A recession is the main threat for Australian equities and there is a risk that we may have already seen the high for the year in the Australian share market after it reached 8,100 in early August
After a few quiet weeks from the central bank, there was plenty to digest this week. RBA Governor Michelle Bullock spoke at the Australian Business Economists annual Anika Foundation lunch. The topic of the speech was “The Costs of High Inflation”. The Governor highlighted that the RBA remained vigilant to upside inflation risks in Australia, because high inflation hurts everyone, particularly those on low incomes. Bullock explained the key drivers of inflation more recently which have been housing costs and market services inflation (and administered prices to a lesser extent). The RBA is of the view that the demand/supply imbalance in Australia is still one where demand is exceeding supply. This has occurred as demand has been stronger than expected but also because the supply-side of the economy hasn’t increased as much as expected. She reiterated that the Board maintains its view it is “premature” to be thinking about rate cuts, unless circumstances change which is basically an unchanged message from the last meeting.
Bullock also spoke about the RBA’s research into how borrowers have dealt with higher interest rates. On the RBA’s numbers, around 5% of variable-rate borrowers have negative cash flow (with a large share of those lower-income households), when essential spending and mortgage repayments are exceeding income which has been around this level for over a year. This is above the <1% number of borrowers that were in this position in early 2021. These borrowers have had to make adjustments, like cutting back on spending to more essential items, trading down to lower quality goods and services, dipping into savings or working extra hours. Bullock said “some may ultimately make the difficult decision to sell their homes” but the media took this quote out of context indicating that the Governor was “warning” households that they may have to sell their homes… which was not the case. The bottom line is that the proportion of households that are in true “mortgage stress” remains low, which is also clear in other indicators like housing listings and mortgage arrears although it could increase as the unemployment rate rises.
Bullock’s comments came after Federal Treasurer Jim Chalmers said that high interest rates were “smashing” the economy (prior to the poor GDP data) which many took as the government “blaming” the RBA for poor GDP growth. Comments like this from the Treasurer are unfair to the RBA, who has one tool to control inflation (monetary policy). It also looked like the government was trying to shift the “blame” for weak economic conditions, when exuberant government spending in recent years has helped to fuel inflation, especially in the past year with government federal and state budget deficits expanding more than expected, leading to a positive “fiscal impulse” which could make it harder for the RBA to reduce inflation.
Easing inflation pressures, central banks moving to cut rates and prospects for stronger growth in 2025-26 should make for reasonable investment returns over 2024-25. However, with a high risk of recession, poor valuations and significant geopolitical risks particularly around the US election, the next 12 months are likely to be more constrained and rougher compared to 2023-24 and there is a high risk of a further correction in the next few months. A recession is the main threat for shares and there is a risk that we may have already seen the high for the year in the Australian share market after it reached our year-end target of 8100 in early August.
Bonds are likely to provide returns around running yield or a bit more, as inflation slows, and central banks cut rates. Unlisted commercial property returns are likely to remain negative due to the lagged impact of high bond yields and working from home reducing office space demand.
Australian home prices are likely to see more constrained gains over the next 12 months as the supply shortfall remains, but still high interest rates constrain demand and unemployment rises. The delay in rate cuts and talk of rate hikes risks renewed falls in property prices as its likely to cause buyers to hold back and distressed listings to rise.
Cash and bank deposits are expected to provide returns of over 4%, reflecting the back up in interest rates. A rising trend in the $A is likely taking it to $US0.70 over the next 12 months, due to a fall in the overvalued $US and a narrowing in the interest rate differential between the Fed and the RBA. A recession is the main downside risk.
Diana Mousina, Deputy Chief Economist, AMP Capital
