Positive economic results in December makes for a complex picture going forward. Central banks have seen enough of a slowdown in inflation to moderate their rate rises, but not enough of a slowdown in their economies to stop raising rates in Q1. Further increases and recession seems likely across major economies.

What is happening in Australia?

While the RBA pulled up stumps for the January holidays, it did however provide an early Kris Kringle present of a 25 bps increase on 6 December.

The RBA expects inflation to peak at 8 percent in the December quarter (data released on 25 January).  This view is supported by a fall in the ABS’s new monthly inflation index for October to 6.9 percent. If the RBA is right about inflation in the December quarter, it may start to moderate its interest rate increases going forward. It would also like time to see the impact of its cumulative 300 bps increase since April.

However, the domestic economy remains strong and will keep the RBA wary. GDP rose 0.6 percent in the September quarter compared to the June quarter. Consumer spending rose 1.1 percent (see chart below). Unemployment remained at 3.4 percent (seasonally adjusted) in November with record levels in the participation rate (66.8 percent) and the job vacancy rate - 3.2 percent in the September quarter. Together this data shows that the supply of labour remains tight while demand remains high.

“Just as the unemployment rate has been falling during a tight labour market, the proportion of vacant jobs has been increasing.” Bjorn Jarvis, head of Labour Statistics at the ABS.

But could the domestic economy be starting to slow as the RBA is hoping? Retail spending fell 0.2 percent in the October quarter while the monthly consumer spending index for October was flat.

With house prices falling, household wealth fell by 1.9 percent for the September quarter, a second consecutive decrease. The household savings ratio has also fallen, which suggests that consumers may be starting to feel a little pressure on top of what they have already experienced with higher prices.

Exports remain strong with mining exports benefitting from increases in commodity prices, agriculture from good rain, and tourism from the removal of COVID testing requirements on travellers. This may keep GDP in positive territory even as domestic demand starts to feel the weight of the interest rate increases, inflation, and the negative wealth effect of falling house prices.   

What is happening around the world?

USA

The Federal Reserve increased the Federal Funds rate by 50 bps in December, down from the 75 bps hikes for each of the previous four FOMC meetings. The Federal Reserve opted for a lower increase because of the slowing domestic economy and the weight of its cumulative 425 bps increases during 2022.

“Growth in consumer spending has slowed from last year’s rapid pace, in part reflecting

lower real disposable income and tighter financial conditions.” Jerome Powell, Federal Reserve Chair, 14 December Press Conference.

Despite a GDP increase of 3.2 percent (annualised) in the September quarter, GDP was negative in the first two-quarters and is well down from its 2021 heights (see chart below).

Most importantly, inflation is also falling, particularly for goods (see chart below). So the Federal Reserve is increasing its attention on inflation in services and the continuing tightness in the labour market.

Most commentators expect the Federal Reserve to increase interest rates further in 2023 to get inflation down to its 2 percent target. As a result, the US will likely slip into recession.

The bear market in stocks continued in December, with the NASDAQ continuing to suffer. Tesla shares decreased -8.22 percent for the month and several tech companies such as Salesforce announced large layoffs.  

China

China has removed most of its COVID-19 measures and has re-opened its economy. This promises stronger 2023 growth, but in the next few months the economy will take a hit as a wave of COVID cases breaks across the country - a return to widespread travel during the Lunar New Year holiday will not help matters.

Chinese manufacturing activity decreased for the fifth consecutive quarter in December while services also plunged (see chart below). Slowing US and EU economies will provide little support through exports.

EU

EU inflation is expected to remain high in the short-term with a high degree of uncertainty because of the war in Ukraine. EU inflation did decrease to 9.2 percent in December after 10.1 and 10.6 percent in November and October. But energy and food inflation remain high at 25.7 percent and 13.8 percent respectively.

The ECB increased interest rates by 50 bps in December and is committed to further increases over the short-term.

“We decided to raise interest rates today, and expect to raise them significantly further, because inflation remains far too high and is projected to stay above our target for too long.” Christine Lagarde, President of the ECB, 15 December press conference.

Japan

On December 20, the Bank of Japan signalled a tightening in its monetary policy stance after years of accommodation. While it left its yield target unchanged, it relaxed its limits on the yield for 10-year bonds, expanding the trading band from plus and minus 25 bps to 50 bps.

Commentators had been expecting a move soon because of a weakening Japanese yen and rising inflation, but they had not expected a move before the expected retirement of the BOJ governor in April.  The move caught markets by surprise and saw Japanese and global markets fall on the announcement and the Yen rise against other currencies. In the longer-term tighter monetary policy will put pressure on the Japanese government which has a government debt-to GDP ratio of over 260 percent.

UK

The Bank of England increased interest rates by 50 bps on December 14 after a 75 bps rise in November. Inflation remains high at 9.3 percent for November. GDP and industrial output are slowing but the labour market remains tight. Currently, the government is dealing with several labour disputes over wages and conditions. According to Goldman Sachs, UK real GDP will contract -1.2 percent in 2023.

“The inflation-matching pay awards that many of the unions are demanding will make the fight against inflation more challenging, and risks interest rates, mortgage payments and bills rising for people as a result.” UK Government press release, 5 January 2023.

What this means for Australian Private Debt

With high inflation persisting, Australian private debt remains an attractive proposition for investors because of its floating interest rates. Good sponsors will also likely be picking up quality clients as the banks start to tighten lending conditions in expectations of an economic slowdown.

At this stage there are few concerns over the health of companies with the Australian economy remaining strong.  If the Australian economy was to fall into recession, companies with strong exposure to commodity exports or non-cyclicals should be preferred as should sponsors with a good track record of client relationships. 

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