Australian Inflation Tops 6%, 4th US Rate Hike, US Recession? Reporting Season & SB Recommends!
Australian Inflation Tops 6%
This week the Australian Bureau of Statistics (ABS) announced Australian CPI inflation for the year to June 2022 had jumped to 6.1% pa, including a 1.8% rise in the June quarter alone. This annual rate of 6.1% increased from the 5.1% annual rate for the 12 months to March 2022. The main contributors to rising costs were fuel, housing, food, and household furnishings.
The latest inflation number was in line with market expectations and also in line with the RBA’s warnings of a possible 7% rate by the end of the year. The local share market did not move significantly on the news, but the AUD jumped a little on the increased likelihood of the RBA continuing to raise rates by several more steps of at least +0.5% each, including at the next meeting in the first week of August.As written by our CIO Ashley Owen this week, there are two major implications of rising inflation and cash rates: Firstly, US cash rates and impacts on US economic activity and global markets; and secondly, Australian cash rates and effects on local housing, spending, jobs and profits.
The US Federal Reserve is by far the largest driver of all global investment markets. With the US inflation rate now running above 9%, we believe the Fed is steady in its resolve to hike rates to bring down inflation. The Fed gave up the inflation fight rather meekly at the end of 2018, but it is looking much more serious about doing the job now.
In Australia, our view is still that a ‘neutral’ (non-inflationary) cash rate is probably ‘at least 3-4%’ (hinted at by the new Deputy RBA Governor last week) and that the RBA will probably need to raise rates above that to bring down inflation. Cash rates of 3-4% would mean home mortgage rates in the region of 6-7%.
The primary concern is that the return of mortgage rates back to longer-term normal levels will place many hundreds of thousands of highly leveraged recent borrowers under pressure. The good news is that unemployment rates remain extremely low, and Australian households (much more so than Americans) have a long record of doing whatever it takes to keep up mortgage payments if the going gets tough.
US Fed Hikes Again
This week the US Federal Reserve, led by Chair Jay Powell, made its 4th rate hike in the current cycle. The move increased the Fed rate by 0.75% to a target range of 2.25%-2.5%. The US operates with a target range rather than the cash rate target adopted here in Australia.
Chair Powell hinted at another significant rise when they next meet, which isn’t until September. Perhaps they will slow the pace or size of rate increases after that, depending on inflation and economic growth.
In the US, much like here in Australia, after a slow and essentially late start to the rate-rising cycle, they have been playing catch up with a series of more aggressive rate increases over a short period of time. We have not had adequate time for the main street economic impact of these increases to be assessed and will not for at least another couple of months. While a further rate rise in September appears most likely, it would then make sense for a period of consolidation as they assess the impact of the monetary tightening.
In terms of the broader market impact, as written by our CIO Ashley Owen this week, US bond yields fell a little on the news – a sign that inflation fears are receding somewhat – Like Australian yields falling back after Australia’s 6.1% inflation number this week. The US dollar also fell back a little, suggesting a pause or at least slowing of rate hikes is in sight. Almost surreally, US share prices surged on the news of this significant hike, especially in the heavily sold-down tech sector. You will read more on this in Ashley’s upcoming market report.
Debate is raging in the US as to whether the economy is in recession. Overnight, data from the US Commerce Department showed a second consecutive quarterly fall in Gross Domestic Product (GDP). Gross domestic product fell by 0.9% year-on-year in the second quarter. The decline followed a 1.6% drop in GDP for the first three months of the year.
Back-to-back quarters of declines in GDP define a recession in most parts of the world, but in the US, it’s not official until economists at the National Bureau of Economic Research (NBER) deem it so. The NBER’s Business Cycle Dating Committee rejects the notion that two quarterly contractions in gross domestic product are conclusive of a recession. Instead, the group of eight economists looks at a series of monthly economic reports to see if there is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”
Speaking on this topic, Chair Powell stated, “I do not think the US is currently in a recession. And the reason is, there are just too many areas of the economy performing too well”. And he pointed to the strength of US employment in particular.
Treasury Secretary Janet Yellen offered her glass-half-full assessment of the US economy, acknowledging a slowdown that she dubbed necessary to subdue inflation while rejecting the notion the country had entered a recession. “We do see a significant slowdown in growth, but a true recession is a “broad-based weakening of the economy,” and “that is not what we’re seeing right now.”
Yellen also remained optimistic when pressed on whether the Federal Reserve’s fight against inflation is destined to cause a serious increase in the jobless rate, which still sits at 3.6%. “I believe there is a path to bring down inflation while maintaining a strong labour market,” she said. “That’s not a certainty, but I believe there is a path to accomplishing that.”
Rounding out her comments, Treasury secretary Yellen stated that she would “be amazed” if the NBER declared a recession. They will be feeling the political heat in the NBER committee room right now!
US Earning Season Positivity
We approached the latest US earnings season with a high degree of nervousness and negativity about the likely results, and with good reason. Despite a slew of headwinds facing the global economy from supply constraints, COVID lockdowns in China, and rampant inflation, major corporates had not yet made significant revisions to their projected earnings. The fear was for a double whammy of companies revealing significant misses on their quarterly numbers and needing to make substantial downward revisions on their forward projections.
While the results have varied meaningfully across organisations and sectors, by and large, this earnings season is turning out to be much better than hoped or, more accurately, not as bad as feared.
On the negative side of the ledger, shares in Wall Mart fell over 7% early in the week after reporting a lower profit outlook. Given the lower economic demographic that Wall-Mart targets, increases in the levels of food and fuel inflation are more significantly limiting their customers spending. It should be said shares in Wall-Mart did recover much of this drop later in the week after the US Fed rate announcement.
The most positive reactions have been to the reports from several leading technology names whose share prices have been hammered in 2022. Microsoft was the first of the big tech to report, sharing numbers that initially disappointed, albeit their share price did rally after an initial negative response. Results from Alphabet (Google) were received more positively, and this morning, after the US market closed, giants Amazon and Apple posted results with revenue growth that actually beat analyst expectations. Both share prices have rallied further in aftermarket trading, rounding out a much more positive month for markets.
Treasurer warns Australians to brace themselves
In a significant update to Parliament, Treasurer Jim Chalmers has warned that Australians must be prepared to accept “tough medicine” in the coming months to avoid recession and worsening living standards.
Treasury has revised down forecasted economic growth, with inflation expected to peak at over 7% by the end of this year. Inflation has now exceeded 6% despite forecasts that it would peak at 4.25% before the election. Inflation is not forecast to settle into the target band until 2024, albeit anyone could be forgiven for maintaining a degree of scepticism when it comes to the forecasts.
The Treasurer said he was hopeful Australia could tame inflation and avoid a recession, but it would require suffering on behalf of Australian households. “Left untreated, inflation which is too high for too long undermines living standards and wrecks the economy,” he said. “But the medicine is also tough to take, and millions of Australians with a mortgage are feeling that right now.”
Mr Chalmers went on to set out three key strategies the government would pursue to deal with the crisis:
- helping with affordability through measures such as cutting childcare costs
- growing wages over time
- unclogging supply chains by investing in renewable energy
Despite the challenging economic situation the new Treasurer has inherited, he maintained his optimism stating, “We have it within us to stare down these threats, to steer our way through this difficult period, and seize the opportunities of this new age”. Delivering this optimism will be a much more challenging task.
Saudi Arabia has unveiled designs for its ambitious urban project “The Line,” hyped as a one-building city in the desert which will stretch over 106 miles and aim to house 9 million people.
The promotional material is spectacular: two mirror-encased skyscrapers stretching more than 100 miles across a swathe of the desert. Is it the ultimate in the future of high-density living or a flamboyant science fiction fantasy?
In short, economists, architects, and analysts are not quite sure. So elaborate is Saudi Arabia’s plan to create an urban utopia that even those working on the project do not yet know if its scale and scope can ever be realised.
This week we were given more insight into the extraordinary ambition of the development when the kingdom’s crown prince, Mohammed bin Salman, outlined central aspects of what he intends to be one of the most ambitious urban developments in modern times. Understandable humanitarian considerations aside, this project is phenomenally ambitious and worthy of your viewing.
Stanford Brown – Investment Market Update
So far, 2022 has seemed like a 50-year trip down memory lane.
This year we have seen inflation at 50-year highs, unemployment at 50-year lows, soaring oil/petrol prices like the 1970s ‘oil shocks’, sudden interest rate hikes, big price falls in share markets, losses on so-called ‘risk-free’ government bonds, ‘one in 100-year’ floods every few months in Australia, heatwaves in Europe, political crises, ‘cold war’ tensions, ‘hot war’ flare-ups, fears of recessions, and talk of 1970s-style ‘stagflation’.
There have been some new elements this time – the collapse of cryptos and “Fin-Techs” (in the 1970s, it was flared tie-dye pants and mood rings), and we now have Coronavirus outbreaks to deal with.
What should long-term investors make of all this? If ‘every cloud has a silver lining’ – where do we go for returns now?
Join us as our inimitable Chief Investment Officer, Ashley Owen, cuts through the noise to focus on the questions that matter for client portfolios in 2022 and beyond!
Click here to register.
SB Talks Podcast
In our latest SB Talks Podcast, released this month, we spoke with Chief Investment Officer, Ashley Owen.
In our discussions we covered:
- Recession fears take precedence
- Inflation remains stubbornly high
- How will central banks react?
- Are we headed for a repeat of the 1970’s?
- How will share markets respond
You can listen and subscribe to the SB Talks Podcast on Spotify here.
Not on iTunes or Spotify? Click here.
Following on from last month’s contribution to this feature by Saxon Tindall, today we welcome SB Benefits Advisory Team Leader Lauren Blair for our second endorsement of a modern Disney classic.