A happy lunar new year saw a strong start to the year for Australian stocks as China looks to regather lost momentum in 2023. However, the RBA is looking to pop the party balloons with some more rate increases this year. Until we know we have seen the peak in inflation, the RBA will continue to play it tough. Hopefully, the domestic economy can hang in there until the RBA is satisfied.
What is happening in Australia
The ASX 200 had its best ever start to a year with a 6.2 percent increase in January and has reached its highest level since April 2022 (see chart below). Consumer discretionary (9.9 percent), materials (8.9 percent), and real estate stocks (8.1 percent) were the best performers. With China’s re-opening a big boost to the materials sector.
Consumer discretionary also showed up in the keenly awaited December quarterly inflation results, which increased 1.9 percent for the quarter and 7.8 percent on an annual basis. Recreation and culture had the largest increase in the quarter (5.4 percent) with domestic holidays (13.3 percent) its largest subcategory. Electricity had the next largest increase at 8.6 percent in the quarter.
The headline figure of 7.8 percent is now the highest quarterly inflation result since March 1990. By September 1990, Australia had entered Paul Keating’s “recession we had to have”! Ominous?
Of course, the RBA predicted that inflation would peak in December. The monthly inflation result for December also shows inflation increasing to 8.4 percent over the year from 7.3 percent in November. All eyes now turn to the January monthly inflation result to be released on 1 March.
On top of peaking inflation, the labour market remains tight. Unemployment was steady at 3.5 percent in December with the participation rate still at near record highs. Despite a small decrease in November, job vacancies remain strong.
Consumer spending increased by 6.3 percent in November and was 11.4 percent on an annual basis. Consumer spending was trending down with 3.1 percent and 0.2 percent in September and October, but has now returned to growth levels not seen since February. This may be just a Black Friday sales effect, but we need to see the December result to be sure.
Business turnover was down in eight of the 13 industries in November and retail turnover was down -3.9 percent in December. Businesses are starting to feel the pinch. So is Treasurer Jim Chalmers for suggesting that markets sometimes need fetters.
“While the latest inflation crisis began with events no Australian could control, Australian governments could have done more to prevent the fragilities left by the first two downturns.” Jim Chalmers.
What is happening around the world
Despite a much higher than expected January employment report re-introducing some doubt - 517,000 new jobs were added when some commentators were expecting it to be below 300,000 - the US looks to be close to reaching the top of its interest rate cycle. The Federal Reserve only increased the Fed Funds rate by 25 bps in January and Chairman Powell struck a dovish tone, particularly in the press conference.
“But we -- You know, if we feel like we've gone too far, we can certainly -- if we
could certain -- and inflation is coming down faster than we expect, then we have tools that
would work on that.” Jerome Powell, Chair of the Federal Reserve, Feb 1, 2023.
Inflation fell -0.1 percent in the month of December with energy falling -4.5 percent. Inflation fell to 6.5 percent on an annual basis, continuing the downward trend since July (see chart below). The Fed’ preferred measure, PCE (Personal Consumption Expenditure) Price Index less food and fuel also fell in December to 4.4 percent on an annual basis.
There are also multiple signs that the economy is slowing. Advanced estimates for the December quarter GDP showed growth slowing to 2.9 percent on an annual basis compared to 3.2 percent in the third quarter. Other smaller measures are also adding some weight, for example, car delinquencies have been steadily rising over the last 18-months and are now double the May 2021 rate.
And despite unemployment falling to a 52-year low, the wage cost index and average hourly earnings are both falling.
Lunar New Year travel was back up to pre-COVID levels and if the statistics can be believed, the accompanying spike in COVID-19 deaths did not eventuate. China has started publishing COVID-19 fatality statistics again after a pause and it seems deaths reached a recent peak in mid-January.
GDP grew 2.9 percent in the December quarter to be just 3 percent for 2022 overall. GDP growth was 8.1 percent in 2021 and the government was targeting 5.5 percent for 2022. Growth should be better this year with the IMF recently releasing a forecast of 5.2 percent.
However, the housing market needs to be watched closely. House prices fell for the sixth month in a row in December (-0.08 percent) despite support measures from the government.
Confidence in the housing market has still not fully recovered since the government forced banks to tighten conditions in August 2020, which led to the struggles of property companies in 2021, notably Evergrande.
EU inflation continues to fall. In January, it fell to an annual rate of 8.5 percent from 9.2 percent in December. Inflation excluding food, energy, tobacco, and alcohol was steady at 5.2 percent.
The ECB is not taking any chances though, they raised interest rates 50 bps at the start of February and indicated that they would raise rates by another 50 bps in March.
EU GDP growth in the December quarter was flat compared to September but up 1.8 percent on an annual basis. German GDP decreased -0.2 percent for the quarter but France and Spain saw increases of 0.1 and 0.2 percent respectively.
Inflation hit a 41-year high in December reaching 4 percent on an annual basis. There were no further monetary policy surprises this month but further tightening is expected when the current Bank of Japan governor retires in April. Recent reports suggest that current deputy Masayoshi Amamiya is the front-runner.
Inflation changed little in December, decreasing from 9.3 percent in November to 9.2 percent in December on an annual basis. Unemployment increased slightly to 3.7 percent in November and nominal average total pay grew 7.2 percent from September to November. Given this, the Bank of England increased interest rates by 50 bps on 2 February.
What this means for Australian Private Debt
While the US and EU may be nearing the end of their interest rate cycle, in Australia we are still looking to see if December really was the peak in inflation. Rates are likely to go up further and while the economy remains strong, it remains a good time to invest in private debt.