Economic Update - September 2023

With the return of El Nino, conditions are hotting up in Australia. However, the US bond market is also feeling the heat with a sell-off leading to higher yields for longer-dated bonds. These are conditions not seen since the 1980s! Back in the People’s Republic of China, some good data is not enough to cut through the pall of doom hanging over the property market.

What happened in Australia?

In his last monetary policy meeting as governor on 5 September, Philip Lowe left interest rates unchanged. He then left the building.

Apart from the change in RBA governor, little else has changed in recent months. The economy  continues to chug along in positive territory while showing signs of braking.

GDP grew 0.4% in the June quarter, which matches the slow growth in the first quarter (see chart below). Retail turnover remains flat with a 0.2% increase in August. Unemployment was also unchanged at 3.7%. Seven out of 13 selected industries saw business turnover fall in July compared to June: manufacturing was down -5%, arts and recreation -6.1%, and utilities were down -14.9%.

While the labour market remains tight and unemployment remains historically low, there are signs of slow down there too. Job vacancies fell 8.9% in the three months to August (see chart below). Job vacancies are still well above pre-pandemic levels but they may have reached a peak.

The monthly inflation indicator increased slightly from 4.9% in July to 5.2% in August on an annual basis. This was mostly driven by an increase in automotive fuel which increased 9.1 percent compared to the previous month (see chart below). This result would not have alarmed the RBA but will keep it watchful.

What happened around the world?

USA

“The world has changed.

I see it in the water.

I feel it in the Earth.

I smell it in the air.

Much that once was is lost,”

J.R.R. Tolkien.

Expectations in the bond market have changed. Some are even calling it a “new era”.

Starting in March 2022, the yield on US 10 year Treasury bonds had been steadily increasing with higher interest rates. However, most of the attention has been on increases in the short end of the yield curve. Commentators keenly watched for an inversion of the curve given its predictive power for recessions.

However, in late August, long-dated bonds did something unexpected. Bondholders began a massive sell-off. And as prices fell, their yields accelerated (see chart below). The market realised that “higher for longer” was not just Fed Reserve salesmanship but a new reality. A reality backed up by stubbornly high inflation, a tight labour market, and a resilient US economy. The yield curve remains inverted but not as much as it was before the bond sell-off.

The increase in the yields was not that unexpected but its suddenness has caught many off-guard. Many commentators are now looking to the banking sector again to see if there will be a repeat of the distress seen at the start of the year with Silicon Valley Bank. Concerns also remain over the commercial property sector. The Fed Reserve has assured everyone that it is working closely with financial institutions of all sizes to prevent any problems.

China

The Chinese property sector continues to hang like a dark cloud over the Chinese economy. Country Garden continued to dodge payment deadlines in September like a donkey in a steeplechase while Evergrande’s chairman was put under police surveillance and it cancelled its planned scheme meetings with creditors. 

However, there was some positive news in September. China’s manufacturing PMI index inched into positive territory for the first time in six months for September while retail spending increased by a larger than expected 4.6 percent in August on an annual basis. Industrial profit increased 17.2 percent in August reversing declines in June and July.

Electric Vehicle (EV) exports continue to perform strongly but the EU announced an investigation into the link between low Chinese prices for EVs and state subsidies Stay tuned for a potential EU-China trade spat! 

EU

The ECB increased interest rates by another 25 bps in September taking the official rate to 4 percent - a new record high. However, as with the US, with inflation continuing to decline, many commentators believe that the EU is at the top of its interest rate cycle.

“Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” ECB, Monetary Policy Decision statement, 14 September 2023.   

August’s inflation fell to 5.2 percent from 5.3 percent in July. A year earlier inflation was 9.1 percent.

Economic activity continues to slow with industrial production falling 1.1 percent in August compared to July. Only Malta, France, and Denmark recorded positive industrial production (see chart below).

Japan

Q2 GDP was revised down in September from 1.5 to 1.2 percent on a monthly basis. This was mostly due to a 1 percent fall in capital expenditure which was previously estimated as being flat. However, the revision is not enough to change the story of moderate growth and inflation losing steam. Inflation fell from 3.3 percent in July to 3.2 percent in August. Like everyone else in the region, Japan will be watching its exports to China.  

UK

After the large fall in inflation in July, inflation decreased by only 0.1 percentage points in August to 6.3 percent. Growth in average weekly earnings also remains high: 7.8 percent in terms of normal pay (nominal) for May to July. However, unemployment ticked up slightly while job vacancies keep moving down from their recent peak (see chart below). This resulted in the Monetary Policy Committee (MPC) being split at 5 votes to 4 on pausing versus raing rates another 25 bps.

What this means for Australian Private Debt

A soft landing still seems likely for Australia and the US but the rise of US long-term bond yields has introduced some uncertainty into financial markets. These higher yields and the uncertainty around bonds will likely increase the attractiveness of private debt for many large companies going forward. For investors, it increases the expectation of higher floating rates in the future.