Global economic outlook weak but global markets rise

Investment markets and key developments over the past week

15 April 2023 | (Source: AMP Capital Markets)

Global share markets had a strong week helped by a further fall in US inflation adding to expectations that the Fed is at or close to the top. For the week US shares rose 0.8%, Eurozone shares gained 1.7%, Japanese shares rose 3.5% but Chinese shares fell 0.8%. The positive global lead helped boost Australian shares which rose 2% for the week with gains led by material, IT, property and energy stocks. Bond yields rose as did oil, metal and iron ore prices. The “risk on” tone also saw the $A rise as the $US continued to fall.

Inflation pressures are continuing to recede. This was evident in a further fall in US inflation and even Indian inflation falling to a 15-month low. US inflation fell to 5%yoy in March with a sharp slowing in annual energy and goods price inflation leaving it well down from its high of 9.1% in mid last year.

While US core (ie ex food and energy) inflation remains sticky at 5.6%yoy due to high services inflation, core services inflation excluding shelter (a key focus of Fed Chair Powell) is starting to slow and shelter (or rent) inflation is also starting to slow with advertised rents pointing to a further slowdown ahead.

Yield curves continuing to point to a high risk of US recession – and that the Fed has probably done enough. A sharp fall in bond yields since February and still rising short term interest rates has seen US yield curves invert further (ie long term rates fall further below short term rates). Even the near term yield curve – which some at the Fed appear to prefer – as proxied by the gap between the 2 year bond yield and the Fed Funds rate – has now inverted. Over the last 50 years all US recessions have been preceded by inverted yield curves as is the case now – but the lag can be up to 18 months and it can give false signals. At the very least the plunge in 2 year bond yields below the Fed Funds rate is signalling that the market expects that the Fed has probably done enough to control inflation and that the Fed will cut rates over the next two years.

(Source: AMP Capital Markets)

In Australia, the yield curve has also now inverted warning of a rising risk of recession – but its track record in signalling recession is poor. The decline in long term rates below the cash rate is signalling though that the money market expects that the RBA has probably also done enough to control inflation.

This is also now starting to be reflected in falling fixed mortgage rates in Australia as they price off longer term bond yields. That said fixed mortgage rates (with eg one major bank cutting its 3 year fixed rate to 5.59%) remain way above the 2% or so lows of two years ago and are still above many variable rates so their recent falls won’t ease the fixed rate reset or contribute to a new property upswing.

Central banks at or near the top:
– The sticky core US inflation evident in March probably leans the Fed towards one last 0.25% rate hike at its May meeting and most Fed speakers appear to favour that. But with falling job openings, a mixed jobs report for March, falling job openings and the minutes from the last Fed meeting indicating that the Fed’s staff expect bank stress to contribute to a “mild recession” it’s a close call. In terms of the impact of banking stress – while Fed emergency funding to banks has slowed, the March NFIB small business survey showed a sharp increase in difficulty in obtaining loans which also takes pressure off the Fed for more rate hikes.
– The Bank of Canada, the Bank of Korea and Singapore’s Monetary Authority all left monetary policy on hold.
– In Australia, strong March jobs data adding to the risk of a wages breakout and the upswing in the residential property market (which if sustained would reverse the negative wealth effect from lower home prices) increase the risk of another RBA rate hike in May. Our base case is that with the labour market being a lagging indicator and economic growth and inflation likely to continue to slow the RBA will remain on hold at its May meeting. But it’s a close call with upcoming data on inflation to be watched closely.

Underlying the soft global growth outlook the IMF revised down its global growth forecasts for this year and next citing the banking problems and sticky inflation, but the revisions were minor and were nothing new for investment markets. The IMF’s growth forecasts for 2023 and 2024 were both revised down – but only by 0.1% to 2.8% and 3% respectively which leaves them little changed from where they have been since mid last year and not way out of line with pre-pandemic average growth rates – see the next chart. The IMF sees inflation in advanced countries falling to 2.6% in 2024. While the IMF expects Australian growth to slow to 1.6% this year and 1.7% next year this is similar to RBA forecasts (and a bit stronger than our own) and is a bit stronger than its expectations for growth in other advanced countries. The good news for Australia is that the IMF expects China’s economy to growth 5.2% this year and 4.5% next year

Further signs of improvement in the Australia-China trade relationship after the restrictions and tariffs imposed on several products in 2020. Earlier this year coal exports resumed to China and its now reportedly reviewing tariffs on Australian barley – holding out hope for a removal of tariffs and restrictions affecting other products, like wine, timber, crustaceans & lamb. This would be good news for the producers affected. It also reduces the risk of restrictions on Australian services exports (mainly tourism and education) to China. But its overall macro impact would likely be minor as apart from coal the exports affected were a small part of Australia’s total exports, many of the industries diverted exports to other markets and Australia has been running near record trade surpluses anyway. It will be swamped by the impact of the removal of travel restrictions on Chinese students and tourists.

Australian economic events and implications

The Australian jobs market remained surprisingly strong in March. Employment rose by another 53,000, participation rose to a near record high, and unemployment was unchanged at 3.5%. Underemployment and labour underutilisation rose slightly though but the overall message is that jobs market remains tight and this runs the risk of a wages breakout. So far wages growth remains “three point something” which is consistent with the 2-3% inflation target but the continuing tight labour market, the lifting of public sector wage growth caps in NSW and Victoria and claims for a 7% increase in the minimum wage all point to upside risks for wages growth which will concern the RBA. So taken on its own the March jobs data adds to the case for another rate hike in May. However, the jobs market at least does not appear to be getting any tighter, it’s a lagging indicator and falling job openings and surging immigration point to a softer jobs market ahead. So, along with other signs of slowing growth and inflation, it makes more sense for the RBA to remain on hold which is our base case, but it’s a close call. The next round of inflation data will clearly be watched closely.

This market commentary is an extract from the weekly economic outlook report authored by Dr. Shane Oliver, Chief Economist for AMP Capital Markets.