Jacqueline Barton

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

Key points

• Trump sweeps the US election, Republicans take both houses
• The US cuts interest rates by 0.25%, other Central Banks, ex Australia, still cutting interest rates
• Australia’s RBA unlikely to join policy easing just yet
• US economy holding up and Private Consumption Expenditure (PCE) inflation close to target

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 your Financial Adviser.

The Big Picture

Donald Trump has won the US election with an emphatic victory. The Republicans are in control of the Senate and appear poised to take control of the House of Representatives. Billed as the most important election in a generation and considered too close to call by most, the American voters have now spoken. The world now waits for what comes next. It appears that Trump’s agenda from a policy perspective at least, is pro-business, stimulatory and possibly more inflationary than under the current Biden administration. From a global perspective there will be much interest in Trump’s foreign policy particularly with respect to the wars in the Ukraine and the Middle East as well as the potential fallout from increasing tariffs on China. While we have a sense of policy direction, timing and implementation remain the subject of intense scrutiny and speculation. Worth noting Trump is not president until his inauguration on 20 January 2025.

It was only on Melbourne Cup Day last year that the Reserve Bank of Australia (RBA) last raised its overnight cash interest rate (OCR). Despite forecasts at that time of three interest rate cuts by the end of calendar 2024, none of these cuts have eventuated. The RBA remains data dependent and reported inflation has remained stubbornly higher than anticipated, despite the per capita recession. But the world of central bankers has moved on a lot this year – and particularly since the September 18th meeting of the US Federal Reserve’s (Fed) FOMC (Federal Open Market Committee) that handed down a 0.50% or 50 basis point interest rate cut to start its easing cycle and followed up last week with a further 0.25% rate cut as did the Bank of England (BoE) on 7 November.

At the September meeting, the Fed pencilled in two more cuts of 25 bps this year and another four for next year. The market is strongly expecting (90% chance) a rate cut two days after the November 5th US presidential election.

The Fed certainly seems to have opened the floodgates. The Bank of Canada (BoC) just cut by 50bps (after three 25 bps cuts) to 3.75% because the long and variable lags of past rate hikes are cratering their economy. The Royal Bank of NZ (RBNZ) also just cut by 50bps to 4.75% following an initial 25 pbs cut.

The ECB has cut three times to 3.25% and its job is not yet done. Inflation is below its target and the economy is weak. The ECB President, Christine Lagarde, kept emphasising that they are being data dependent. As we repeatedly write, being data dependant risks being late with policy changes and growth slowing more than intended, driving the economy into a recession. Monetary policy is far from being an exact science.

Sweden’s central bank cut three times to 3.25%. The Bank of England (BoE) just got caught short because its inflation read came in at under target (at 1.7%) and it has only recently made its second cut – to 4.75% – more cuts are expected.

The People’s Bank of China (PBOC) has a broader set of monetary policy tools. The PBOC just cut its loan prime rates (LPRs) this week – to 3.1% for 1-year (mainly for corporate) loans and 3.6% for 5-year (mainly for mortgage) loans.

With all our peer central banks already having started their cutting cycles – and many having their rates below our 4.35% (or soon to be there) – the RBA is looking very alone.

Australia has already had six consecutive quarters of negative per capita growth. We have had five consecutive negative quarters of growth in retail sales volumes (without allowing for our rampant population growth). The IMF just released its updated global forecasts for growth. It has pencilled in 1.2% for Australia in 2024 and 2.1% for 2025. With both being well below population growth, the per capita recession might take us up into 2026. It beggars belief that the RBA can talk about demand pressures fuelling inflation. Our problems are all supply-based. True, if we crushed the economy until it needs its last rites, we could get inflation down to any number we want. But the RBA has a dual mandate of price stability and full employment. The ‘fix’ should be on the supply side with home building and electricity generation investment.

It is true that the unemployment rate is near historic lows at 4.1% but the world has changed and the old data are largely irrelevant. Almost anybody can quickly get a job in food delivery or Uber rides these days. Lots of people reportedly have two jobs because one doesn’t put enough food on the table. And it should be noted that many governments are aware that sampling unemployment numbers with telephone calls no longer works. A graphic on Bloomberg TV showed that survey response rates to phone calls is down to 18% from the pre-pandemic average of above 50% in the US. Apparently, GenZ and others are no longer as responsive to answering inbound phone calls.

In the US people complain about the effect of inflation on the cost of living. But, since 2019, wages in the US have risen 5% more than prices so that, at least on average, US folk are much better off than pre-pandemic. Not so for us! Our wages have risen 7% less than prices. But the RBA stands stubbornly steadfast on interest rates. In a relative sense, we have lost 12% (=5%+7%) to our US brothers and sisters in purchasing power since the onset of the pandemic.

US growth is holding up better than many thought possible. The first estimate for the September quarter was 2.8% p.a. which is only just a little down from the prior quarter’s 3.0% p.a. The consumer is reportedly holding up but, also, government spending is playing a material role in attaining growth.

The presidential election is dividing the nation. We can’t recall such vitriol being hurled from both sides. We think both sides are exaggerating the economic problems that would flow from their opponent’s proposed policies for political gain.

Despite the apparent policy divide between the Trump and Harris policies, in our opinion, we see no evidence that either side would address the massive government deficit. The latest report is the US Government has a deficit of $1.83 trillion (trn) with interest payments making up $1.16 trn, or two-thirds, of the deficit. Total debt now stands at about $35 trn!

US government debt rose sharply in the pandemic – and for good reason – but, as conditions improve, the debt mountain needs to be addressed before it risks rendering the economy dysfunctional.

Recent data suggest US consumers are getting more positive about their future prospects. A monthly consumer confidence index rose to 108.7 from 99.2. A figure below 100 signifies quite gloomy times but the same index was consistently over 125 for the years leading up to the pandemic.

We see some cause for concern in the US regardless of the election outcome. A possibly crippling dock strike on the East and Gulf coasts in the run-up to the election was settled (at least as an interim measure) within days. The union was offered pay rises totalling 62% over the next six years and a pledge not to introduce automation.

Boeing machinists were offered a 35% increase over four years but they turned it down. If this is the start of a wage-price spiral, inflation could return with a vengeance.

US consumer price inflation (CPI) has largely been contained. If it were not for the problems in calculating shelter inflation (which makes up a third of the CPI) all would seem to be fine. However, retail sales grew 1.7% over the last year which drops to -0.7% when sales are corrected for inflation. There are mixed signals in the data about the strength of the consumer.

Australia’s quarterly inflation read came in at the end of October for the September quarter. Because of the way the Australian Bureau of Statistics (ABS) allowed for the electricity subsidy, the inflation reading is artificially low and will spring back when the subsidy ends. The headline rate was 2.8% but it would have been 3.5% had electricity price inflation not fallen by the subsidy impacted -24.1%. Of course, electricity tariffs did not fall by that amount. The fall is due to the way the ABS imputed the across-the-board flat subsidy. Rents rose by 6.6% and tobacco prices by 12.9%. Neither of those would likely fall if our interest rate was increased!

The first week of November was dominated by the Fed and RBA board meetings, US jobs data and the presidential election. Nevertheless, we see the company earnings expectations – as collected by LSEG (formerly Thomson-Reuters) for the component listings on the S&P 500 and the ASX 200 – indicate strong optimism for the next 12 months. These forecasts imply above average capital gains for both indexes. But, with so much important information to be imparted in the very near term, it would be foolish not to expect some additional short-term market volatility.

Asset Classes

Australian Equities

The ASX 200 was down in October (-1.3%) but the movement was far from even across the sectors. Most sectors were down -2% to -7% but Financials, the largest sector by market capitalisation, grew by 3.3%.

Our analysis of the LSEG survey of broker-based company earnings forecasts suggests that they are expecting a capital gain materially above the long-term average of 5% (plus dividends and franking credits).

International Equities

The S&P 500 fell in October (-1.0%). The World Index was down less (-0.4%) and Emerging Markets were down -2.2%. The Nikkei was up strongly at +3.1%.

With some of the ‘magnificent 7’ US companies reporting well in October, together with the general AI revolution, the LSEG forecasts for growth in the S&P 500 are again well above the historical average over the next 12 months. However, not all agree. Indeed, there was a big sell-off on some big tech stocks based on their forward guidance at the end of October.

The reputable Goldman Sachs is predicting an average 3% p.a. growth in the S&P 500 over the next ten years against an average 13% over the last 10 years. Goldmans is one of the contributors to the LSEG survey. We think there is merit in going with the consensus average rather than any one forecaster – and there is solid academic research to back that approach.

Bonds and Interest Rates

Central banks were unusually active during October, with most now well into a cutting cycle. But it is already too late for some to avoid an economic downturn. The US might just pull off a ‘soft landing’ but there is so much restrictive monetary policy response still in the pipeline, it is far too soon to call a soft landing as having been achieved.

US 10-year Treasurys yield got down to below 3.7% in September but it has since risen to about 4.3%. The yield curve between maturities of two and 10 years is no longer inverted. Some of the variation in yields is possibly due to perceptions in how the Middle East conflict might be resolved and some due to how US domestic policy might change under a new president.

The RBA left interest rates ‘on hold’ at its last meeting and few expect any change at its next meeting in December. The RBA is still under the cloud of having stated that rates would not go up before 2024. And if they start to cut now, it is too soon after their last hike 12 months ago to do so without losing face. But they will lose much more credibility if they wait too long to start cutting, particularly as almost everyone else of significance is well into their cutting cycles. The four big banks are all now predicting the first cut in February.

China cut its loan prime rates this month – to 3.1% for 1-year (mainly corporate) loans and 3.6% for 5-year (mainly mortgage) loans. It also relaxed some conditions on home lending.

Japan has experienced some instability in its monetary policy stance as the new prime minister was thought to have a different view from the man he replaced. The election at the end of October took away the government’s majority. It is not yet clear how that scenario will unfold.

Other Assets

Brent and West Texas Intermediate (WTI) crude oil prices were up slightly over October (1.9% and 1.6%, respectively). There was some intra-monthly volatility as opinions varied about how the Israel-Iran conflict may or may not escalate.

The price of gold continued its charge; it gained 4.1% on the month. It is up 32.7% on the year-to-date!

The price of copper fell -3.0%. The price of iron ore fell sharply (-7.1%) but closed October at just above the $US100/tonne mark.

The VIX ‘fear’ index was elevated throughout October and closed the month at 20.4, a level at the top of its normal trading range. It has subsequently declined post the US election.

The Australian dollar depreciated against the US dollar by -5.2%.

Regional Review

Australia

Australian jobs data are starting to look more resilient than they were a few months ago. 64,100 jobs were created in the latest month, of which 51,600 were full-time positions. The unemployment rate dropped to 4.1% from 4.2%.

Reports of hardship in the payment of mortgages and companies going into liquidation seem to tell a different story. Except for the jobs data, there are no important macro data points for Australia that are encouraging. Historically, jobs hold up the longest going into a slowdown because of the cost of re-hiring and training. The unemployment rate then rises sharply if the economy hasn’t been sufficiently stimulated.

The Westpac consumer sentiment index did improve to 89.8 from 84.6. The latest reading is the best since May 2022, but it was well below that read just before the pandemic and after the 2020 lockdowns. The NAB business conditions index rose to 6.9 from 3.6, and the business confidence index rose to -1.9 from -4.5. While both business indicators rose, they did not do so by enough to bring much joy.

Retail sales rose 2.3% for the last 12 months or 0.1% after adjusting for inflation. With the population growing at around 2.5%, the volume of goods and services bought by the average household has fallen by over 2% over the last 12 months.

China

The China Purchasing Managers’ Index (PMI) for manufacturing climbed back above the 50 level that divides expected contraction from expansion, for the first time since April. The reading was 50.1 against an expectation of 49.9 and a previous month’s reading of 49.8.

Exports and imports were both much weaker than expected, but economic growth at 4.6% was just above the expectation of 4.5%. Retail sales, at 3.2%, beat the expected 2.5%, and industrial output at 5.4% beat the 4.6% expectation. Following this data release, China’s leader, Xi Jinping, called for a concerted effort to return growth back to the Party’s expectation of 5%.

The PBOC has started making moves to help stimulate the economy using several tools. We think that it is now possible that the economy will start to perform as expected by the government.

US

The jobs data released in October easily beat expectations of 135,000 new jobs. The 254,000 jobs created helped bring the unemployment rate down to 4.1% from 4.2%.

Nevertheless, retail sales adjusted for inflation continue to fall over a trailing 12-month period. However, wages grew by 5% more than price inflation since 2019.

Headline Private Consumption Expenditure (PCE) inflation came in at 2.1%, but the Fed-preferred core rate was 2.7%. The CME Fedwatch tool now attaches a 65% chance of a 0.25% interest rate cut in December, down from a 73% chance prior to the election outcome being known.

Europe

UK inflation came in at 1.7%, which is under its target of 2.0%. The economy is not looking great, so it seems that the BoE is behind on cutting its interest rates. The current reference rate is 4.75% following a further reduction of 0.25% at its meeting on 7 November.

Rest of the World

Canada appears to have realised too late that it was too slow in starting to cut interest rates. The unemployment rate rose from 5.0% at the start of 2024 to 6.5% in the latest reading for September. That is why the BoC has cut four times this year to a total of 1.25% points of cuts to 3.75%.

The RBNZ has similarly been aggressive in cutting. Its OCR now stands at 4.75%.

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

Key points

• The US Federal Reserve cuts its cash interest rate by 0.50%
• Inflation is now largely contained, the US is cutting interest rates – Australia however, is still ‘on hold’
• Share markets were buoyed by the first US interest rate cut and solid economic data
• China embarked on further stimulus – their share market rallied strongly on the news

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 your Financial Adviser.

The Big Picture

September ended on a high note. There was good news from the US Federal Reserve (Fed) who cut their interest rate by 0.50%.  Other key developed world central banks, Europe, Canada, Sweden and Switzerland also cut their interest rates. China cut a number of its main policy interest rates and eased home lending restrictions. Iron ore prices rose about +9% on the last day of September on this news and several important stock market indexes hit all-time highs near the end of the month. The odd-one-out was Japan. It chose a new PM and this unexpected selection caused concern about rate hikes – so the Nikkei fell by more than 4% on the last day of the month.

We’ve been waiting for over a year for the US Fed to start its interest rate-cutting cycle. We have argued the inflation measure it uses is flawed and the Fed has all but acknowledged that. We have reason to believe a true representation of inflation would show it has been on or below the 2.0% target for a while – also there are some growing signs of weakness in the US economy.

The Fed surprised some when it started cutting interest rates with a 0.50% reduction at its September 18^th meeting. Importantly, it flagged another 0.50% (or two 0.25%) interest rate cuts before the end of the year. And another 1.0% next year! The US is likely to be out of restrictive monetary policy interest rate settings by very early 2026 at the latest. This was a significant change in the outlook and while markets have been anticipating this move for some time, they have responded positively to the change.

There is a lot of money held as cash or invested in other high quality short maturity investments like Cash Management Accounts, Short Term Deposits and Bank Bills. Some of that will be looking for a new home as short-term rates fall i.e. investors will seek longer maturity instruments to lock in higher interest rates for longer. The other avenue, in the nearer term at least, will be share markets.

The latest US Consumer Price Index (CPI) inflation gauge data were good. The monthly rate of +0.2% and +2.5% for the year, was the lowest since the start of the inflation bubble in early 2021. The core inflation rate that strips out volatile items such as food and petrol was +0.3% for the month and +3.2% for the year.

The official CPI, less shelter inflation, was only +1.1% for the year. The shelter inflation component on its own was +5.2% on the year which, at a 30% weight of the CPI, almost entirely explains the high reading of +3.2%.

The US Personal Consumption Expenditure (PCE) inflation report (a measure preferred by the Fed) was released at the end of September. It showed that the headline rate for the month was +0.1% and +2.2% for the year (and this includes the ‘old’ shelter calculations). The core rate was +0.1% for the month and +2.7% for the year. The Fed’s 2% inflation target is all but been achieved.

The Fed had already steered us onto a course to expect more cuts of 1.50% by the end of 2025. Now the updated results from the CME Fedwatch tool that many turn to for guidance on the timing and magnitude of expected interest rate cuts, projects about a 60% chance of the Fed interest rate being under 3.0% by the end of 2025, at the time of writing.

With a neutral interest rate thought to be in the range of 2.5% to 3.0%, the implication is that the US only has just over a year of restrictive monetary policy to go. However, with lags between interest rate changes and their economic impact thought to be in the range of 12 to 18 months, it will be quite a while before we can judge whether or not the Fed achieved a ‘soft landing’ and contained inflation without the economy experiencing a recession.

The Bank of England (BoE), European Central Bank (ECB), Bank of Canada, the Sweden Riksbank, and the Swiss National Bank, the Peoples Bank of China (PBOC) and the Royal Bank of New Zealand (RBNZ), among others, have all started their interest rate cutting cycles. China seemed particularly aggressive in its reduction to policy interest rates as it seeks to help stimulate growth in its sluggish economy.

The major central bank missing from this list is, of course, our own Reserve Bank of Australia (RBA). For a level of completeness, we note that Norway also is yet to implement interest rate cuts. The RBA met in the middle of September but decided to keep interest rates on hold. There is a slew of data showing that the Australian consumer is hurting as a result of high interest rates but the RBA only seems to be focused on one of its twin mandates: ‘price stability’ and ignoring its obligations with respect to ‘employment’.

The problem with the RBA and government focus is that they seem to be confusing the RBA official cash interest rate (overnight cash rate for settling commercial bank imbalances) with the home mortgage interest rates charged by home lenders.

It is misleading to say that we were less aggressive than the US Fed in raising rates. Since most home mortgages in the US are funded as 30-year fixed-term loans, the average mortgage interest rate hardly budged in the last two or three years in the US. Australian borrowings typically are based on variable or ‘floating’ interest rates with some exposure to short-term fixed rates – usually less than three years. Our average mortgage rate has gone up from around 2.6% p.a. in early 2022 to 6.0% p.a. now. That’s why mortgage-holders in Australia are suffering! By comparison, the US borrowers have had an easier time of it in the post Covid period.

To further emphasise this problem for borrowers, Australia’s latest National Accounts data for the June quarter showed that the household savings ratio was only 0.6%, or the same as in the previous quarter. The average ratio in ‘normal’ times is about 5% to 6%.

If 0.6% is the savings ratio, households are spending 99.4% of their disposable (after tax) income. People, in typical jobs, are required to set aside 11.5% into an appropriate superannuation account. That means, by saving only 0.6%, the super guarantee payments are (on average) implicitly coming out of past (non-super) savings or current living expenses!

It is true that the savings ratio did get this low and lower in the run-up to the GFC. However, that time there was a debt-fuelled surge in spending and investing (such as with margin loans for shares). This time is different. Households are struggling as can be noted by inflation-adjusted (average) wages being down by more than 7% since 2020. Retail spending, adjusted for prices but not population, has been down over the previous year for five consecutive quarters. Per capita (household) GDP has experienced negative growth for six consecutive quarters. The latest quarterly GDP read was only +0.2% or +1.0% for the year which was buoyed by well over 2% population growth!

Some observers point to strength in our labour market but they typically do not point out full-time employment has not been strong. Yet the population has been growing at record levels. Sky News reported that close to 600,000 of the jobs created during the current government term (over two years) were in the public sector – hence funded by the tax-payer – or about two-thirds of the total jobs created.

There almost seems a sense of euphoria in markets after the Fed’s first cut and the accompanying dovish statement about the future. A number of major stock market indexes reached new highs in the last week of September: Australia’s ASX 200; the US S&P 500, the Dow Jones index and the European Stoxx 600. The China CSI 300 index didn’t reach an all-time high but by recording a weekly gain of +15.7%, it registered its best week since November 2008 and then it popped another +8.5% after the new policies were announced on the last day of September (a 16-year record).

There is always the chance of a negative shock and at least a ripple in stock markets but we do not see a significant chance of bad macro data this year – except possibly in Australia. Even if, say, the US labour market deteriorates, the fact that interest rate cuts are already underway might support markets. The Fed has left the door open to alter the pace of changes in this interest rate cutting cycle.

Asset Classes

Australian Equities

The ASX 200 reached an all-time high after the Fed interest rate cut and was up +2.2% on the month. Five sectors went backwards in September but Materials (+11.0%), IT (+7.4%) and Property (6.5%) made impressive gains.

Our analysis of the LSEG survey of broker-based forecasts of company earnings showed a marked improvement in the Financials sector, and, hence, the broader index. We now think capital gains may be above the historical average over the coming 12 months.

International Equities

The US S&P 500 share index and its equally-weighted version, both reached all-time highs after the Fed interest rate cut. The S&P 500 was up +2.0% on the month. Since the ‘magnificent seven’ stocks dominated the first half gains in the broader index, it is encouraging to see the gains spread to a broader range of companies.

China’s Shanghai Composite was up +17.4% (including +8.5% on the last day of September – a 16-year record) and Emerging Markets were up +5.7%. The Nikkei was looking at a strong month until the new prime minister sparked interest rate hike fears brought the index down -4% in one day and more at the open on the last day of September. The Nikkei finished down -1.9% on the month.

Bonds and Interest Rates

The US Fed has been the focus of our attention even though a number of other central banks had already started cutting their interest rates. A 0.50% cut by the Fed was taken very positively in both equity and bond markets. Since most US mortgages are written as 30-year fixed term loans, we do not expect a big bounce in consumer expenditure in the US. If mortgage rates do start to fall, mortgagees in the US can refinance with no penalty if they had taken the loan out at recent higher interest rates.

The market and the RBA are at odds with each other. The markets (and us) think that there is a reasonable chance of an interest rate cut in November or December whereas the RBA is still talking in terms of no cuts this year. Three of the big four banks state that they see the first cut in February next year. However, pricing tools based on derivative markets imply a material chance of an interest rate cut this year.

The Bank of England was on hold in September after its first interest rate cut in four years at its prior meeting. The UK’s latest monthly inflation read did rise from +2.0% to +2.2%.

The Bank of Canada has already cut its interest rate three times in this cycle. Switzerland, the ECB and Sweden have also cut more than once. Norway is perhaps the only other ‘major’ central bank not to have yet commenced policy easing.

We do not see any evidence of a worrying build-up of wage or producer price inflation in the economies of the countries that we follow. China has just made a number of easing moves in an attempt to stimulate the economy which is in danger of not keeping up with government growth forecasts. We think that the current paradigm of cutting interest rates around the world has a lot of merit.

Other Assets

Iron ore prices dipped below $US100 per tonne but recovered towards the end of the month – up +9.6% on the month. China eased home lending restrictions and iron ore prices popped +9% on September 30^th.

Crude oil prices Brent and West Texas Intermediate (WTI) were down sharply at around -9% and -8%, respectively.

The price of gold is on a charge as it gained +5.1% on the month.

The price of copper was also up sharply at +8.0% for September.

The VIX ‘fear’ index, a measure of US share market volatility, was back to a ‘normal’ range at 13.1 but then closed the month at 16.7 on the last day.

The Australian dollar appreciated against the US dollar by +1.9%.

Regional Review

Australia

We saw several reports in September extolling the strength of our jobs market because 47,000 jobs had been created. Delving only slightly deeper into the report, we noted that full-time employment went down by more than -3,000 jobs. Part-time jobs made up the difference. Our unemployment rate was reported as 4.2%.

June quarter economic growth data were published this month. Our economy only grew by 0.2% this quarter which became -0.4% when adjusted for population growth. Over the year, growth was 1.0% and per capita growth was -1.5%. That result made for the fifth successive quarter of negative per capita growth – and extended the per capita recession by most people’s definition.

Our monthly CPI read looked good in both headline (+2.7%) and core (+3.0%) but we have issues in the way the ABS has addressed the electricity subsidy. A lump sum subsidy is not a price change but the ABS treated it so. Electricity price inflation was reported as a fall of -17.9% over the year. As soon as the subsidy is removed, electricity inflation must spring back to near prior levels unless something else impacts prices.

RBA Governor Bullock stressed in her post board-meeting press conference that one good number wouldn’t budge her on rates. We agree with that view but keeping rates high does not impact positively on CPI inflation. It is time to focus on the other of the RBA’s policy responsibilities – employment.

China

The China Purchasing Managers’ Index (PMI) for manufacturing still seemed stuck at just below the ‘50’ mark at 49.1 from 49.4 for August (at the start of September) but it bounced back to 49.8 at the end of the month.

Exports were strong at +8.7% but imports only recorded growth of +0.5%. CPI inflation was +0.6% against an expected +0.7%.

Retail sales grew by +2.1% following +2.7% the previous month. Industrial output rose +4.5% following +5.1% in the prior month.

These generally weaker numbers appeared to have pushed the government into trying to stimulate growth in China’s economy. The People’s Bank of China (PBOC), unlike most other central banks, uses a variety of instruments to help guide its direction. An unusually large number of ‘levers’ were pulled in September to affect a more stimulatory environment. It is difficult to assess what the aggregate response by the economy will be. What we can reasonably say is, now that they have started stimulating the economy with a purpose, if more stimulus is needed, they will do what it takes to achieve their objectives.

US

The contest between presidential candidates Harris and Trump is still tight in the sports-betting markets. Harris is just ahead but Trump has taken a couple of brief turns in front in the recent past.

There seems to be lots of bias in how analysts judge the candidates’ policies. Left-leaning analysts write of the inflationary consequences of Trump. For example, the removal of 8 million-plus illegal immigrants would cause massive disruption but they would first have to find them and then the means to remove them. Assessing the amount of actual disruption to growth and inflation is fraught with severe difficulties.

With regard to Harris’ policies, we have not seen too much in terms of detail or costings. Giving free medical insurance to all illegal immigrants and more is not apparently funded. Obama failed with Obamacare so what chance dealing with illegals? Similarly, Harris’s $50k automatic tax deduction for start-ups sounds great but we have seen no costings.

Apparently, the election result is forecast to turn on three key states and there is an inherent bias towards the Republicans in the electoral college. Although everyone is entitled to express an opinion in a democracy here or in the US, we suspect the election outcome is all too close to call.

US jobs improved from the low 89,000 figure reported in August to 142,000 in September. The unemployment rate went down from 4.3% to 4.2%. But there are some anomalies in the component pieces of the labour market puzzle. Powell is obviously concerned but we think he is well aware of the situation.

The Conference Board Consumer Confidence Index fell from 105.6 to 98.7.

The US has three important sets of inflation data released each month. Since, in essence, the Fed has declared the inflation fight is of secondary importance, if not over, suffice it to write here that there were no disturbing features in this month’s plethora of inflation data. The Fed has accepted the position we have held for quite some time. But what if the Middle East conflict ramps up? We can’t predict that or any consequences. Investing is a process of dealing with risk as it becomes apparent.

Europe

The UK economy put in two successive months of 0% growth or +0.5% for June quarter. This followed the +0.7% growth rate in the March quarter. Its inflation read went up from +2.0% to +2.2% so the BoE was ‘on hold’ this month.

The ECB is dealing with a weakening eurozone economy but it cut for a second time in this cycle to deal with the problem. There are lags in the system but cutting interest rates now is better than not cutting at all.

Rest of the World

The Israeli conflict is apparently expanding into Lebanon with no real signs of a solution in sight. Thus far, there has not been a material spillover into instability in major financial markets. Iran doesn’t seem keen to get involved.

Canada’s inflation, at 2%, is the slowest since February 2021. It has now made its third cut in interest rates. Its unemployment rate climbed to +6.6% in August – up from +5% in early 2023.

Japan changed PM in a fresh election and, with fears of interest rate rises, the Nikkei opened down -4% on September 30^th.

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

Key points:

• Has the US and Australia finally reached a turning point in their interest rate cycles?
• Despite conjecture we think the RBA is done
• The US Federal Reserve has clearly changed its rates position but no cuts until September
• Stock markets finish July with a rally

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 your Financial Adviser.

The Big Picture

So much new macro and company-specific data are released each month, it would be easy to lose sight of the big picture. Many analysts and commentators react on the same day as a data release; and another day’s data arrives before they can properly digest the previous set of numbers.

It is no wonder, therefore, that different analysts and commentators reach different conclusions from the same data. We think it is not possible to provide a balanced view without a very strong background in at least statistics, economics and finance. And then it still takes time to mull over the big issues.

This monthly is our attempt to take a step back and take stock of, not just of this month’s data and central bank comments, but also have a deeper reflection of previous months of such inputs.

And research, as opposed to commentary, often requires new methods and techniques to be developed to challenge the orthodoxy. Just because someone says raising interest rate quells inflation doesn’t mean that statement should be adopted without challenge. And often, qualifiers are needed to express fully how ‘things work’.

Our monthly investment committee is one forum we use to challenge current popular views. This month, we had a particularly lively interaction. This economic update benefits from the result of that interchange.

There is no doubt that the US Federal Reserve (Fed) chair, Jerome Powell, has modified his view on what monetary policy action is currently appropriate. And others from that institution have also recently changed tack.

In last month’s update we reported that Powell had at last acknowledged that there are serious problems in the way the US data agency calculates the rate of inflation in shelter (specifically rent). This component takes up about one third of the index so it is important to get it right. But Powell said he isn’t currently interested in changing his metrics. But he must now consider that the number he has been fed might be misleading! The official inflation rate prints are severely biased upwards and Powell acknowledged that similar agencies in other countries do a better job.

Next, Powell acknowledged the so-called “Sahm rule”, named after a former Fed economist, Dr Claudia Sahm, which is used to call an impending recession. The rule came close to triggering such a call at the start of July.

The rule is a simple. It measures the increase in unemployment over a year in a particular manner. The media has also picked on this rule and we all await a recession signal (and a recession?) following the August 2^nd jobs data.

This indicator was not conceived until 2019 and it didn’t attract any significant attention until December last year. Sahm’s claim is that a recession followed every time the signal called one. While that analysis appears to be correct, it is only based on correlations and not causation – and it has not been tested on a new recession [what we call out-of-sample-testing in econometrics]. The 2022 splutter in the global economy was not a recession in the usual sense as it was caused by lock-downs in the face of the pandemic.

Interestingly, two members of our investment committee independently came up with a similar set of criticisms of the Sahm rule. One of the fundamental problems is that the nature of work has changed since the pandemic arrived. People now often work from home – or in hybrid form – and the proliferation of travel and delivery options from the likes of Uber means that it is so much easier to get part-time work now – even if it is only a temporary solution to pay bills and put food on the table. During the post-Federal Open Markets Committee (FOMC) media conference, at the end of July, Bloomberg reported that Sahm is aware of this issue.

We have no evidence that the Sahm rule will work this time if, indeed, it is triggered. But we agree we would be foolish to ignore it. The media thrives on simple rules, whether they make economic sense or not. If the market reacts to a signal that doesn’t have a strong academic pedigree, others still need to be aware of it. We only have to think back a few years to the false-positive from the inverted yield curve to amplify this point.

If the US unemployment rate goes up one 0.1% point to 4.2% (and there are no revisions to past data) on August 2^nd (or later) many people will expect an impending recession (in 6 – 24 months) in the US – and that group looks like including current Fed chair Jerome Powell. We will watch from the side-lines not sure whether the rule needs some tweaking for the new economy. If it is triggered that will force Powell to bring it into his thinking.

Indeed, at his last appearance in Congress, he stressed that the Fed has a dual mandate of maximum employment and stable prices. We don’t recall the last time he stressed that by so much.

And, to complete the warning signals, Powell reiterated that there are long and variable lags between monetary policy changes and their effect on the real economy.

Importantly, William Dudley, a former Governor of the New York Federal Reserve, has flipped a 180 degree turn on policy. He had been one of the prominent ‘higher for longer’ advocates. Towards the end of July, he suddenly said that rates should be cut as soon as possible. There was an FOMC rates meeting on the last day of July. Almost everyone thought that was too soon. September looms large. Powell even said that if things go well, “a cut is on the table” for that meeting.

The probability of a US interest rate cut in September has risen to 87.5% for one cut and 100% for two cuts – as measured by the well-respected CME Fedwatch tool.  There is over a 70% chance of two or more cuts by November 7^th and a 75% chance of three or four cuts by December 18^th.

We think a rate cut would have been good but we didn’t expect one. September 18^th is the date of the next FOMC meeting. Importantly, the annual central bank conference at Jackson Hole, Wyoming, is scheduled for August 22^nd – 24^th. This year’s agenda is titled “Reassessing the Effectiveness and Transmission of Monetary Policy” and it seems like an excellent opportunity to set the stage for a September cut. There are two jobs and two Consumer Price Index (CPI) inflation measure reports due by the September FOMC.

In the last month or so, the Swiss and Canadian central banks have cut interest rates twice and the list of one-cut-banks is long and growing: China, ECB, and Sweden. Britain seems almost set to cut in August.

Japan just made its second hike in this cycle. Japan is struggling to get back to normal behaviour but from a below-normal rate level.

Australia is the stand out. The RBA rate tracker tool on the ASX website puts the price of a rate increase (hike) on August 6^th at 25% as recently as two weeks ago. While there are plenty of commentators supporting an interest rate increase because they think that a hike is needed to bring inflation down, we think they are incorrect in their thinking. The RBA at its meeting on August 6^th determined to leave its official cash interest rate on hold at 4.35%.

It is a fact that the latest inflation rate (3.8%) is above the target 2% to 3% zone. But there are two well-argued causes of inflation – demand pull and cost push, or demand and supply causes.

All the big problems in the Australian CPI inflation are due to supply-side factors in: rents, insurance, education, electricity and the like.

The Federal Government did act to alleviate some pressure from electricity and rent inflation. Almost everyone expected the high read for Q2 inflation but, looking to Q3, Westpac has calculated that quarterly inflation will fall from 1.0% in Q2 to 0.1% after the government changes take effect. Westpac is not arguing that the fall in inflation is because of interest rates.

We mention in each of our recent monthly updates that Australia has been in a per capita (household) recession for over a year. Quarterly per capita GDP growth is repeatedly negative. Retail sales volumes (price-adjusted but not by population) just posted its 17^th successive monthly negative annual growth rate.

But there is new, even more alarming data. ASIC reported that the number of companies going into administration in the 2024 financial year (FY24) was a third more than in the previous year. Indeed, the FY24 number was greater that the sum of the numbers in FY23 and FY22 combined. It has been reported that around a quarter of the companies in trouble are in the construction sector. That won’t help the rental crisis.

Australia is not alone with corporate difficulties. The US just reported that the number of first-half 2024 filings for bankruptcy and related difficulties was the highest half-year number since 2010!

When we were writing about long and variable lags quite a while ago, we suggested that monetary policy takes 12-18 months to work through the economy. That cumulative effect of rate hikes from 0% to 0.25% to the current 5.25% to 5.50% in the US is now taking its toll – and it will get worse. Australia should not ignore these issues. We believe the first interest rate cut in Australia is needed now and 0.5% would be a good start.

Although politics is outside our remit, we cannot ignore some of the events of July. An assassin got very close to killing former president, Donald Trump. Whatever your politics, there is no room for violence on the streets.

Markets did take a bit of a dive a few days after the shooting. Some say it was related but we don’t know. What we do know is that some markets shrugged off ‘these July blues’ and returned to solid gains. US small cap stocks had a brilliant month (over +10%) so it is not a case of analysts being shy of equities – it’s just a rotation from magnificent-7 (Artificial Intelligence and Technology) type stocks into the rest of the market. And the ASX 200 closed the month above 8,000 again.

The calls for President Biden to step aside from his own supporters eventually had the desired effect. Almost too swiftly, nearly all the major Democrat figures threw their weight behind Kamala Harris.

The betting odds (according to sports betting websites) are still firmly in favour of a Trump victory but there are endless media stories about how Harris has closed the gap. We don’t know if this is fact or wishful thinking. We will find out in November.

Providing all the central banks, including our own, start easing interest rates at a reasonable rate, the extent of any recessions might be contained.

There were some very poor company results filed to the US stock market from mega-cap tech-stocks – but also some good ones! What was refreshing is that, in the sell-off of some big names, the Russell 2000 index – representing small cap stocks – made some good gains (11.1%) during July – as did the ASX 200 (4.2%). Perhaps the market is broadening out rather than pausing.

Asset Classes

Australian Equities

The ASX 200 climbed 4.2% during July and closed the month at a record 8,092. The utilities sector was down ‑2.9%; resources and IT were all but flat; there were strong gains across the other seven sectors which included the banks.

International Equities

The S&P 500 was looking at a slightly down month in July but the FOMC-induced last day rally saw the index gain 1.1% over the month. Other markets were mixed and the World Index was flat at 0.1%.

Bonds and Interest Rates

The US Fed did what was expected of it and more at the July 31^st FOMC. There was no change in interest rates but there was a distinct dovishness (easier or lower interest rate policy) in the statement and Powell’s media conference. There is a chance that a soft landing will have been engineered but, as Powell pointed out, there is a long and variable lag on the way down for rates too.

The Bank of Canada and the Bank of China cut rates in July. The Monetary Policy Committee of the Bank of England is divided over whether to cut in August or not. The ECB was on hold in July.

The RBA despite remaining on ‘hold’ has not ruled out the notion of hiking rates despite its twin mandate of full employment and price stability.

Since, in our opinion, the RBA is not appearing to heed the guidance being provided in publicly-available data, we find it difficult to predict what they will do. However, we can say that the longer they keep the overnight cash rate at its current (or a higher) level, the worse will be the impact on the Australian economy.

Other Assets

Iron ore prices just held above $US 100 per tonne despite falling 4.5% over the month.

Brent Crude oil prices fell 9% over the month to under $US80 per barrel but, popped to $80.72 on the news that Iran’s leader has pledged retaliation against Israel’s attack.

Copper prices fell 6.5% but the price of gold jumped 4.1% over the month.

The Australian dollar against the US dollar depreciated by 2.0% in July.

The VIX index, being a proxy for the cost of an insurance policy against falls in the S&P 500, climbed from a ‘normal’ 12.4 at the beginning of July to 17.7 at the end of the month.

Regional Review

Australia

Employment rose by 50,200 in the latest report (for June) but in percentage terms, the growth was worrying. The annual growth in full-time employment has been falling over the past year and it is now 1.2% which is less than the natural rate of population growth in this country. However, part-time annual growth in employment has been above 6% for the past year, making total annual employment growth look respectable at 2.8% in June.

It has also been reported that the average working week in Australia is running at just over 32 hours compared with nearly 38 hours for the US and around 35 hours for the UK and Canada, such is our dependence on part-time work.

In a separate report, it has been noted that around half of our part-timers would rather be working full time. The current situation is not one of full employment even though the unemployment rate of 4.1% might seem low by historical standards. The world has changed since the pandemic and the RBA needs to be more cognisant of this.

Retail sales quarterly volume came in at ‑0.3% for the quarter and ‑0.6% for the year. That makes for seven of the last eight quarters being negative! And that does not allow for the effect of the 2.5+% population growth. Aussies are consuming less ‘things’.

The NAB and Westpac business and consumer sentiment indexes are at low levels but above those at the worst points in past economic cycles.

The monthly and quarterly CPI series were updated on the last day of July. As widely predicted, they were not going to be good but the problem is not excess demand – it is all about supply conditions. The RBA should cut interest rates but we don’t think they will in the near term.

China

The China Purchasing Managers’ Index (PMI) for manufacturing was steady at 49.5 at the beginning of July. Below 50 is indicative of a weakening economy.

Imports unexpectedly fell by ‑4.9% but exports rose by 1.5%. Inflation as measured by CPI was 0.2% for the headline rate when 0.4% had been expected. The core inflation read, which strips out volatile items like food and fuel, rose by 0.6% when 0.7% was expected.

Probably because of this weaker data, the People’s Bank of China cut its key lending rate by 0.1% points to 3.35%. We expect further stimulus to follow.

US

The assassination attempt on former president Trump at a Republican rally was fortunately unsuccessful. Since the would-be assassin appears to be a young person who was attached to both the Republican and Democrat parties – and to no known extremist group – there is no reason for us to expect any further fallout. Apparently, the young man’s father (who has 20 guns at home) took him out to a shooting range to practice shortly before the assassination attempt. The US Constitution’s ‘Second Amendment’ (the right to bear arms) has a lot to answer for.

President Biden succumbed to extreme pressure from high-ranking members of his own party to step aside from the nomination for the November presidential election. Biden’s performance in the first presidential debate with Trump was seemingly the catalyst in starting the demand for an alternate nominee.

Perhaps too swiftly, Vice President Kamala Harris was endorsed by just about every major figure in the party. There are conflicting reports about the gap between Harris and Trump in the polls but it is accepted that, despite a strong bias to Trump, the gap (odds on betting sites) has closed since Harris became the Democratic party’s presumptive nominee.

US jobs data deteriorated a little in June. The unemployment rate rose to 4.1% which is just below the 4.2% trigger point for calling a recession under the Sahm rule. We expressed some reservations about using this largely untested rule elsewhere in this update. Since we believe others, possibly including the Fed, are more confident in the rule, it could play a major factor in affecting monetary policy and, as a result, market behaviour.

Economic growth as measured by the change in Gross domestic Product (GDP) jumped out of the blocks at 2.8% (for the year) in the June quarter when a more modest 2.0% had been expected. But retail sales volume over the year came in at ‑0.7%!

Of the many inflation rate indicators published each month, two seem to have given markets and the Fed some optimism. The CPI for the month was ‑0.1% (largely because gasoline price inflation was ‑3.8%); the Personal Consumption Expenditure (PCE) reading at the end of July was 0.1% (or 2.6% for the year).

As we repeatedly state, the shelter component is poorly estimated and distorts the CPI and PCE measures. In our opinion, the inflation rate of ‘everything but shelter’ has been contained for a year and is consistent with the Fed target of 2%. Since Powell clearly stated that he does not have to wait until the aggregate measure is 2%, we think he has opened the door for an imminent interest rate cut.

Europe

The UK economy rebounded with a 0.4% GDP growth rate in May following 0.0% in April and 0.7% for the March quarter. Inflation came in at 2.0% but 1.9% had been expected.

The Bank of England and the European Central Bank (ECB) are behaving cautiously about relaxing monetary policy (reducing interest rates further).

A Labour government took office in the UK in a landslide victory in July. The Tories (Conservative party) had been in office for 14 years!

Rest of the World

Japan missed on both its imports and exports predictions. These data were not enough to cause concern over its economy – but it does make us sit up and wait for the next numbers. The Bank of Japan (BoJ) increased interest rates for the second time in this cycle but only to 0.25%.

Canada’s interest rate cut in July was its second such cut in two months.

The conflicts in the Ukraine and the Middle East show little sign of an imminent resolution.

We acknowledge the significant contribution of Dr Ron Bewley and Woodhall Investment Research Pty Ltd in the preparation of this report