Economic Update - March 2024

Bridges may be crashing down, cargo ships sinking in the Red Sea, and the Panama canal drying up but the major stock markets continue to push new highs. If we are in an AI stock market bubble, surely ChatGPT would tell me?

The US has gone from “soft landing” to “no landing” while Japanese interest rates have finally returned to the black. Meanwhile in Oz, while the politicians fight over who should be on the new RBA boards, the RBA has moved from a hawkish to a “neutral” stance as the economy continues to slow. 

What happened in Australia?

While the RBA kept the cash rate unchanged in March, the market gleefully noted that the RBA had changed its language from “not ruling out future rate rises” to “it could move rates either way”. This helped buoy the ASX 200 to a record high above 7,900 points during the month.

While the RBA still sees some excess demand in the economy, GDP only grew 0.2% in Q4 2023 on a quarterly basis. Further, the latest monthly indicator showed inflation was flat for the third month in a row while inflation excluding volatile items and holiday travel continues to fall (see chart below).

The RBA wasn’t spooked by the Wage Price Index rising to 4.2% in Q4 2023 - its highest level since 2009. Instead, it is confident that the labour market will continue to soften. Although data released later in the month showed that unemployment (seasonally adjusted) fell in February from 4.1% to 3.7%, job vacancies continue to fall from their peak in May 2022 (see chart below). 

There is no doubt that many households are doing it tough, especially young households. A recent ranking of the world’s happiest nations had Australia at 10th but this dropped to 19th when looking at those under 30.

Since the RBA began raising rates, debt servicing costs have risen between 30 to 60%. As a result, 1 in 20 mortgage holders are now spending more than they are earning.  

Australia recorded a record current account balance of AUD 11.8 billion in Q4 2023. Increases in the price of coal and ores helped push the trade balance to the new level. In fact net trade was the largest positive contributor to GDP in Q4.

However, this may turn out to be a high watermark with iron ore and other mineral prices generally decreasing this year. Further, the Department of Industry, Science, and Resources recently released their latest forecast for Australia’s resource and energy exports, and only the value of iron ore exports will increase next year before falling along with the other resources (see chart below).

This projected fall in resource and energy export revenue will weigh against Australia’s economic growth in the next few years and will help tip the RBA’s scale towards rate cuts.   

China recently lifted its 218% tariff on Australian wine but given that China is consuming less wine in the last few years, this will not provide a huge boost to exports. Most wine companies have already switched their exports elsewhere anyway.

What happened around the world?

USA

The S&P 500 hit record levels driven by AI and the NASDAQ (see chart below). It rose over 10% in the quarter and over 27% compared to a year ago. Bitcoin also hit record highs even as Sam Backman-Fried was sentenced to 25 years in gaol.

The Federal Reserve kept the Fed Funds rate unchanged in February but the market was more fixated on the “dot-plot” projections of Fed Board members and presidents. The dot-plot showed an increase in the median inflation and GDP estimates for Q4 2024 compared to the December meeting: core PCE inflation increased from an estimated 2.4% to 2.6% and GDP growth from 1.4% to 2.1%.

However, the dot-plot still showed a median of two 25 bps rate cuts in 2024. This confused the markets given the increases in the inflation and growth estimates. Given the changes to the dot-plot, the market expected FOMC members to be more hawkish in their estimates for rate cuts.

Since the meeting, however, Jerome Powell and several Federal Reserve presidents have suggested that there may be less rate cuts in 2024 than the always-optimistic market has factored in:

“In my view, it is appropriate to reduce the overall number of rate cuts or push them further into the future in response to the recent data,” Federal Reserve Governor Christopher Waller.

“The fact that the US economy is growing at such a solid pace, the fact that the labor market is still very, very strong, gives us the chance to just be a little more confident about inflation coming down before we take the important step of cutting rates,” Jerome Powell.

PCE fell from 0.4% to 0.3% in February on a monthly basis but increased from 2.4 to 2.5% on an annual basis.

Towards the end of the month, the collapse of the Francis Scott Key Bridge in Baltimore attracted a lot of attention. Although 847,000 import vehicles moved through the port last year, the impact on the US economy  is expected to be limited as companies switch to other east coast and west coast ports.

What perhaps didn’t get enough attention was the continuing high delinquencies for CRE (Commercial Real Estate) CLOs (Collateral Loan Obligations) (see chart below). Flashbacks to 2007-08 anyone? In the last 7 months, delinquencies have more than quadrupled for the USD 80 billion market. Many have long been concerned about the US CRE market given that many US downtowns are still struggling after the pandemic. However, most of the vacancies are in older buildings and not across the board.

China

At the National People’s Congress in early March, an ambitious 5% growth target was chosen. President Xi Jinping also delivered the new mantra of “New productive forces”.

China’s tech sector has been catching up to its struggling property sector (see chart below)  and is expected to reach 19% of GDP by 2026.

However, the property sector remains much larger and there was little good news on that front. China Vanke debt was downgraded to ‘junk’ status by Moody’s and Country Garden missed a USD 13.3 million bond interest payment. House prices also continued to fall in February (see chart below).

The IMF recently suggested that China needs to focus on increasing consumer demand as the solution for medium to long-term growth. Managing Director Kristalina Georgieva described China as being at a “fork in the road”.

Hedge fund guru Ray Dalio recently said that China risks a “lost decade of growth” if it doesn’t restructure its debt. Most commentators just want more government stimulus.  

EU

Euro area GDP climbed back from -0.1% in Q3 2023 to 0% in Q4 on a quarterly basis. Germany was down -0.3% for the quarter.

However, despite all the bad news coming out of Germany, including very un-German strikes and difficulties with the German budget, there was a small ray of light: German business outlook improved in February (see chart below).

Euro area inflation continues to fall, decreasing from 2.8% in January to 2.6% in February on an annual basis.

Like other major stock indices, the Stoxx 600 index hit a record high in March.

Japan

They finally did it! The Bank of Japan finally raised interest rates to positive territory in March after months of telegraphing the move.

The Bank of Japan’s resolve was strengthened by a 23rd consecutive  month of inflation above its 2% target and by an average wage increase from the Rengo federation of unions above 5% for the year so far- the biggest in 30 years (see chart below).

“The large-scale monetary easing policy served its purpose.” Governor Kazuo Ueda.

62% of economists surveyed by Bloomberg believe there will be another rate rise by October.

So far, the rate rise has not brought the end of the world, however, the Yen has weakened considerably against the USD which has forced the BOJ to intervene.

Despite the interest rate gap with the US decreasing with the BOJ’s rate rise, which should attract greater demand for the yen, the market is likely expecting the gap to increase as the US Fed is expected to cut rates more than the BOJ this year.

The Nikkei 225 continued to reach new record highs over the month.

UK

UK inflation decreased from 4% in January to 3.4% in February (see chart below). Like the other major stock market indices, the FTSE 100 also reached record highs over the month.

What this means for Australian Private Debt

While stock markets have been going gang-busters so far this year, private debt remains very attractive with the current high interest rates. The Australian economy also looks on course for a “narrow” soft landing.