THERE’S been increased chatter about yield curve inversion and potential recession, on top of speculation around inflation, commodity prices and the conflict in Ukraine.
Fed Chair Powell is showing signs of frustration with the view linking curve inversion to an inevitable recession — particularly since recent data indicates the US economy remains very strong.
The minutes from March’s Federal Open Market Committee meeting — due this week — are expected to contain details on the Fed’s thoughts about quantitative tightening.
Australian data also suggests ongoing economic strength, but the signs are more worrying in Europe. German data in particular shows an increased risk of recession.
Policy decision and timing in Europe are complicated by a strong inflationary pulse. This is underpinned by continued capacity constraints, second-order effects of the Ukraine war and China’s Covid response.
Despite all this US equity markets remained largely unchanged. The S&P 500 gained 0.1% last week.
The Australian market continued its bounce. The S&P/ASX 300 lifted 1.2% last week on the back of a 3.62% increase in resources.
A strong economic recovery has prompted a $150 billion expected improvement in public finances for 2025-26. This is underpinned by lower unemployment benefits and higher income from commodities.
Last week’s Federal budget set aside about 75% for fiscal repair and deployed 25% into new spending initiatives. This comes on top of an already strong economy.
Measures addressing the cost of living were probably the most significant feature, totalling around $10 billion.
This equates to 1% of household income for the next six months and includes:
Australian retail sales increased 1.8% month-on-month in February — better than expectations of 0.9%.
Sales now are only 0.7% below the pre-Omicron peak in November. NSW did best with 3.6% growth and WA was the laggard at -2.9%. Fashion and eating out dominated with about 15% growth.
Statistics released during the week indicate housing credit growth continues to accelerate to a post-GFC high, while residential approvals have rebounded strongly from a Covid-induced delay.
It is also worth noting that the Budget expanded the First Home Loan scheme. Property prices have rolled over modestly.
Business credit growth is also strong, running at 10% year-on-year. This is also a post-GFC high.
Other data showed household wealth was growing as quickly as ever.
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On the jobs front, vacancies are up 47% year-on-year to a record high of 424,000.
The ratio of job vacancies to unemployed persons has also spiked to a record high 75%.
Normally for every job vacancy there are three-to-four unemployed people available. Now there are only about 1.25.
The transmission of this feature of the current cycle into wage growth continues to be very muted. But we are keeping an eye on negotiations surrounding minimum wages.
Australian businesses are still reporting that the tight labour market is a key constraining factor in their operations.
In the US 431,000 new jobs were added in March based on payroll data.
This was below expectations, though the January and February figures were revised up 95,000.
This marks the 11th consecutive month of job gains above 400k — the longest stretch since data was first recorded.
The participation rate also climbed 0.2% to 62.4% — compared to a pandemic trough of 60.2% in April 2020. There is evidence that women and retirees continue to return to the workforce.
The unemployment rate fell to 3.6%, one of the lowest on record.
Average hourly earnings rose 0.4%, after rising only 0.1% in February. The annual growth rate remains high at 5.6%, but all eyes will be on April to see if the trend of moderation continues.
Core PCE inflation rose 0.35% month-on-month in February and is running at 5.4% year-on-year versus 5.2% year-on-year in January. This was in line with consensus and is the lowest monthly gain since September 2021.
The breadth measures moderated substantially in contrast to the CPI data, due to different index constructs. Specifically the PCE has a higher weighting to healthcare and a lower weighting to petrol and housing which results in lower overall readings of PCE versus the CPI.
Indicators of manufacturer and retailer pricing power remain at extremely high levels. It is unlikely that inflation can be slowed materially until this recedes. At this point there is little evidence of demand destruction caused by rising prices.
The Dallas Fed’s Exuberance indicator is providing a different perspective on the state of the US housing market.
While materially lower than pre-GFC levels, it still shows just how strong the environment has been compared to any other era going back to 1981.
The move in the mortgage rate is rapidly impacting equity values in the space, though current activity levels remain very robust.
Surveys of economic activity in the Eurozone and China point to significantly slower activity.
The Ukraine war and higher commodity prices are dragging on Europe, while Beijing’s zero-Covid policy is seeing further shutdowns in China.
We expect the economies of the EU and the US to begin to diverge materially from here, given the much lower exposure of the US economy to these headwinds.
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Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
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