Economic update – May 2023

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

Key points:
– Peak inflation now appears to be behind us
– US economic growth showing some resilience but is weakening
– Inflation is declining as higher interest rates start to bite on household spending
– Interest rates in Australia look close to peaking this cycle but appear to be data dependent

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

There are signs that the US economy is softening but, following the anticipated 0.25% rate increase early this month, will this be enough to cause the US Federal Reserve (Fed) to now pause its interest rate hiking cycle? At the time of writing, the market-based probability of a pause at the Fed’s June 14 meeting is 100%, notwithstanding, expectations of Central Bank interest rate movements are more volatile in the current environment of elevated uncertainty. Again, and at time of writing, markets are forecasting that the Fed will have cut interest rates at least once by the end of the year which is at odds with the Fed’s view that they won’t. This divergence of views, in part, makes it somewhat easier to reconcile the market reaction to the Fed’s decision to raise interest rates this month when confronted with a softening economy and knowledge of a potential recession. We note the European Central Bank (ECB) followed the Fed and increased their cash rate by 0.25%.

It can take quite a while – many say about 12 to 18 months – for interest rates to work their way through to the ‘real economy’ (like jobs and growth). Nobody has a good handle on what impact the interest rate hikes of the past year have already done to the economy. In the US, the market expected a modest 2% GDP growth (annualised) for the March quarter of 2023 and it came in at about half of that at 1.1%. The latest monthly US retail sales fell by -0.9% against an expected -0.5% for the month. The annual figure was -3.1%. Usually, when a recession hits, it generally occurs quite quickly.

Many economists expect a US recession to start this year. Any recession might be expected to get worse the more interest rates are hiked – or held at too high a level for too long.

A recession need not have a negative impact on the share market going forward. The US March quarter reporting season has already produced a few stellar results among the large tech companies. Of those companies that have reported so far (approximately 50%), 80% have delivered better than expected earnings for March quarter after earnings expectations had previously been marked down. We think a mild recession has been priced in and this seems reasonable unless the Fed blindly institutes further interest rate rises beyond what is already factored in for May.

Annual US inflation rates are still high owing to the double-digit supply (input price) induced inflation of nearly a year ago. Recent monthly data are now more promising. The Fed’s preferred inflation measures, the Consumer Price Index (CPI) and Private Consumption Expenditure (PCE) indices both came in at only 0.1% for the month of March.

The economic picture here is quite different from that in the US. The month of April ended with an estimated 100% chance of the Reserve Bank of Australia (RBA) being ‘on hold’ in May. The markets were taken by surprise on Tuesday 2nd of May when the RBA increased the cash rate by 0.25% to 3.85% citing concerns of residual strength in inflation as the reason. The RBA press release announced this change also opens the way for further rate increases should the RBA deem them as necessary to contain inflation and return it to the target band of 2% to 3% by mid-2025. Ahead of the rate increase a number of banks had already started cutting some of their mortgage rates!

Our labour force data published in April was particularly strong. The unemployment rate was steady at near a multi-decade low of 3.5%, 72,000 new full-time jobs were created and 19,000 part time jobs were lost. Retail sales were soft, up 0.2% for the month but 6.4% for the year, indicating a slowing in trend growth.

Australian inflation is still a little elevated at 1.4% for the March quarter but the RBA’s preferred variant came in at 1.2%. The annual rate was 7% which is down from the 7.8% recorded in the December quarter of 2022.

A review of the RBA by an independent panel was completed. They recommend a specialist committee be formed to consider interest rate changes and for it to meet only 8 times per year rather the current 11. The changes could actually improve monetary policy implementation and decision making.

The best economic news of the month came in the publishing of China’s economic growth data which came in at 4.5% p.a. when only 4.0% p.a. had been expected. The December 2022 quarter was 2.9% p.a. and the official forecast for 2023 is 5.0% p.a. China’s inflation is also well contained. We see the resurgence of the Chinese economy after the pandemic lockdowns as being a big positive factor in Australia being able to avoid a recession.

The European economy continues to languish with the latest estimate for March quarter growth at 0.1%, narrowly avoiding a technical recession marked by two successive quarters of negative growth. EU inflation was the lowest in a year at 6.9% but the UK is still struggling with inflation at 10.1%.

The ‘banking crisis’ that started in the US regional banks over a month ago does not appear to be spreading materially although there have been a couple of subsequent failures noting that depositors’ funds were protected. We do not think this is the beginning of a systemic issue in the banking system but do note that it is a clear indication that stress and vulnerabilities exist which could lead to isolated issues with other regional banks.

Sadly, the situation in the Ukraine does not seem to be improving. However, the economic consequences for the global economy anticipated at the outbreak of the conflict have not occurred to the extent expected. Food prices are still elevated but their rate of change has settled down and some falls have been recorded. Shipping costs of containers and the like are down over 82% from the pandemic peak and the Covid lockdown in China is largely behind us.