic. The PM appears to be at odds with some of the regional leaders.
Although we are a much smaller country our 1,200 or so new infections per day seem tiny compared with the around 35,000 figure for the UK and 150,000 for the US. Despite this, Australia was slow to the party in getting vaccinated. Much of that tardiness was at the doorstep of the federal government’s failure to plan early enough for the pandemic and secure sufficient supplies of vaccine – and then the delayed reaction to shutdowns by state leaders.
Our vaccination rates are now ballpark where the US and UK were as they started to open up their economies a few months ago. Social unrest is mounting against lockdowns and Sydney has at least another four weeks to go. We need better communication and analytical comparisons with other countries to help residents understand the basis of the respective state’s COVID 19 restrictions.
It is pretty clear that infections will not go away even when we are mostly up-to-date with two jabs. We will have to learn to live with COVID-19. We cannot wait for, or expect to achieve, close to zero infections before we re-open.
Given the current direction of policy, and the China impact on our resources demand, we are likely to soon get some soft economic data. Some are even suggesting a quarter of negative growth is on the horizon.
China’s economy has softened in the last month or so. Retail sales at 8.5% for the month missed the expected 11.5% and industrial output at 6.4% missed its expected 7.8%. The China manufacturing PMI expectations index closed August at 50.1 from 50.2 the month before, both reads are only just above the 50 level that divides optimism from pessimism. These figures are not so much bad as just not good!
China CPI inflation came in at only 1% for the year but that was on the back of a 43% fall in pork prices! Producer prices increased by 9% for the year.
The US inflation rate is still elevated and the jury is still out on whether or not it will just turn out to be a blip or something more long term. Powell is still in the blip camp but some of his regional Fed presidents are not. At any one meeting of the Fed, only four of the twelve regional presidents get to vote on policy changes. However, all 12 go out and freely express their opinions to the media.
It has been said that current non-voting members are encouraged to canvas extreme views to soften up the market and then Powell aims to produce a consensus after gauging public reaction to media reporting.
While we have again witnessed some extreme views from the regional Federal Reserve banks, we believe that Powell will hold a steady line and formally announce the start of ‘gentle’ tapering at the September meeting. The following meeting is not until November which would be too late to announce and then start tapering this year – as previously stated.
The Fed currently buys back $120bn of bonds per month. That could be reduced by say $10bn per month with the programme ending in late 2022. We think interest rate hikes will not start until at least 2023 unless the economy really starts to boom.
The latest jobs report showed that 943,000 jobs were created in July and the unemployment rate fell to 5.4%. Wage inflation was 0.4% for the month or 4.0% over the year. This report was strong but nowhere near strong enough to cause a panic about the resurgence of wage inflation. There are reports of pockets of difficulty in hiring but there are still close to five million people who lost jobs in the pandemic who need to come back to the workforce before real bottlenecks start to appear.
Many people are struggling in balancing working from home and home schooling. And wage inflation is probably elevated by the absence of some lower paid food and drink servers in the latest workforce.
The European economy continues to post mixed results. On balance, economic growth is below what is expected but they too suffer from the temporary price inflation and some labour market bottlenecks.
Rest of the World
Afghanistan faces a possibly turbulent future. The Taliban reportedly worked with the US to make the US evacuation happen but splinter groups, notably ISIS-K, has created major problems and violence. Without the US presence, there may be many Afghans who helped the US over the last two decades who will now face hardship and worse.