Economic update – June 2024

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

Key points:
– The US Fed gets back on track talking of ‘when’ for rate cuts as data continues to soften modestly
– RBA inflation data still on the high side but in per capita terms the situation is considerably weaker
– Markets, lead by AI stocks, remain positive and bond yields are likely to have seen cycle highs in 2024

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

Support for the rate hike scenario canvased by many for the US Federal Reserve Board (Fed) and the Reserve Bank of Australia (RBA) has all but vanished from the agenda. There had been a brief ‘wobble’ as people grew impatient waiting for the fruits of the higher-rates-for-longer programme.

The Fed remained on hold in May – as expected. It did however, slow down ‘the run-off of the balance sheet’. That is, the Fed is not performing QT (quantitative tightening) with as much zeal as it once was. Is that the first sign of the Fed thinking it might have over-tightened?

The RBA was also on hold but it again opted for the ‘can’t rule anything in or out’ explanation. Imagine if you presented at your GP with a condition that you were worried about. The GP replies, “I can’t rule in that I need to prescribe some serious course of action; and I can’t rule out that you are fine – so I’ll do nothing for the moment.’ Wouldn’t you, in horror, rush up the street to the next clinic?

In the GP analogy, it seems perfectly sensible for the GP to say something like, ‘you might have a touch of … so I’ll start you off with a low dose of …’ or ‘I think you are fine but if you get any signs of … in the next week or two come straight back.’

The Bank of England (BoE) was also on hold in May but they seem to be flagging a possible cut for June. The European Central Bank (ECB) is on a similar tack. The Bank of Japan (BoJ) is weighing up its options. It wants to go for a second hike of 0.1% points to steer monetary policy back to something looking a little more like normal. But it doesn’t want to move too hastily after 16 years of a -0.1% rate! The current BoJ rate is in a range of 0.0% to +0.1%.

The Bank of China has a much more complicated approach to enacting monetary policy but it is making moves to ease policy to cope with the property development debt crisis.
In short, global central banks reacted somewhat nervously to inflation, unemployment and growth data in May. While we saw no clear-cut signals in the major economies, we did note some nascent signs of weakness in the US and continued weakness in Australia. US jobs data were a fraction softer, retail sales were flat and wage growth was only 0.2% for the month.

Australia data still points to an ongoing recession. The unemployment rate jumped up to 4.1% and, on a per capita, inflation-adjusted basis, retail sales and economic growth have been going backwards for over a year. It is only the major inflow of migrants that masks the underlying problems for those unwilling to do a proper economic analysis. Aggregate GDP demand has been rising but more slowly than population growth.

The Australian Federal Budget was handed down in May. Apart from the stage 3 tax cuts (which are not really cuts but mere lip-service to tax indexation from bracket creep in the face of strong inflation), there was a little rent assistance for some and a $300 rebate for any household with an electricity bill! That’s less than a dollar a day for each household. Anything is better than nothing but we can’t expect much in the way of a stimulatory effect after inflation-adjusted wages have dropped to around 7% less than they were in mid-2022.

In our opinion, the real issue in managing monetary policy is dealing with the so-called perceived ‘stickiness’ of inflation. In the US, rents make up about 33% of the CPI. Official CPI less shelter data have been well-contained for a year. The average of the last 12 such monthly measures is only 1.8% (less than the 2% target) and the latest two numbers were 2.3% and 2.2%, respectively; not a problem!

Because of the way shelter inflation is calculated, it cannot react in a timely fashion to an improving situation as does inflation-for-everything-else. Shelter inflation peaked at 8.1% in the first quarter of 2023. It had inched down only to 5.5% by April 2024. Leases are usually written for 12-months or more and the statistical agency only samples rent every six months. There is a massive lag between actual inflation and measured inflation! A simple improvement in the calculation could remove the inflation problem in a trice!

The latest US CPI-less-shelter read was 2.2% and that for shelter was 5.5%. With a third weighting to shelter, the aggregate CPI is 3.4% = (1/3) 5.5% + (2/3) 2.2%. In our opinion, it is almost impossible for shelter inflation to get down to 2% until 2025 but only because of the method of calculation. So, aggregate inflation has almost no chance of dipping below 2% unless the whole economy collapses in a heap.

Even if one ignored the calculation issues with shelter inflation, what school of economic thought would advocate raising rates to reduce rents? The dominant factor in determining rents is the demand-supply imbalance of people who need shelter.

US March quarter GDP growth was revised downwards from 1.6% to 1.3%, or 0.3% for the quarter. This further sign of weakness causes us some discomfort but on the positive side, it could help the Fed to decide to start cutting rates.

US PCE inflation data were more or less on expectations. The headline rates were 0.3% and 2.7% (for the month and the year) while the core were 0.2% and 2.8%. We believe these estimates are biased in the same fashion as the CPI variants owing to the way shelter inflation is calculated.

The housing inflation component of the Australian CPI is calculated differently from that in the US and with different weights. There is a new-home sales component and a rent component in Australia. New home-sale inflation peaked at 22% in July 2022 and it has since fallen to 4.9%. Rent inflation was within the 2% to 3% band when new home inflation peaked in 2022. Rent inflation has since increased steadily, as rates were increased, and it has climbed to 7.5% in April with no real sign of relenting. Rents in Australia also have at least an 18-month lag in the formulae between measured rent inflation and the underlying cause.

The latest official headline and core monthly CPI reads were 3.6% and 4.1%, respectively. Alcohol and tobacco inflation came in at 6.9%. Other big-ticket items were insurance, 8.2%, auto fuel, 7.4%, and health, 6.1%. Our frustration with the RBA’s monetary policy management can be expressed through the question, which of these rates would fall if interests remained on hold or increased? The apparent answer is probably none, maybe a little on insurance.

CPI inflation less housing (our estimate) was 3.4%. While these data were above the RBA target band of 2% to 3%, they are not sufficiently high to cause us any material concern.

It is clear that the Australian data are significantly impacted by the immigration issue and not so much by higher interest rates. Indeed, if the RBA unwisely raised rates, it would further negatively impact home owners on variable-rate mortgages and do nothing for the renters. Indeed, higher rates might slow down development in building new apartments.

To be clear, immigration is not the problem. Australia was built on the concept. The problem is not planning – specifically for accommodation – this time around which has also been impacted by supply side aftershocks from Covid.

We only have to look to Australian retail sales volumes (i.e. inflation-adjusted) to understand the plight of the Australian consumer. The first quarter result was -0.4% for the quarter or -1.3% for the year. With population growing at over 2.5% pa, retail volumes on a per capita basis fell by nearly 4% over the year to 31 March. The RBA board say they can’t rule anything in or out! Our next GDP data for the March quarter are to be released on June 5th and we think that data will amplify this story.

There is a glimmer of hope in Europe. Economic growth in both the UK and the EU was positive in the March quarter reversing some of the negativities witnessed in 2023.

The China economic situation is never easy to read. Problems in the property sector abound but imports for the latest month were up 8.4% compared to an expected 4.8%. Exports were up 1.5%. There were mixed results in the monthly data releases.

As a general conclusion, we think there is no clear-cut path back to prosperity here, in the US or elsewhere. However, neither do we think we are on the precipice of disaster. Rather, we believe there are strong benefits to easing monetary policy now. Seemingly paradoxically, we think the ASX 200 index can do well in Australia while the consumer is languishing. Companies earn profits on aggregate sales, both at home and overseas, and not on the average individual’s economic health in Australia.

The so-called ‘AI bubble’ does not appear to be out of control. Nvidia reported well. Unlike in the dot.com boom when little was being built and the ‘dream’ was on sale, serious AI companies are making things – and selling them – that people will want. Of course, there will be speed bumps as technology interfaces with reality. We think the investing future is relatively bright in many markets.