Central bankers were already suffering from analysis paralysis with inflation versus recession, but March has now thrown banking crises into the mix. We live in interesting times! The good news is that for the investor, there are gains to be had in various asset types, including equity, fixed income, and private debt. You just need to know where to look.
What is happening in Australia?
Dr. Philip Lowe’s job is getting easier.
In February, monthly CPI fell to 6.8 percent on an annual basis (see chart below). This continues the downward trend from the RBA-predicted peak in December. If inflation continues to fall then Dr Lowe can take his hand off the interest rate lever and let tightening financial conditions and past rate rises do their work.
Looking at the February inflation result in more detail, holiday and travel prices saw their usual fall from the January highs (-14.6 percent), but the real story was the continued slowing of annual inflation in meat and seafood, the purchase of new owner-occupied dwellings, and automotive fuel (see table below). Automotive fuel and fruit and vegetables are the volatile items excluded from the second line in the chart above.
Meat and Seafood
Purchase of new owner-occupier dwellings
In addition to slowing inflation, the Australian economy is also showing signs of slowing. While unemployment is static, job vacancies decreased by 1 percent in February compared to November. Consumers are also feeling the pinch with retail sales decreasing from 7.5 percent in January to 6.4 percent in February. Further, first home buyer loans fell to a five-year low in January and new loan commitments continued their downward trend in February. Household wealth has fallen 3 percent in 2022 and would have been worse except for the bump to super balances from a buoyant domestic stock market in Q4 2022.
“While some households have substantial savings buffers, others are experiencing a painful squeeze on their finances.” Philip Lowe, Monetary Policy Decision Statement. 4 April 2023
What is happening around the world
After the collapses of Silvergate Capital, Silicon Valley Bank, and Signature Bank at the start of the month, markets thought that Jerome Powell might pause interest rate rises in March. He didn’t.
While he acknowledged tightening financial conditions and its dampening impact on the American economy, the FOMC still voted to raise the Fed Fund rate 25 bps on 22 March.
However, the tightening financial conditions on top of the slowing economy and inflation, will likely mean that the Federal Reserve will not need to raise interest rates as high as they previously envisioned. Inflation has continued its downward trend since June and fell to 6 percent on an annual basis in February (see chart below).
“So our decision was to move ahead with the 25 basis point hike and to change our guidance, as I mentioned, from ongoing hikes to some, some additional hikes maybe” Jerome Powell, FOMC Press Conference, 22 March, 2023.
The Chinese economy continues to benefit from its opening up with the international trade in goods and services up 10 percent on an annual basis in February. Manufacturing PMI and employment were also up in March, but were a little subdued compared to the strong increases in February. However, the best news out of China was an increase in home sales and home prices (see chart below). If the property market can recover, then China will surprise on the upside, otherwise any growth will continue to have a vulnerable underbelly.
The ECB raised interest rates by 50 bps on 16 March, as had been previously planned. In its projections, the ECB expects inflation to average 5.5 percent in 2023 before falling to 2.9 percent in 2024, and 2.1 percent in 2025.
February’s inflation was released at the end of the month and showed a decrease from 8.5 percent in January to 6.9 percent in February on an annual basis.
GDP for Q4 2022 was released and showed that the EU GDP decreased 0.1 percent in the quarter with the biggest contributor to the fall being a decrease in private investment (gross fixed capital formation) and household consumption (see chart below).
However, the labour market remains tight and labour costs increased 5.7 percent in the December quarter on an annual basis.
Japanese inflation slowed for the first time in 13 months in February to 3.1 percent. However, all eyes are on Kazuo Ueda as he takes over the Bank of Japan in April. Many are concerned about how any tightening in monetary policy could lead to a flood of Japanese money back to Japan and the impact it could have on economies like Australia,the Netherlands, New Zealand, and Brazil (see chart below).
The UK made some encouraging headway in trade agreements in March. It finally ironed out an agreement with the EU over Northern Ireland and concluded negotiations to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).
However, inflation increased from 8.8 percent in January to 9.2 percent in February on an annual basis. Average weekly earnings increased 6.5 percent for regular pay in the three-months to January on an annual basis. Markets had been betting on a pause by the Bank of England, but after these results, the BOE raised interest rates by 25 bps on 23 March. It is however optimistic that inflation will slow over the rest of the year.
“CPI inflation increased unexpectedly in the latest release, but it remains likely to fall sharply over the rest of the year.” BOE, 23 March, 2023
What this means for Australian Private Debt
Interest rates keep rising but with tightening financial conditions and slowing economies it seems that they may be nearing a peak in many of the world’s major economies, including in Australia. This presents some upside for returns from private debt in Australia. So long as there is no global financial contagion, the quality of Australian commercial debt appears to be steady. An improving Chinese economy is also a plus for many Australian companies.