A pause for now, but the inflation tiger remains uncaged

Peter Warnes  |   20th Apr 2023 | 8 min read

Despite the distraction of a storm in a teacup, where some say the prosecutors may have sipped too much Jack Daniels, this week was a data fest, along with the Reserve Bank’s April Monetary Policy Decision. Under the leadership of Reserve Bank governor Philip Lowe, the board of the central bank collectively got off the pot. The decision to pause and go to the sideline, was probably made easier by OPEC+’s decision to cut production by over one million barrels per day from 1 May. The resulting spike in oil prices stems from the supply-side decision rather than increased demand but will have inflationary consequences. This adds to several issues already impacting the global economy and the likely contraction in economic activity for the remainder of 2023. China looks to be the exception. Already faced with the uncertainty surrounding the US regional banking sector and the likelihood of a tightening in credit conditions, economic activity is expected slow as the lagged effects of 10 rate increases impact consumer and business demand. The decision to pause provides “additional time to assess the impact of the increase in interest rates to date and the economic outlook.” The board admits “global inflation remains very high” and that includes Australia. “Wages growth is continuing to increase in response to the tight labour market and higher inflation. At the aggregate level, wages growth is still consistent with the inflation target, provided that (if) productivity growth picks up.” In the foreseeable future, the chances of a meaningful improvement in productivity are Buckley’s, made even more unlikely in the tightest labour market in 50 years. There has been a change in the wording around savings buffers from, “Many households have also built up large financial buffers and the saving rate remains higher than it was before the pandemic” late last year to “while some households have substantial savings buffers, others are experiencing a painful squeeze on their finances” currently. The savings rate is now well below pre-pandemic levels.

Exhibit 1: Australia household saving ratio (%)

Exhibit 1: Australia household saving ratio (%) Source: tradingeconomics.com, Australian Bureau of Statistics Lowe’s guidance was softened from his March “further tightening of monetary policy will be needed” to April’s, “further tightening of monetary policy may well be needed”. While there is some discussion as to whether the tightening has peaked or not, markets are pricing in cuts from early 2024. The RBA’s forecasts do not see inflation back to 3%, the top end of the desired target range, until mid-2025. Cutting too early, before the beast is back in its cage, could be dangerous. House prices have not fallen to the extent many predicted. In fact, in March, they rose by 1.4% in Sydney and turned positive in Melbourne, Brisbane and Perth mostly due to a lack of supply. Lower rates would trigger a demand response and potentially reignite inflation. The consequences would then be very unsettling and disrupt allegedly current well-anchored expectations. The March quarter CPI to be released on 26 April will be critical to any decision at the next RBA board meeting on 2 May. The data will account for price movements in all components rather than the partial Monthly CPI Indicators. It will not recognise higher transport fuel prices following the OPEC+ decision. The headline read is likely to remain above 6% with the core and trimmed mean shadowing. Still way too high for comfort or complacency.

US data a-plenty

Positively, the US Personal Consumption Expenditures (PCE) Price Index for February was modestly better than expected and trending lower. The headline reading increased 0.3% month-on-month (m/m) against expectations of 0.4%, with the annual rate down from 5.3% in January to 5.0%. The core, excluding food and energy, also increased by 0.3% versus expectations of 0.4%, and the annual rate easing from 4.7% to 4.6%. The PCE is the US Federal Reserve’s (the Fed) preferred inflation benchmark and the chairman Jerome Powell has another favourite market, the core PCE Services excluding Housing, which came in at 4.6% year-on-year. When you exclude food, energy and housing, all components every household requires to exist, and focus on goods and services that are more discretionary, it seems alien to all common-sense and pragmatic ways of thinking. While the trend encourages, the core readings are still too high, comfortably above the mid-point of the 2%–3% target. There is still more work to do, and the markets are currently pricing in a 58% chance of the Fed lifting the federal funds rate by 25-basis points on 3 May to 5.00%–5.25%, increasingly in the restrictive zone. Subsequent Fed speak indicates the PCE data was roughly in line with expectations. Recall, the recent projections of the participants at the Federal Open Market Committee’s (FOMC) March meeting were for a core PCE reading of 3.6% for 2023, up marginally from 3.5% at December. Indicating a touch of caution, the personal saving rate (personal saving as a percentage of disposable personal income) increased from 4.4% in January to 4.6%, the highest since late 2021. Also of note, were comments from the president and CEO of the Federal Reserve Bank of Boston Susan Collins that recent banking issues had influenced her economic projections given the likelihood of at least some credit tightening. New York Fed’s John Williams, who is vice chair and a permanent member of the FOMC added, “stresses in parts of the banking system are likely to result in a tightening of credit conditions that will in turn reduce spending by businesses and households”. “The magnitude and duration of these effects, however, is still uncertain” and consequently, he “will be particularly focused on assessing the evolution of credit conditions and their effects on the outlook for growth, employment, and inflation”. The improving PCE readings drove bond yields lower across all maturities and provided equities markets with a reason to move higher. There was end-of-month and quarter window dressing also on display adding to the market performance. After a solid start in January, markets struggled through February and then encountered the US banking issues in March. The feature of the March quarter was the volatility in global bond markets, ending the period with meaningfully lower yields, assisted by safe haven buying on fears of a spreading banking crisis after bank failures and the Credit Suisse implosion. Lower yields lifted technology stocks with Nasdaq being the best performing of the major US indices after its strong recovery from its December beat-up. There was a flow on to the S&P 500, while the more industrialised Dow Jones lagged.

Exhibit 2: 1Q23 market and bond-yield gyrations

Exhibit 2: 1Q23 market and bond-yield gyrations Source: Morningstar

GDPNow 1Q23 forecast tumbling fast!

Picking up from last week, the GDPNow model nowcast of real GDP growth (seasonally adjusted annual rate) for the March quarter (1Q23) was cut from 3.2% on 24 March to 2.5% on 31 March after recent releases from the US Census Bureau and the US Bureau of Economic Analysis, the nowcasts for 1Q23 real personal consumption expenditures growth, real gross private domestic investment growth, and real government spending growth all decreased, resulting in a meaningful reduction in the overall real GDP growth forecast.

Exhibit 3: Evolution of Atlanta Fed GDPNow real GDP estimate for Q123

Exhibit 3: Evolution of Atlanta Fed GDPNow real GDP estimate for Q123 Note: The top (bottom) 10 average forecast is an average of the highest (lowest) 10 forecasts in the Blue Chip survey. Source: Blue Chip Economic Indicators and Blue Chip Financial Forecasts An update on 3 April saw the nowcast fall to 1.7%, a near halving in just over a week. The downgrade followed the construction spending release from the US Census Bureau, down 0.1% in February against an expected flat reading and a disappointing ISM Manufacturing Index. The headline index fell from 47.7 in January to 46.3, below the consensus estimate of 47.5 and the lowest reading since May 2009, excluding the pandemic period of May 2020 (43.5). The main sub-indices were all weak: new orders 47 to 44.3; employment 49.1 to 46.9 with companies bringing down headcount; and prices paid at 49.2 from 51.3 in disinflation territory. The headline and all sub-indices are in the contraction zone. Of the six biggest manufacturing industries, two—Petroleum & Coal Products; and Machinery, registered growth in March. This is the fifth consecutive monthly reading below 50 which defines a contraction in manufacturing activity and is a clear sign recessionary pressures are gradually mounting. There is a knock-on effect to corporate profits, which are also in decline sequentially for four quarters, the fifth probably just ended. A further update on 5 April sees the latest estimate at 1.5% following the release of the disappointing ISM Manufacturing Index. The ISM Services Index also missed expectations on the downside and is yet to be accommodated in the GDPNow forecast. The index fell from 55.1 in January to 51.2, just in expansionary territory, a below the expected 54.4. The forward-looking new orders component slumped 10.2 points to 52.2 while the employment sub-index fell from 54 to 51.3. From an inflation viewpoint, the prices paid component declined from 65.6 to 59.5 chalking up its fifth consecutive monthly fall. The ADP private sector payrolls also missed consensus with 145,000 jobs created against expectations of 210,000. The sliding exit rate of the March quarter suggests a few rough quarters ahead where negative GDP reads look increasingly likely. The magnitude of the contraction is the $64 question.

A jolt, but should be comforting for the Fed

February’s Job Openings and Labor Turnover Survey (JOLTS) confirmed evidence from the employment sub-index of the ISM Manufacturing Index. Job openings fell 632,000 from January’s unrevised levels, to 9.93 million against expectations of a 300,000 decline, the first-time openings have fallen below 10 million since May 2021.The job openings to unemployed ratio, another of the Fed chair Powell’s favourite indicators, fell from 1.9 to 1.67, the lowest since November 2021. Powell has alluded to a ratio nearer 1.0 and who knows he may just get his wish. JOLTS is considered a lagging indicator, but the recent stream of data reveals a struggling US economy. The March jobs report is due on Good Friday (US time) with expectations of a gain of around 240,000 non-farm payrolls and an unchanged unemployment rate of 3.6%. Disappointing or dismal data was previously welcomed by investors—bad news was good news as investors hoped it would slow the rate hiking cycle. Now with the end in sight, the bad news is being taken for what it is. Perhaps there is a mounting sense of inevitability. The S&P 500 one year forward P/E is currently near 18.5 or an earnings yield of 5.4%. With the US 2-year treasury yield at 3.78%, the equity risk premium is a thin 1.62% or 2.1% using the 10-year yield. This is hardly a margin of safety any prudent investor would entertain. OPEC+ is going to defend oil around US$80 per barrel and the possibility of US$100 by the September quarter cannot be dismissed. Given the level of uncertainty both economically and geopolitically is it difficult to get enthusiastic about equities. There will be a time, but not just yet.

China’s recovery gathers pace

After soaring from 47 in December to 50.1 in January and to 52.6 in February, China’s official Manufacturing Purchasing Managers’ Index took a breather in March, easing to 51.9, above expectations of 51.6. To put these improvements in context, the jump from December to February was the fastest pace since April 2012. March’s Non-Manufacturing PMI was more impressive, increasing from 56.3 in February to 58.2, against expectations of 55 and at its highest level since May 2011.

Exhibit 4: China non-manufacturing PMI (%)

Exhibit 4: China non-manufacturing PMI (%) Source: tradingeconomics.com, National Bureau of Statistics of China The services sector accounts for 55% of GDP and 48% of employment, a critical sector for the economy and jobs, and there is increasing focus is on expanding domestic demand and for a gradual transition away from dependence on fixed asset investment. The data reinforced the newly appointed premier Li Qiang’s positive remarks at the Boao Forum and at this early stage it appears his predecessor Li Keqiang’s conservative GDP growth target of “around 5%” for 2023 will be comfortably achieved.


Australia was once part of the ancient supercontinent Gondwana, also called Gondwanaland, which included the modern continents of Africa, South America, Antarctica, and India. After price controls on coal and gas and now the possible introduction of an additional tax on the ‘super profits’ of gas producers, even on exports, could lithium miners be the next target. Given Labor’s target for 50% of all new cars sales by 2030 to be electric, the Minister for Climate Change and Energy Chris Bowen, who wants to see EV manufacturing take off in Australia with government help, would want to make EVs accessible to all. Price controls on spodumene concentrate would help reduce prices and why not tax the super profits of miners as well. “We can make electric vehicles in Australia. Not only do I think that, so do the electric vehicle manufacturers,” Bowen has stated. Drawing on his vast business experience, “There’s work to do to make that more viable in Australia, but the economics of an electric vehicle are a lot different to the economics of making internal combustion engine (cars).” Given Australia’s labour cost regime, the economics would certainly be different. While discussing the pros and cons of The Voice, perhaps we should also re-name Australia, Gonewana. Inflation is on the wane particularly in the goods sector. However, food remains an issue. We know fruit and vegetable prices are volatile as reflected in an email I had from a friend during the week: At Harris Farm Markets Cammeray today, navel oranges $7.99/kg, last week $5.99/kg, +33%; Kanzi apples $6.99/kg, last week $3.99/kg +75%; cavendish bananas $2.75/kg last week $1.75/kg +57%. On my weekly shopping expedition, I noticed the Arnott’s biscuit range, including all the loved ones from Jatz, Orange Slice, Monte Carlo, Kingston to Shortbread Cream, all up 40% at Coles and Woolworths from $2.50 to $3.50. There is plenty of evidence the price rises are still coming down the pipeline.

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