Tim Hext: Avoiding a double-dip recession
Avoiding a double-dip recession: portfolio manager Tim Hext (pictured) of Pendal’s Bond, Income and Defensive Strategies team will discuss this in the article below.
My first year in markets was 1989 and my first trade was buying some bank bills at 18.5%. I should have bought a 30-year bond!
Crushing inflation had become a cruel venture, bringing on the recession that Paul Keating said we “had to have”.
Living in Melbourne in 1990 was to witness first-hand an imploding economy. Businesses closing almost every day. Unemployment soaring. House prices collapsing. People struggling. Any job was a good job — forget whether it was inspiring.
Recessions were seen as a natural part of the business cycle.
In the early 1990s, even the most optimistic economist would have expected another recession within 10 years. The odds of a 30-year wait would have been longer than Parramatta or Carlton going without a premiership for decades. The true miracle was avoiding a recession during the GFC. China rode to the rescue and the real economy avoided the fate of financial markets.
Walking around a number of shopping centres and strips in the past month brought back memories from Melbourne in 1990. “For Lease” signs everywhere and shops boarded up. I stopped to look in the windows of closed businesses. Some signs said “Opening Soon When Safe” – but sadly many have closed for good.
Large numbers of retail stores were marginal before the crisis. Rent relief beyond 50% was at the behest of landlords. Some landlords have worked to keep tenants but others have merely added the other 50% to future bills.
Perhaps the crisis has merely accelerated the push to clicks over bricks – and retail will bounce back. If enough workers are still getting paid they will spend it online. Restaurants may survive via delivery. The fleets of electric bikes around my neighbourhood have swollen.
Last quarter I spoke about the shape of the recovery as the economy cautiously began to open up.
Adding to the list of V, L, U and W we now have the Reverse Square Root, the Nike Swoosh, and other shapes showing the speed of the recovery.
This quarter I will look at the progress so far and ask the question: when will we get back to where we were in February? We did not know it at the time, but the high-water mark fell in between the bushfires and COVID.
In February 13,056,700 Australians were employed. This was an all-time high. Australia’s population was 25.5 million. The population increased by 350,000 in the prior year including 210,000 being migrants. A record 66% of Australians over 15 years of age were either working or looking for work, meaning an unemployment rate of 5.1%.
Flash forward to May 30 and 7.5% of jobs had been lost according to tax office data. This equated to 980,000 jobs. At the worst point in April, it was 9% or 1.18 million. These are jobs where people are not getting paid. How many will return with the re-opening of the economy and how many have disappeared permanently? That remains to be seen.
Graph 2 shows the different measures of employment. Since March the Bureau of Statistics has released tax office data in a weekly payrolls report. This data is electronic rather than survey-based like the official labour force numbers. This is a far more accurate measure. It captures the large cohort of workers laid off but waiting for businesses to reopen so they can hopefully get their jobs back.
On March 20 Newstart was renamed JobSeeker and increased from $550 to $1100 a fortnight. About 1.6 million Australians are now on JobSeeker, up from 700,000 on Newstart in February. The labour force survey shows 835,000 jobs lost from February to May.
Where it gets interesting is the collapse in the participation rate from 66% to 63%. The labour force survey suggests only 210,000 people joined the unemployment queue with the rest dropping out. This conveniently keeps unemployment at 7.1%, not the 12% other measures are showing.
When asked in the survey “are you looking for work”, it appears for various reasons a large number of people are saying “no”.
JobSeeker numbers reveal the true damage. Numbers suggest everyone who lost a job is now on JobSeeker – even if they tell the Bureau they are not looking for work. The JobSeeker eligibility requirement of “actively looking for work” has been temporarily waived, but will return shortly.
Then there is JobKeeper. This is designed to keep people employed even if they are not working – or are working fewer hours. The $1500 fortnight payment, designed to roughly match the minimum wage, is paid through the employer in arrears. Businesses must have suffered a 30% fall in turnover if less than $1bn or 50% fall if greater than $1 billion. Numbers on JobKeeper are estimated to be 3.5 million after a mistake initially predicted 6.5 million, or half the workforce.
JobKeeper is scheduled to end on September 27 although it may be tightened rather than abandoned altogether. No system is perfect. Some businesses believe they are more viable while closed under JobKeeper, which the government doesn’t want to encourage. For smaller businesses 80% turnover means losing JobKeeper – while also likely remaining unprofitable.
GDP is a volume-based measure. It’s called a chain volume because it’s linked quarter by quarter. There are three approaches to measuring chain volume – income, expenditure and production. Headline GDP is a simple average of the three.
In volatile times like this GDP can be confusing because it’s always reported as a growth number. The real question is how long it will it take the economy to get back to pre-COVID levels. The following graph shows the actual GDP rather than the rate of change. The graph also shows GDP per capita, a better measure of productivity in the economy.
It will take until early 2022 for the economy to return to its December 2019 size, based on estimates from the RBA’s May Monetary Policy Statement.
The RBA has tended to overestimate GDP in the past five years. Health outcomes make forecasting extremely difficult of course, but this assumption looks optimistic.
Viewed from a GDP per capita basis, however, the picture is less dramatic. Almost half of Australia’s GDP growth over the last decade has been due to immigration. Australia’s population growth has now collapsed and is unlikely to resume to pre-COVID levels for a number of years. This may mean GDP per capita has a better chance of improving.
Forecasting medium-term inflation followed some simple rules over the past 25 years. From 1993 to 2012 tradables (40% of CPI) were largely flat. Non-tradables (60% of CPI) were 4%, landing around the 2.5% target. In the last decade, non-tradable inflation started to fall to around 3%, led by health and education. This meant CPI settled closer to 2%.
Even before the crisis non-tradables were beginning to slip to 2% and CPI closer to 1.5%. This was largely due to a fall in housing (rents, building costs and utilities), which we viewed as cyclical, not structural. This meant we entered 2020 sharing the RBA’s confidence that CPI would drift back to 2% over 2020 as population growth and a lack of new building activity kicked in. COVID-19 has shot down that view.
The story of the economy is now one of widespread excess capacity. Shutdowns meant demand and supply were both hit. Coming out of shutdowns there are pockets of demand exceeding supply as global supply chains have been hit. However, in the larger items – particularly labour – excess supply dominates.
Joining this mix is a move to wage freezing. This is led by governments but is also likely in the private sector. The recent minimum wage decision gave a 1.9% increase, down from 3% or higher compared to recent decisions. However, as the pool of labour supply increases in many areas, new employees may come in on lower wages.
The real area of concern for inflation is rents. Rents make up 8% of the CPI basket, large enough to move the dial overall.
In pockets of inner-city Sydney and Melbourne, rents are already down about 6%. The levelling of the population means negative rent growth will spread to wider areas in these cities, which rely heavily on students and international workers for tenants. Other cities and rural areas may be less affected. But if rents were to fall 3% nationally this would feed into a 0.25% fall in inflation. There may also be second-round effects.
Until recently the RBA was happy to forecast and accept 2% CPI as the long-term average, despite a formal 2-3% target. Markets now have that closer to 1.25% over the next decade, after falling as low as 0.5% at one point. From a bottom-up perspective even 1% looks optimistic over the next few years.
CPI will be negative 1% or even lower in the June quarter, largely due to free childcare during the quarter. This will be removed, but an era of frozen costs seems here to stay across wide areas such as education, healthcare and government charges.
Excess supply in the economy will be with us for at least the first half of this decade.
Structural forces already in place were accelerated by COVID-19 and low GDP and inflation have pushed rates close to zero. The RBA believes negative rates do more harm than good, so they have stopped at zero. The stimulus required from monetary policy for a crisis of this scale was not there – otherwise rates would now be -3%.
Unconventional policy has held down term rates but this really only helps around the edges. Put simply, the RBA has done an excellent job from a liquidity role during this crisis – but from an economic stimulus role it has turned up with a knife to a gunfight.
The federal government now has all the firepower. The initial response to the crisis has been excellent overall. Fiscal policy needs to more permanently enter a new era. Ghosts of Tony Abbott’s debt scaremongering still seem to have an influence in Canberra.
Already there is talk of how we are going to pay for all this stimulus and that we are labouring future generations with our debt. You would think the government is a household; with a printing press out back it is not. If Australia is to avoid a lost decade we need to get comfortable with government debt sooner rather than later.
Short rates stuck at zero mean longer rates will also be supported. Any sell-offs in bonds as the economy opens up and data picks up should be bought into. Term premium should not drift higher despite the usual scaremongering around money supply pushing up inflation.
The same voices were out there after Quantitative Easing during the GFC. Once again they will be disappointed. One of the best trades earlier in the decade was harvesting the high carry and roll available. Levels today are not so generous, but still offer good value.
Australia has begun the long, slow grind of re-opening the economy.
Some damage will be repaired quickly while other damage has been terminal. As always, health outcomes partly hold the key to the speed of the recovery. However, the federal government is now front and centre and its actions can either prevent or cause a double-dip recession. The more timid their fiscal policy, the longer, deeper and more painful the slowdown.
Bond markets will remain well supported. Plenty of countries have been down this path before us and so far only the US managed, at least for a while, to emerge from the anchor of zero rates. They look like the exception, not the rule.
The grab for yield is once again upon us. For now it is a trend you must go with rather than fight.
We remain long duration and in portfolios with credit overweight investment grade. These themes have further to run in the quarters ahead.
Tim Hext – portfolio manager with Pendal’s Bond, Income and Defensive Strategies team.
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