Summary for Q1 2023
This past quarter has shown that the economy is certainly facing some challenges (see listed below). Despite this, our disciplined approach and continued long term focus helps to turn down the noise and resist temptation to react. We look forward to seeing what’s in the upcoming budget this Tuesday. Until then, take care and please reach out should you have any questions.
- Economic conditions are deteriorating as central banks hike interest rates to lower inflation at unprecedented levels.
- Argument has been strong household balance sheets & excessive money supply created the buffer to shield consumers from these ancillary pressures.
- Poor capital allocation decisions undertaken during the boom years are being exposed, higher profiled examples include SVB (Silicon Valley Bank) Credit Suisse & Porter Davis Homes. We expect more to come as the impact of higher rates flows through corporate & household balance sheets.
- Pre 2022 was all about growth, 2023 will be about corporate earnings & the impact of higher rates & costs. Excessive valuations from low rates have unwound but expectation of further reversion to longer term trend (ie falls).
- Domestically inflation is peaking and beginning to fall, how quickly rates fall will depend on consumer spending & unemployment as a key indicator.
- All nine recessions since 1955 have been preceded by an inverted yield curve which occurred in April 2022. These tend to occur 12 – 18 months from the indicator with expectations US will enter a ‘mild’ recession over 2023/2024.
- Global macro headwinds remain – Russia/Ukraine conflict & Saudi oil production targets continues to impact energy prices, whilst China’s slower reopening impacted supply.
- Expectation that markets will remain volatile for some time to come.
Pulse of the engine
Consumer sentiment is falling but lagging business confidence, RBA priority is on returning inflation to normal levels regardless of impacts on these measures. Expect further tightening as profit falls, unemployment rises.
Are we there yet?
A 3 year high quality investment grade bond might have a higher yield – ~5.5% or so – but a 1.4% loss in days (50 Bpts movement in Govt spreads smarts along the journey to earning that return.
Volatility will remain high whilst markets absorb the impact of corporate pressures ie SVB, Credit Suisse.
Yield
Price
Historical impact of rate rises
Interest rate rises have been faster & gone further in this cycle than ever before. With history as a guide, Central banks have tipped driven economies into recessionary environment more often that not.
Federal Reserve Bank – Pass Hiking Cycles
Source: Chartr, U.S. Federal Reserve 10/2022
Reserve Bank of Australia – Pass Hiking Cycles
Is inflation moving?
In Australia, inflation is lagging the US by about six months and looks to have peaked in the December quarter.
Services inflation has remained sticky, as has shelter (rents) which are showing signs of slowing. In Australia, rent continues to remain high & electricity prices are anticipated to remain elevated indicating inflation may take a little longer to peak &/or fall.
AMP Pipeline Inflation Indicator
Source: Bloomberg, AMP
Australia Pipeline Inflation Indicator
Source: Bloomberg, AMP
Impact of rate rises – Australian RE
The AFR’s Karen Maley numbers it. “Just over one-third of all mortgages are fixed-rate loans, and about half of these are due to mature next year,” she reported.
“That means these loan borrowers face the daunting prospect of their mortgage jumping from as low as 2 per cent to more than 6 per cent.”
The RBA estimates that 40% of home borrowers have less than 3 months prepayment buffers, 15% of variable rate borrowers will have negative cash flow by year end if the cash rate rises to 3.75% and nearly 900,000 fixed rate mortgages are due to reset to interest rates that are more than double their initial level
Mortgage servicing costs (% of disposable income)
Source: ABS, RBA, Morgan Stanley Research. Estimated from housing debt and average mortgage rates. Incorporates MSe cash rate path of 4.1% and impact of fixed rate switching.
Collapse in money supply
US Leading Economic Indicators showing 6 monthly changes (red shows recession). Every time it falls below -4 has seen a recession. The chart below shows M2 has collapsed along with an inverted yield curve suggests a recession is looming.
M2 is the U.S. Federal Reserve’s estimate of the total money supply including all of the cash people have on hand plus all of the money deposited in checking accounts, savings accounts, and other short-term saving vehicles such as certificates of deposit.
