For many people, both here and abroad, it has been a particularly tough few months for a variety of reasons. We have had Covid-19’s impact lingering on (but working through); Rains and floods galore; Shortages and delays of goods, staff; services, skills and tradies; Commodity, oil and energy prices soaring; The continuing and tragic impact of the elevated Russian/Ukraine conflict in Europe; and the Chinese ‘expansion operations’ and tighter economic reforms.
And now, the RBA raises the official cash rate 25pbs, its first rise in over 11 years!
So, we face two more twists, albeit they have been brimming for a while, and which we have discussed in our previous commentaries. The inflation rate in Australia is running higher and higher and, similarly, inflation is doing so around the world, causing the central banks of many nations to increase official interest rates. Furthermore, we have a ‘here we go again’ Australian Federal Election occurring in three weeks’ time. The very topical matters of interest rates and the Federal Election are discussed further on below.
These are turbulent and unusual times for all of us, including for most central banks and governments. It is also a time of adjustment and, as such, current events are weighing on the markets too, even though several of the ‘reasons’ noted earlier are slowly changing favourably for the long-term benefit.
Primarily instigated by the onset of Covid-19 in early 2020, much as it can be said that the global economic management of the past two or, so years has been considered successful management on the run, it was so because of the authorities mainly using the channels of the flooding of cash and credit liquidity to stave off a major probable global calamity. The earlier than anticipated and effective arrival of the vaccine to the virus was also a huge game-changer. The pendulum of the Covid-19 situation has turned, as we know, yet this shift has, in the process, also caused abnormalities to economic current outcomes, especially those noted above. And our daily lives and even lifestyles have changed too since early 2020. Flexible working location (home and office combination) and hours an obvious change.
Nevertheless, we must keep things in perspective and understand that we are in a correction phase or, maybe better seen as more a return to more normality, particularly regarding the onset of higher inflation and interest rate rises. These will balance out more to the historic norms, but we do have inflation back, wage growth coming back, and we will have higher interest rates. Providing these all settle around a few percent, as is anticipated, say by early 2023, then it is back to normality, which is a good thing. The monetary policymakers aim to reach neutral relatively quickly to essentially get interest rates back to the right levels, which are higher than present.
Having interest rates virtually at zero for two years was good to have for most of the period noted, but it is not needed now, and is not sustainable in a cash rich world pushing up asset prices, etc. The economic changes that we are now seeing and feeling, are the shorter-term consequence of what should be closer to getting us arriving again to the right status quo!
The RBA should have raised rates earlier but at least it has now moved before 2024!
The Governor of the RBA, Philip Lowe, must cringe at what he stated publicly as late as last year in that “…the central scenario remains that the conditions for a lift in cash rate will not be met until 2024…”. Obviously, Lowe got that one very wrong. Once again, predicting macro future events and timings can be thwarted with danger, even for the supposedly very well-informed RBA Governor who is on a salary north of $1mm!
A rise in official interest rates in Australia circa mid-2022 has actually been on the cards for a while because, as inflation has been rising quickly most notably since the start of this year, not just in Australia, but also across much of the world. The annualised 5.1% inflation rate in Australia last week forced the RBA’s hand based on its monetary policy targets. So, no real surprise, and more rate rises on the way, also no real surprise. High demand not being met (yet) by limited supply. This anomaly is being addressed within the adjustment and sometimes pain of the ‘return to normality’. I think the new normality will be a little different though in how we feel and act because the past couple of years has also changed us and changed how the world operates more permanently now.
In saying all this, the May Monetary Policy Statement, released yesterday by the RBA, provides a very good update on the economic state of play in Australia (and, also, with broader world) on the machinations behind it. I have given some edited notes below from the quoted Statement on what I consider are the key points that the RBA outlines with its action now and likely continued action in the next year or so. Overall, the RBA’s Statement appears clear, and quite positive and realistic for the picture of Australia economically ahead.
In the Statement, it states that…”The RBA Board judged that now was the right time to begin withdrawing some of the extraordinary monetary support that was put in place to help the Australian economy during the pandemic. The economy has proven to be resilient, and inflation has picked up more quickly, and to a higher level, than was expected. There is also evidence that wages growth is picking up. Given this, and the very low level of interest rates, it is appropriate to start the process of normalising monetary conditions (FMA comment: this is done by increasing interest rates, and by tapering-to-stopping quantitative easing bond buying programs).
The resilience of the Australian economy is particularly evident in the labour market, with the unemployment rate declining over recent months to 4 per cent and labour force participation increasing to a record high. Both job vacancies and job ads are also at high levels. The central forecast is for the unemployment rate to decline to around 3½ per cent by early 2023 and remain around this level thereafter. This would be the lowest rate of unemployment in almost 50 years.
The outlook for economic growth in Australia also remains positive, although there are ongoing uncertainties about the global economy arising from: the ongoing disruptions from COVID-19, especially in China; the war in Ukraine; and declining consumer purchasing power from higher inflation. The central forecast is for Australian GDP to grow by 4¼ per cent over 2022, and 2 per cent over 2023. Household and business balance sheets are generally in good shape, an upswing in business investment is underway and there is a large pipeline of construction work to be completed. Macroeconomic policy settings remain supportive of growth and national income is being boosted by higher commodity prices.
Inflation has picked up significantly and by more than expected, although it remains lower than in most other advanced economies. Over the year to the March quarter, headline inflation was 5.1 per cent and in underlying terms inflation was 3.7 per cent. This rise in inflation largely reflects global factors. But domestic capacity constraints are increasingly playing a role and inflation pressures have broadened, with firms more prepared to pass through cost increases to consumer prices. A further rise in inflation is expected in the near term, but as supply-side disruptions are resolved, inflation is expected to decline back towards the target range of 2 to 3 per cent.
In a tight labour market, an increasing number of firms are paying higher wages to attract and retain staff, especially in an environment where the cost of living is rising. While aggregate wages growth was subdued during 2021 and no higher than it was prior to the pandemic, the more-timely evidence from liaison and business surveys is that larger wage increases are now occurring in many private-sector firms.
Given both the progress towards full employment and the evidence on prices and wages, some withdrawal of the extraordinary monetary support provided through the pandemic period is appropriate.
The RBA Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time. This will require a further lift in interest rates over the period ahead. The Board will continue to closely monitor the incoming information and evolving balance of risks as it determines the timing and extent of future interest rate increases…”.
Fairly clearly stated and net positive is the outlook by the RBA. Australia is positioned well to other economies for strong continued above trend growth. On this, the fund manager, Ausbil, has just written that “Relative to the rest of the world, (looking ahead), Australia’s starting position is quite favourable, with solid growth, lower headline and core inflation levels, lower cash interest rates, an unemployment rate falling to 3.5% from 4%, and wages growth still lagging for some time at 2.5%. A negotiated settlement in Ukraine would present (further) upside to the economic outlook”.
As said, the markets are in the process of adapting to this changing environment. Volatility in the markets will be around so we should understand this and be remembering that volatility brings opportunity too. However, property prices thrived on the ultra-low interest rates of the past couple of years, so to expect a correcting downward in prices because of these rising interest rates will happen. Corrections can be very positive sometimes too. So, very probably, frustrated property buyers can finally flap their wings! My eldest son certainly hopes so!
In the race for this month’s Federal Election, we are seeing jostling, sledging, promise making and more attacks and counter attacks between those wishing to lead our country for at least the next three years. The voters are fed up and quite disinterested by the same old, same old.
However, placing political cynicism aside, it must be difficult and bordering on stupid for our political leaders to keep stepping up making promises of what they will do and what their opposition will not do!
I do think that there is genuine desire for each side of politics to want to make ‘promises’ and actually know that they can execute and deliver them when they are ‘in power’. Unless a government can run a country for its elected term, be able to implement its policies during that term, and for them and us, the voters, to properly assess the results of their policies, much of the electioneering is simply false. Yet, with the political leaders’ repeated line of ‘when we get in power, we will do this and we will do that’, just does not appear to hold these days in what seems to be near an ever-hung lower and/or upper houses. Alas, at this stage, this upcoming election result appears no different. Politicians’ credibility is very poor because of this very point of lack of execution often caused by politics itself! Politicians are limited or even unable from delivering many ‘promises’ as they just cannot get them through the political dogfight that our political system seems to be, sadly.
Politicians must be honest and sincerely announce during the electioneering exactly what is their platform on why they should be elected; and to say where they will genuinely find it hard to deliver in certain areas unless they have bipartisan support. Politicians must be honest about how it will be, not making many promises which they will be unable to deliver. If they cannot control it, how can they say they will deliver it. Not easy, but let’s have some reality and truthfulness by them all, in these somewhat unsettling short-term times.
Politicians really need to have a straightforward approach and solution process to the issues which people feel are relevant to them. People want to hear about matters such as Health; Wages; National Security; and, of course, Cost of Living. The last item is what is on everyone’s mind, and connected to their pockets given the notable rise in, let’s, just say everything we all pay for these days!
In a nutshell, people, including investors, know you cannot predict the future, but they do want better surety in our leaders’ approach about the future. Plan wisely and plan realistically and execute the plan!
As investors, we should remain invested, focused, and diversified. Even though the winds of change are in play, we should always favourably use the tailwinds, and manage the headwinds, as we keep sailing to our goals over time. A good destination at the end is well worth it!
Disclaimer for information provided in this Commentary: This document, and the contents contained within, is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, or plan feature. The views expressed in this are subject to change at any time. No forecasts are or can be guaranteed.