Economic Update September 2024

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

Key points:
– ‘The time has come for interest rate policy to adjust’ Jerome Powell
– Has the Fed managed to steer the US economy to a soft landing?
– RBA governor Michelle bullock rules out an official interest rate cut this year
– More evidence the easing cycle has begun, Bank of England makes first rate cut in four years

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
Jerome Powell, the Chairman of the US Federal Reserve (Fed), announced that ‘The time has come for policy to adjust’ at the annual Jackson Hole Symposium for Central Bankers in August.

It was hardly a surprise given that the market had been pricing in cuts but the clarity and simplicity of Powell’s statement was well received by markets. He stressed that the exact timing and extent of the cuts will be determined with reference to the data.

The market has priced in four cuts this year starting on September 18th. Given that there are only three meetings left this year, the implication of four cuts is that at a ‘double cut’ of 0.5% may be announced at one of the Federal Open Markets Committee (FOMC) meetings.

But August wasn’t plain sailing for the Fed or markets. The US jobs data, released on the first Friday of the month, reported that only 114,000 jobs had been created when 185,000 had been expected. The unemployment rate was 4.3% which ‘triggered’ the so-called Sahm Rule for calling a recession. The Sahm Rule is based on the increase in the unemployment rate over a given 12-month period. We do not believe that there has been sufficient experience with this rule since it was created by Claudia Sahm, then a Fed staffer, in 2019 for us to follow it with any conviction. It is a rule that was simply fitted to the data in hindsight. There has been no recession declared since then.

It had previously been stated that a recession might be expected in the ensuing 6 – 24 months after a Sahm signal. Professor Campbell Harvey, who gave us the ‘inverted yield curve trigger’ for recessions disagrees. He said the Sahm rule was a lagging indicator by an average of about four months. You may recall that his trigger gave a false signal of a US recession a few years ago. Perhaps it is a duel between those who ‘own’ a trigger?

Our independent analysis showed that the inverted yield curve trigger produced too many false positives to be reliable. We also found the Sahm Rule to be lacking. However, it is wise to track these popular measures as some market participants believe in them – and therefore markets are affected by them.

It is also important to stress that the US jobs data are based on a small sample of companies and, as a result, data can bounce around quite a lot. Markets have looked past the previous few low jobs numbers! Moreover, illegal immigrants are not included in the unemployment data but they may be counted in the employed ranks!

Following the US jobs data, and a manufacturing expectations index (ISM) showing weakness, markets sold off quite heavily in the first week of August but bounced back a few days later after fresh, more positive data were reported. Markets can be fickle and short termist!

And then the Bureau of Economic analysis (BEA), that publishes the jobs data, revised down the previous years’ worth of data by 68,000 jobs per month or 818,000 in total! That is the biggest of the regular annual revisions since 2009. However, on the economic growth side, the June quarter revision to Gross Domestic Product (GDP), a measure of growth in the economy, came in at 3.0% – up from the initial 2.8% estimate.

We think it is fair to say that most people think the Fed may have pulled off a ‘soft landing’ (meaning a slowdown and end to inflation without a recession). Given the lags in interest rates on the real economy we think it is far too soon to pop the champagne corks. The general thinking is that interest rate cuts take 12 – 18 months to work through – just as interest rate hikes do.

The August season for June quarter US company reports of earnings, revenues and prospects went reasonably well. Virtually the last company to report, Nvidia, was the big one. As the poster child of the ‘Artificial Intelligence (AI) revolution’ it was fortunate that the chip-manufacturer exceeded market expectations on the top (sales) and the bottom line (profit) – and in its prospects going forward (guidance). Clearly the good news was not good enough for everyone as the share price took a bit of a hit in the following trading session.

If a US shallow recession does ensue, we don’t think that will bode particularly badly for markets. And the presidential contest between Harris and Trump culminating with the election in November will keep markets somewhat distracted.

In Australia, the RBA held its scheduled August board meeting and kept interest rates ‘on hold’. After the governor, Michele Bullock, had repeatedly said at the previous media conferences she won’t rule anything in, and she won’t rule anything out, at this meeting she ruled out an interest rate cut for the remainder of 2024! She may well live to regret that, as her predecessor Phil Lowe regretted his ‘no hikes before 2024’ prediction.

The RBA is worried about inflation being too high and not responsive enough to tight monetary policy. However, we argue that the recalcitrant components of the Consumer Price Index (CPI) inflation measure are unlikely to respond to tight monetary policy (higher interest rates). In the latest data release, inflation in tobacco prices was 13.5% for the year – no doubt due to recent increases in government taxes. And rent inflation which happens to be a major component of the CPI, was 6.9%. We have argued that higher interest rates are more likely to raise rents rather than bring them down – for obvious reasons, namely the cost of borrowing to invest in property.

The latest monthly Australian CPI read was buoyed by an improvement to 3.5% p.a. from the previous read of 3.8% p.a. largely due to the government one-off subsidy for electricity consumption. Electricity inflation came in at  5.1% p.a. from +7.5% p.a. the month before. Since the subsidies were equal for each consumer (rather than having changed in the price of a unit of electricity) it was not really a lower inflation read. Rather, it is a statistical jiggle that will work its way out of the calculations as it is not expected to be repeated next year.

A significant part of the market is expecting an interest rate cut by the RBA this year – say, on Melbourne Cup Day. The latest labour market data looked a bit too good to be true with 60,500 full-time jobs added and the unemployment rate being only 4.2%. We expect these data might soften in months to come.
With meaningful caps now being discussed on international student numbers, our population growth might soon better mimic the historical rate rather than the recent 2.5% p.a. plus rate of the post Covid era.

In turn, this reduced immigration might have the effect of converging per capita (household) and aggregate growth data (national level) around the current per capita behaviour. If this occurs then a recession would be unquestionably called in Australia.

The Bank of England (BoE) just cut its interest rate for the first time in four years. The latest British growth rate was 0.6% for the June quarter which follows 0.7% for the March quarter. Since the BoE interest rate cut was based on a 5:4 split vote, they might not cut interest rates again soon.

The Bank of Japan (BoJ) raised rates for a second time after 16 years of a negative rate. As a result, the Japanese yen appreciated against the US dollar and largely ended the ‘carry trade’ – the phenomenon by which investors borrowed in yen at low (or negative) interest rates and invest it elsewhere. It is a bit like the Swiss loans’ case that saw many farmers caught out in the mid to late 1980s in Australia as the Swiss Franc appreciated strongly against the Australian Dollar and borrowers had to pay back significantly greater amount of capital than they borrowed as they invested in Australian dollar assets but had to pay back the loan in Swiss Francs.

In unrelated news, Japan’s prime minister stepped down but some good macro data were recorded. June quarter growth came in at 3.1% p.a. when 2.5% p.a. had been expected. Exports slightly missed expectations at 10.3% p.a. but imports came in at a huge 16.6%p.a.  when only 4.1% p.a. had been expected.

There appears to be a general consensus forming that central banks around the world – except for the BoJ, which is attempting to normalise rates from below neutral, and the RBA, which seems to be confused – are in the process of starting to ease the global monetary policy cycle (reducing interest rates) and a deep recession has largely been averted. Markets can see through any shallow recessions as they are based on expectations rather than published data which are reported with a lag.

And with the AI rally still underway, companies might benefit from producing associated hardware and software as well as from productivity gains from using AI.

Asset Classes

Australian Equities
The ASX 200 was flat over August. IT made strong gains at +7.9% and Energy was the biggest loser at -6.7%.

With much of the latest company reporting season behind us, it is interesting to note that there is no material aggregate change to earnings expectations from our analysis of the London Stock Exchange Group (LSEG) survey of brokers expectations.

Forecast yield from the LSEG database is lower than its long-term average. Yield is expected to be 3.3% over the next 12 months, plus franking credits where relevant. Our analysis of the prospects for capital gains on the broad index over the next 12 months is for a little below the long-run average of 5%.

International Equities
The US S&P 500 Index finished the month strongly with a 1% gain on the last day and +2.3% for the month. Other major market indexes were mixed. Japan’s Nikkei was down -1.2% while China’s Shanghai Composite lost -3.3%. The German DAX was the best of the rest at +2.2%. Emerging markets posted a small gain of 0.2%.

Our analysis of the LSEG data for the S&P 500 point to a continuation of the strong momentum seen so far in 2024.

Bonds and Interest Rates
Every year at about this time, central bankers congregate in the US at a resort in Jackson Hole, Wyoming. The location was chosen because of its proximity to a great fly-fishing spot – the pastime of the then chair of the US Fed!

Often not much happens – at least that filters through to investors. But this year, Powell made a totally clear statement that there are no more ifs and buts – interest rates are on their way down. He did qualify that statement a little by saying that the timing and extent of the interest rate cuts are not set in stone.

The CME Fedwatch tool interprets the new Fed policy stance as follows: one or maybe two cuts in September; another in November and there is a good chance (around 70%) of four cuts by the end of the year. A double cut is on the cards to get Santa starting a Christmas rally in markets.

The prospects for interest rate cuts in 2025 are obviously less clear but CME is pricing in a fair chance of rates being normalised – or nearly so – by the end of 2025. Providing this path is swift enough to avert any more than a shallow recession, markets might thrive.

We don’t expect the Fed to need to go below a neutral rate of 2.5% to 3.0% unless the wheels fall off the economy i.e. growth slows materially.
Most major central banks are guiding their interest rates towards neutral levels – except for Australia. After the last media conference when governor Bullock ‘ruled out’ any cuts before 2025, it seems a bridge too far for her to cut at the September 24th board meeting – not quite a week after the Fed will almost certainly have cut its interest rate. But Melbourne Cup Day could be a goer. Let’s hope so because so many people are struggling with mortgage stress and price inflation of even basic commodities and goods.

Another danger for us is that the RBA hangs on too long to its current interest rate setting while the US interest rates decline putting upward pressure on our dollar. That wouldn’t help our exports including commodities (iron ore), agricultural produce and education.

Other Assets
Iron ore prices dipped below $US100 / tonne during August but finished at $101 with a gain of 0.5%.

Brent crude oil prices fell  2.4% over the month while West Texas Intermediate (WTI) crude oil was down -5.6%. Both prices traded above $80 / barrel earlier in the month but fell well below that mark as tensions in the Middle East dissipated. The oil price spike was likely not enough to flow through into global inflation in any meaningful way.

Copper prices were almost flat for the month but the price of gold surged by 3.4% to close above $US2,500 per ounce.

The Australian dollar appreciated 4.9% against the US dollar. With projected movements in global interest rates, there may be pressure for a further appreciation over the next month or two.

The VIX index, being a proxy for the price of insurance against falls in the S&P 500 share market index, retreated to 15.0 after peaking at 38.6 during the month. While 15.0 is, perhaps, not average, it is close enough to normal levels to declare the early August recession panic is over – for now.

Regional Review

Australia
Employment rose by 58,200 and full-time positions expanded by 60,500 at the expense of a loss of 2,300 part-time jobs. In growth terms, full-time employment expanded by 2.1% which is a little above long-term average population growth. Part-time positions grew by 5.8%. The unemployment rate stood at 4.2%.

We found that US and Australian unemployment data behave quite differently in relation to GDP growth and we think it would be flawed to try and rely on a Sahm-Rule trigger for Australia. The latest unemployment data – using the same (misguided) Sahm-rule calculations – would have triggered a recession call here.

The quarterly wage price index for the June quarter was reported in August. Wages grew by 0.8% for the quarter and 4.1% for the year. When we correct for price inflation, real wages fell by  0.2% over the quarter and grew by +0.2% over the year.

While it might at first seem inflationary to have nominal wages grow by 4.1% it should be noted that wages, after correcting for price inflation, are more than 7% below where they were at the start of the Covid pandemic. Workers need to catch up to reduce the cost-of-living pressures long before wages and prices can start to contribute to a wage-price spiral.

Retail sales for July were flat but up 2.3% on the year. When adjusted for inflation, sales were down -1.2% for the year – the 18th successive negative change.

China
The China Purchasing Managers’ Index (PMI) for manufacturing seems stuck at just below the ‘50’ mark at 49.4 – down from 49.5.

Growth for the first half of 2024 was 5.0% p.a. Retail sales grew at 2.7% and industrial production at 5.1% in July. China CPI inflation was 0.5% p.a.

Imports bounced back to come in at 7.2% against an expected 3.5% but exports missed at 7.0% against an expected 9.7%.

US
The contest between presidential candidates Kamala Harris and Donald Trump is tight in the betting markets. Harris was just ahead but Trump has taken a couple of brief turns in front recently.

While many commentators are trying to distinguish between the candidates with ‘estimates’ of how inflationary their policies would be, we feel much of this part of the discussion as being too heavily influenced by the commentators’ personal preferences for the candidates. The TV debate(s) might wedge some daylight between them!

If it weren’t for the problems with measuring inflation in shelter, US inflation looks very much under control. For the last three months, official CPI-less-shelter inflation has come in at 2.1%, 1.8% and 1.7% all at the bottom end of the 2% p.a. to 3.0 % p.a. inflation target range of the Fed.

Producer Price Index (PPI) inflation, reflecting input cost inflation was +0.2% for the month and +2.9% for the year. Average weekly earnings only grew by 0.2% for the month or 3.6% for the year. There is no price pressure brewing!

The Fed’s preferred Personal Consumption Expenditure (PCE) core inflation measure came in at 0.2% for the month and 2.6% for the year – 0.1% (one notch) below expectations. Given the strength of Powell’s Jackson Hole address, there seems little to stop the Fed from starting its interest rate cutting cycle on September 18th possibly (but not likely) with a double cut of 0.5%.

US retail sales grew by 1.0% for the month or 2.7% for the year; 0.3% was expected for the month. When adjusted for price inflation, real retail sales grew by 0.8% for the month but fell  0.3% for the year. The US economy is no longer strong but it hasn’t yet slipped into recession – if, indeed, it will.

Europe
The UK economy grew by 0.7% and 0.6%, respectively, in the first two quarters of 2024.

European Union (EU) inflation drifted up a notch to 2.6%.

Rest of the World
The big ‘misses’ on Japan imports and exports predictions we reported last month were largely reversed this month with double digit gains on both.

The Middle East conflict is going through some new stages as countries north of Israel are now appear more engaged. Oil prices did spike in line with increased hostilities but that spike has now largely dissipated.

The Ukraine has reportedly attacked inside Russia but there do not (yet) seem to be any major consequences for markets.

The Reserve Bank of New Zealand (RBNZ) cut its Official Cash Interest Rate (OCR) from 5.5% p.a. to 5.25%. p.a. It signalled 4.92% as its end-of-year target so one more cut of 0.25% is to be expected.