Market Musings: Navigating the minefield
After recovering strongly from its COVID disruptions the Australian economy is entering rough seas. This is something many haven’t had to deal with often. Outside of the external shocks generated by the GFC and pandemic the Australian economy has performed well over the past few decades. But the current environment is tricky, with the path to a ‘soft landing’ narrow.
Inflation is too high, and the RBA is raising interest rates swiftly to slow down activity, to better align demand and supply and cool price pressures. The RBA has already put through a lot of tightening into the system, with the cash rate (now 3.35%) back above the RBA’s estimate of ‘neutral’ implying that policy settings are in ‘restrictive’ territory for the first time in over a decade. With further rate hikes to come (we see the cash rate rising to ~3.85% in April/May), the RBA’s policy stance will become even more contractionary. Along with the interest rate sensitive housing market, this will be felt most acutely by heavily indebted households. The squeeze on household budgets is predicted to slow consumer spending, and in time this should broaden out to business investment and jobs.
Given the RBA’s rapid-fire tightening cycle, high debt burdens of many households, and falling house prices, an uber-bearish story is an easy one to create. But a closer look under the hood indicates that while a slowdown should be anticipated and recession risks are rising, it isn’t all one way. Many households have built up excess savings during COVID that can help counteract the cost-of-living squeeze, while others are net savers and benefit from rising rates. Similarly, although house prices have turned, there is still a pipeline of residential construction and infrastructure work that is yet to be completed. Reopened international borders are also growth supportive. Reaccelerating population growth as net migration lifts, and as international students and tourists return are sources of demand that have been missing the past few years .
To help make sense of the push-pull dynamics at work, gauge whether recession fears are crystallising, and pick up eventual economic and policy turning points, which are all important when it comes to projecting future AUD trends, we have developed several composite trackers. Our Australian macro trackers are based on a wide range of timely sentiment and high frequency data that cover different parts of the economy, look at labour market trends, and try and measure the inflation pulse.
As shown in the charts above and below, sentiment measures have clearly stepped down. Based on historical patterns, we anticipate this will flow through to the activity data, and in time into the labour market. Indeed, there are already signs that labour demand has started to soften. Our aggregate tracker, which has provided a solid lead to private demand growth ~6-months ahead, is currently pointing to slowing, but not dire, momentum over Q1/Q2. Likewise, our inflation pulse suggests the CPI peaked at the end of 2022, and that annual inflation should decelerate over H1 2023, arguably a bit faster than the RBA has penciled in. All up, these signals support our expectations that while the RBA could raise interest rates a bit further over the next few months, it may be starting to overdo it, and market pricing looking for the RBA to reach ~4.15% by September may prove to be too aggressive given the growth, labour market, and inflation slowdown set to transpire. For the AUD, this plays into our thinking that interest rate differentials should remain in the US’ favour for some time, acting to limit near-term bounce backs .
Peter Dragicevich
Currency Strategist - APAC
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