Economic Update - December 2023

The copyright to Peter Pan is now in the public domain. While Peter won’t grow up, we have economies that are not quite ready to slow down all the way! The soft landing didn’t happen in 2023 but still looks good for 2024. 

What happened in Australia?

Everybody has gone on summer holidays including the RBA who left interest rates unchanged in December. At her last speech of the year, RBA governor Michele Bullock argued that Australia was still on course for a soft landing:

“We are trying to make sure that we slow the economy enough to bring inflation down to our target band … and we can do that while preserving the employment gains we’ve won through the pandemic and coming out of the pandemic.”

Inflation continues to fall with the monthly inflation indicator decreasing in October (4.9%) and November (4.6%) (see chart below).

The labour market is also starting to soften, which should take pressure off wages and costs in the service sector. Unemployment has now increased from its recent low of 3.4% in November 2022 to 3.9% in November 2023 (see chart below).

 However, inflation remains relatively high compared to the US where inflation has fallen faster over the course of the year (see chart below). Although they would not admit it, this puts some pressure on the RBA and means rates will likely be higher for longer.

What happened around the world?

USA

Chair Powell and the FOMC kept rates steady in December. While GDP was stronger than expected in the third quarter, they see clear signs that the economy is slowing and the labour marketing is softening. They also must also feel vindicated in their past decisions with inflation and their preferred inflation measure of PCE continuing to fall (see chart below).

However, the FOMC minutes does sound a warning over general financial conditions and how a recent easing could force the FOMC to leave the Fed Funds rate higher for longer.

“Furthermore, participants observed that, after a sharp tightening since the summer, financial conditions had eased over the intermeeting period. Many participants remarked that an easing in financial conditions beyond what is appropriate could make it more difficult for the Committee to reach its inflation goal.”

The “Dot Plot” of the projected interest rate from the December meeting now shows that committee members believe that rates will come down more in 2024 and 2025 than what they did in the September meeting (red vs blue bars in the chart below). But they are still more cautious than they were earlier in the year (purple and green bars).As former US Treasury Secretary Larry Summers recently said, the Fed needs to be cautious because, “The moment they turn, or announce they're going to turn, is going to be a seismic moment.”

China

The People’s Bank of China injected record levels of liquidity into the economy in November and December (chart below). Inflation has gone negative and with the impact of the property crisis, there are concerns over deflation and future growth. In November, the IMF projected that China’s GDP growth would fall to 3.5% by 2028 - the boom years may be over.

The lack of confidence in the economy can be seen in the stock market which has been trending down since April. Notably, big foreign investors like US pension funds have taken most of their money out (see chart below). China is no longer the flavour of the month like it has been over the last 20 years and it will take a massive improvement for investors to regain their taste for China.

EU

The ECB kept interest rates stable in December.

Inflation fell to 2.4% in November from 2.9% in October. The ECB indicated that inflation could increase again in the short term and the flash estimate for December shows a slight increase to 2.9%, with some volatility around energy; and food, alcohol, and tobacco prices. However, the ECB expects inflation to average 2.7% in 2024 and 2.1% in 2025 - just above its target rate.

Japan

In early December, Japan’s larger than expected fall in Q3 GDP of -2.1% annualised was revised down to -2.9% (see chart below). Private consumption, which makes up around half of the economy, was revised down from flat to -0.2%. This makes it even trickier for the BoJ to carry out its intended monetary policy tightening.

UK

The BoE kept rates stable in December.

UK inflation continues its recent fall, down from 4.6% in October to 3.9% in November. Q3 GDP was also revised down slightly from flat to -0.1%. Unless there is a big change, the BoE is unlikely to make any changes in the short term.

What this means for Australian Private Debt

The Australian economy remains in a solid position. Inflation keeps falling and while it is not falling as fast as in the US and interest rates are likely to be higher for longer, that is good news for investors in Australian private debt!