Economic Update October 2024

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 18th 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 30th.

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 30th.

 

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