• How are Australia’s states and territories performing?
• Each quarter CommSec attempts to find out which state or territory is Australia’s economic leader. Now in its 15th year, the report also includes a section comparing annual growth rates for the eight key indicators across the states and territories as well as Australia as a whole, enabling comparisons in terms of economic momentum.
• Overall, the economic performances of Australian states and territories are being supported by a solid job market and strong population growth at a time of rising interest rates.
• Australia’s state and territory economies have slowed in response to higher borrowing costs and price pressures. The future path will depend on the response of inflation to higher interest rates.
• Australia’s state and territory economies have slowed as consumers respond to higher borrowing costs and price pressures. The future path will depend on the resiliency of the job market and interest rates.
• And while it was close, South Australia has gone back-to-back to lead the performance rankings. South Australia ranked first on four of the eight indicators.
• Western Australia is now ranked second with Victoria in third position.
• NSW, Queensland, the ACT and Tasmania couldn’t be split for fourth position. And the Northern Territory is eighth.
• We acknowledge that the economic performance ranking criteria disadvantages the small, open economy of the Northern Territory. As a result we highlight the annual growth rankings—a measure of economic momentum.
• Measuring annual growth rates of the eight economic indicators, Western Australia is in first spot ahead of Queensland. Victoria is third and the ACT is fourth. NSW is fifth ahead of South Australia in sixth spot followed by the Northern Territory and Tasmania in seventh and eighth spots respectively..

Analysis

• Last quarter we noted that South Australia, NSW and Victoria “are most likely to challenge for top spot”. While we were right about South Australia, Western Australia was the surprise, up from fourth to second.
• Western Australia gained ground in five indicators, especially economic growth.
• Looking ahead, South Australia, Western Australia and Victoria could conceivably take top spot in the next quarterly survey.  But apart from the Northern Territory, none of the other states and territory can be ruled out given solid population growth and firm job markets.
  

Methodology

• Each of the states and territory economies were assessed on eight key indicators: economic growth; retail spending; equipment investment; unemployment, construction work done; population growth; housing finance and dwelling commencements.
• The aim is to find how each economy is performing compared with ‘normal’. And just like the Reserve Bank does with interest rates, we used decade-averages to judge the ‘normal’ state of affairs. For each economy, the latest level of the indicator – such as retail spending or economic growth – was compared with the decade average.
• While we also looked at the current pace of growth to assess economic momentum, it may yield perverse results to judge performance. For instance retail spending may be up sharply on a year ago but from depressed levels. Overall spending may still be well below ‘normal’. And clearly some states such as Queensland and Western Australia traditionally have had faster economic growth rates due to historically faster population growth. So the best way to assess economic performance is to look at each indicator in relation to what would be considered ‘normal’ for that state or territory.
• For instance, the trend jobless rate in NSW stood at 3.7 per cent in March 2024. But the NSW unemployment rate was 23.5 per cent below its decade average, while the South Australian jobless rate of 3.8 per cent was 35.8 per cent below its decade average. So South Australia ranks above NSW on this indicator.
• Seasonally adjusted or trend measures of the economic indicators were used to assess performance on all measures. The preference was for the less volatile trend measures. Original data is used to assess population growth.

The post CommSec State of the States: April 2024 appeared first on AdviserVoice.

• How are Australia’s states and territories performing?
• Each quarter CommSec attempts to find out which state or territory is Australia’s economic leader. Now in its 15th year, the report also includes a section comparing annual growth rates for the eight key indicators across the states and territories as well as Australia as a whole, enabling comparisons in terms of economic momentum.
• Overall, the economic performances of Australian states and territories are being supported by a solid job market and strong population growth at a time of rising interest rates.
• Australia’s state and territory economies have slowed in response to higher borrowing costs and price pressures. The future path will depend on the response of inflation to higher interest rates.
• For the first time in the 14 years of our quarterly reports, South Australia is on top of the leader board. South Australia ranked first on four of the eight indicators.
• Victoria is now ranked equal second with NSW. Western Australia ranks fourth ahead of Tasmania in fifth spot. The ACT is sixth, ahead of Queensland in seventh spot and the Northern Territory in eighth.
• South Australia ranks first on relative economic growth, relative unemployment, construction work done and dwelling starts.
• Victoria is now in equal second position with NSW and Western Australia is fourth.
• Victoria ranks second on retail trade. NSW ranks second on relative economic growth and construction work done. Western Australia ranks first on relative population growth.
• Behind Western Australia is Tasmania in fifth spot. The ACT is sixth and Queensland is seventh on the economic performance table.
• And the Northern Territory sits in eighth position.
• We acknowledge that the economic performance ranking criteria disadvantages the small, open economy of the Northern Territory. As a result we highlight the annual growth rankings—a measure of economic momentum.
• Measuring annual growth rates of the eight economic indicators, Western Australia is in first spot ahead of Queensland. Victoria is third and NSW is fourth. South Australia is fifth ahead of the Northern Territory in sixth spot followed by the ACT and Tasmania in seventh and eighth spots respectively.
• Western Australia leads other states and territories on annual growth rates on three of the eight indicators. The Northern Territory leads on two indicators. And Queensland, South Australia and the ACT lead on one indicator.

Analysis

• Last quarter we noted that Victoria would face challenges for first position from four other economies. This proved correct with South Australia lifting from second position to first.
• South Australia gained significant ground in construction-related sectors as well as overall economic growth.
• Looking ahead, trends in jobs, consumer spending and housing will be important with Queensland, NSW and Western Australia possessing firm momentum.
• Seven of the eight states and territories could conceivably take top spot in the next quarterly survey but South Australia, NSW and Victoria are most likely to challenge for top spot.

Methodology

• Each of the states and territory economies were assessed on eight key indicators: economic growth; retail spending; equipment investment; unemployment, construction work done; population growth; housing finance and dwelling commencements.
• The aim is to find how each economy is performing compared with ‘normal’. And just like the Reserve Bank does with interest rates, we used decade-averages to judge the ‘normal’ state of affairs. For each economy, the latest level of the indicator – such as retail spending or economic growth – was compared with the decade average.
• While we also looked at the current pace of growth to assess economic momentum, it may yield perverse results to judge performance. For instance retail spending may be up sharply on a year ago but from depressed levels. Overall spending may still be well below ‘normal’. And clearly some states such as Queensland and Western Australia traditionally have had faster economic growth rates due to historically faster population growth. So the best way to assess economic performance is to look at each indicator in relation to what would be considered ‘normal’ for that state or territory.
• For instance, the trend jobless rates in NSW stood at 3.4 per cent in December. But the NSW unemployment rate was 30.1 per cent below its decade average, while the South Australian jobless rate of 3.8 per cent was 36.5 per cent below its decade average. So South Australia ranks above NSW on this indicator.
• Seasonally adjusted or trend measures of the economic indicators were used to assess performance on all measures. The preference was for the less volatile trend measures. Original data is used to assess population growth.

Read the report.

The post CommSec State of the States – January 2024 appeared first on AdviserVoice.

• How are Australia’s states and territories performing?
• Each quarter CommSec attempts to find out which state or territory is Australia’s economic leader. Now in its 15th year, the report also includes a section comparing annual growth rates for the eight key indicators across the states and territories as well as Australia as a whole, enabling comparisons in terms of economic momentum.
• Overall, the economic performances of Australian states and territories are being supported by a solid job market and strong population growth at a time of rising interest rates.
• Australia’s state and territory economies are slowing in response to higher borrowing costs and price pressures. The future path of economies will depend on the response of inflation to higher interest rates.
• In the latest survey there is little to separate six of the state and territory economies. Victoria has surprised, jumping from fifth to first position. Victoria was consistently firm across all the indicators, improving its ranking on four of the eight indicators.
• South Australia is now in second position, ahead of NSW and Queensland.
• South Australia ranks first on relative unemployment. NSW ranks second or third on four indicators. Queensland ranks first on home lending.
• Behind Queensland is Western Australia, remaining in fifth position, ahead of Tasmania. There is little to separate the top six economies.
• The ACT is ranked seventh ahead of the Northern Territory.
• We acknowledge that the decade-average method disadvantages the Northern Territory. Significant LNG construction over 2012–18 inflated a range of economic indicators. So we highlight rankings of economic momentum—that is, the annual growth rates for the eight indicators.
• Western Australia now heads the leader-board of annual growth rates, ahead of NSW, Victoria and Queensland in joint third position.South Australia is fifth; the ACT is sixth. Then the Northern Territory is seventh, ahead of Tasmania.
• Western Australia leads other states and territories on annual growth rates for three of the eight indicators.
• NSW, South Australia, the Northern Territory, Queensland and the ACT all lead on one indicator.. .

Analysis

• While Victoria now claims first position on overall economic performance, it faces challenges from four other economies. Even Western Australia could post a challenge to Victoria, given its current momentum.
• However, Victoria was consistent in the latest survey – first, second or third on five of the eight indicators.
• Looking ahead, trends in consumer spending and migration are important to watch as well as the US and Chinese economies.
• Success achieved in lowering inflation expectations, balancing supply and demand, and thus reducing the rate of inflation will determine the path of interest rates and economic activity across all states and territories.

Methodology

• Each of the states and territory economies were assessed on eight key indicators: economic growth; retail spending; equipment investment; unemployment, construction work done; population growth; housing finance and dwelling commencements.
• The aim is to find how each economy is performing compared with ‘normal’. And just like the Reserve Bank does with interest rates, we used decade-averages to judge the ‘normal’ state of affairs. For each economy, the latest level of the indicator – such as retail spending or economic growth – was compared with the decade average.
• While we also looked at the current pace of growth to assess economic momentum, it may yield perverse results to judge performance. For instance retail spending may be up sharply on a year ago but from depressed levels. Overall spending may still be well below ‘normal’. And clearly some states such as Queensland and Western Australia traditionally have had faster economic growth rates due to historically faster population growth. So the best way to assess economic performance is to look at each indicator in relation to what would be considered ‘normal’ for that state or territory.
• For instance, the trend jobless rates in NSW stood at 3.3 per cent in September. However, the NSW unemployment rate was 32.9 per cent below its decade average, while the South Australian jobless rate of a record low 3.7 percent was 38.9 per cent below its decade average. So South Australia ranks above NSW on this indicator.
• Seasonally adjusted or trend measures of the economic indicators were used to assess performance on all measures. The preference was for the less volatile trend measures. Original data is used to assess population growth.

Read the report.

The post CommSec State of the States – October 2023 appeared first on AdviserVoice.

• How are Australia’s states and territories performing?
• Each quarter CommSec attempts to find out which state or territory is Australia’s economic leader. Now in its 14th year, the report also includes a section comparing annual growth rates for the eight key indicators across the states and territories as well as Australia as a whole, enabling comparisons in terms of economic momentum.
• Overall, the economic performances of Australian states and territories are being supported by a solid job market and strong population growth at a time of rising interest rates.
• But Australia’s state and territory economies are slowing in response to higher borrowing costs and price pressures.
• The future path of economies will depend on the response of inflation to higher interest rates.
• In the latest survey there is little to separate the top four of the state and territory economies.
• Tasmania has retained top spot in the State of the States’ economic performance rankings, improving its ranking on retail spending.
• Tasmania ranks first on equipment spending and dwelling starts.
• NSW remains in second position and has narrowed the gap with Tasmania. South Australia slips to third place.
• NSW ranks first on relative unemployment. South Australia ranks first on relative population growth.
• Behind NSW and South Australia in fourth spot is Queensland. Western Australia is fifth while Victoria slips to sixth. There is little to separate the top six economies.
• The ACT is ranked seventh ahead of the Northern Territory.
• We acknowledge that the decade-average method disadvantages the Northern Territory. Significant LNG construction over 2012–18 inflated a range of economic indicators. So we highlight rankings of economic momentum—that is, the annual growth rates for the eight indicators.
• Measuring annual growth of the eight economic indicators, NSW is first, ahead of Queensland with Western Australia, Victoria and South Australia in joint third place. The ACT is sixth, ahead of the Northern Territory and Tasmania.
• There are encouraging signs for the Western Australian economy. Western Australia leads other states and territories on annual growth rates for two of the eight indicators.
• NSW, South Australia, Tasmania, the Northern Territory, Queensland and the ACT all lead on one indicator.

Analysis

• While Tasmania remains in first position, it faces challenges from NSW. And while Tasmania leads on two indicators, it ranks eighth on relative population growth—pointing to slower economic activity ahead.
• NSW is the most consistent economy, leading on relative unemployment, and second or third on four indicators.
• Looking ahead, trends in population, the job market and housing should be closely monitored. As noted in the last survey, the potential for stimulus in the Chinese economy will be important for resources and tourism-focussed states.
• But clearly, the success achieved in lowering the rate of inflation will determine the path of interest rates and economic activity across all states and territories.

Methodology

• Each of the states and territory economies were assessed on eight key indicators: economic growth; retail spending; equipment investment; unemployment, construction work done; population growth; housing finance and dwelling commencements.
• The aim is to find how each economy is performing compared with ‘normal’. And just like the Reserve Bank does with interest rates, we used decade-averages to judge the ‘normal’ state of affairs. For each economy, the latest level of the indicator – such as retail spending or economic growth – was compared with the decade average.
• While we also looked at the current pace of growth to assess economic momentum, it may yield perverse results to judge performance. For instance retail spending may be up sharply on a year ago but from depressed levels. Overall spending may still be well below ‘normal’. And clearly some states such as Queensland and Western Australia traditionally have had faster economic growth rates due to historically faster population growth. So the best way to assess economic performance is to look at each indicator in relation to what would be considered ‘normal’ for that state or territory.
• For instance, the trend jobless rates in the ACT and NSW both stood at 3.1 per cent in June. However, the NSW unemployment rate was 37.8 per cent below its decade average, while the ACT jobless rate was 19.6 per cent below its decade average. So NSW ranks above the ACT on this indicator.
• Except for economic growth, seasonally adjusted or trend measures of the economic indicators were used to assess performance on all measures. While preference was for trend measures, in many cases these have been suspended in the wake of the COVID-19 crisis. Rolling annual nominal data was used to assess economic growth.

Read the report.

The post CommSec State of the States: July 2023 appeared first on AdviserVoice.

A volatile run of employment numbers continued in December

There was a lot of noise in the December labour force numbers released today. In seasonally adjusted terms employment fell by 14.6k from a revised gain of 58.3k in November (originally reported as +64.0k). Consensus and CBA were expecting +25k.

As the facing chart shows the change in employment in seasonally adjusted terms was volatile throughout 2022 as the economy reopened from the covid lockdowns of 2021. Looking at the trend numbers provides a clearer picture. Employment growth slowed over the second half of 2022 from very high levels earlier in 2022. Trend employment growth was +26.5k in December, around the same level of employment required each month to keep the unemployment rate steady.

Full time employment rose by 17.6k in the month while part time employment fell by 32.2k. This continues the trend over the past three years where full time employment growth has outpaced part time growth.

The unemployment rate held steady at 3.5% (was revised up from 3.4% in November). The unemployment rate has averaged 3.5% since May 2022 and suggests the labour market is neither tightening nor loosening. An increase in the supply of labour has occurred to meet rising demand over the course of the last year.

This balance though is expected to shift over 2023. The rapid return of net overseas migration as noted here, when combined with a slower economy and reduced demand of labour should push the unemployment rate higher. Job vacancies are falling, albeit remain at an elevated level.  We expect the unemployment rate to lift to grind higher to ~ 4¼% by end 2023 as the economy grows below trend.

The participation rate fell from a record high of 66.8% to 66.6% in December. The underemployment rate rose to 6.1% in the month, from 5.8% in November. Hours worked fell by 0.5% in December and the annual pace of hours worked continued to slow, down to 3.2%/yr.

The number of people working reduced hours due to illness rose in December as another wave of covid occurred.  There was a 50% higher number of people working lower hours than in a normal December this month.

By state employment losses were largely contained to NSW (‑13.8k) and Victoria (‑13.2k). There were smaller losses in QLD (‑4.2k) and Tasmania (‑1.9k). NSW continues to have the lowest unemployment rate of all the states at 3.1% (ACT lower at 2.8%). QLD has the highest at 3.8%. There were small employment gains in SA (+2.9k) and WA (+4.0%).

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Inflation, inflation, inflation… it all comes back to inflation.

Special issue

For the past 21 years we have produced “The Big Issues” – a report highlighting the issues to watch over the coming year.

Each year we have identified around 8-10 issues that we thought would dominate economic or financial market attention. And last year was no exception with eight indicators discussed and dissected.

But this year is different…

This year we thought about all the possible issues, but they all seemed to come back to just one – Inflation.

For instance, we could pose the following questions and they all lead back to inflation:

• Where are interest rates going?  It depends on inflation?
• Will job markets remain tight? The worry is that wages will rise, leading to higher prices.
• Will supply-chain issues be resolved? The worry is that inflation stays higher for longer.

As always we encourage you to assess the following discussion on your own terms, regularly posing the question “So what”? That way you constantly assess what it all means for you and your business.

So to the first key point…

It’s global

One of the key factors driving inflation rates higher over the past year is Covid-19. More specifically, the fact more and more people caught Covid, causing them to stay home, and therefore prevented businesses from producing the things we want – cars, phones, computers – you name it.

Production was – and still is – being disrupted, but demand (spending) has remained healthy.

In other words, we were hit by a good old fashioned imbalance between supply and demand. Too much demand and not enough supply has pushed up prices for the goods.

In part, this came about because central banks and governments were perhaps too successful at keeping people in jobs and in keeping businesses in business. Interestingly, the unprecedented success that the world’s bio-medical researchers had in producing a vaccine for Covid actually contributed to the supply-chain problems.

And because people kept their jobs and they couldn’t travel, they bought more goods – especially at on-line retailers and other businesses. But the factories, trains, ships, planes and delivery vans have struggled to get the products to where they were supposed to go.

The good news is that supply (production) is catching up with the demand for goods. And demand (spending) is slowing, being checked by higher interest rates (and the higher prices of the goods themselves).

But if we are going to get on top of surging inflation rates, we need to see continued progress over the coming year. Otherwise, central bankers will have to be even more aggressive in lifting interest rates.

The Ukraine war didn’t help…

The inflation problem wasn’t helped by Russia’s invasion of Ukraine in February. Prices for a raft of commodities rose sharply and held at the higher prices for a number of months.

Prices lifted for commodities such as oil, gas, wheat and oilseeds. In fact crude oil posted a gain of 40 percent in the space of seven days.

While bad news for the world’s motorists, as always the double-whammy arrived in the form of higher transport and distribution costs.

The OPEC+ oil cartel could have responded to the initial surge in crude oil prices by lifting production quotas. On March 2, OPEC+ concluded that “current oil market fundamentals and the consensus on its outlook pointed to a well-balanced market” lifting production by just 400,000 barrels per day over April.

Oil prices averaged US$92 a barrel in February and US$108 in March and averaged US$98 in the period since.

Looking ahead, OPEC+ has shown no inclination to pump more oil onto global markets, a move that could stem inflation pressures and reduce the risk of recessions in developed economies.

Investors should keep a close watch on OPEC+ decisions on production quotas and the response to events such as recessions in major economies. Clearly OPEC+ has a key role in alleviating inflation problems and providing the groundwork for central banks to lower interest rates.

The response by global central banks…

During the latter months of 2021 and early months of 2022, the view from a number of central banks was that the spike in inflation would prove temporary.

The US Federal Reserve didn’t start lifting rates until March. But after starting slowly, the Fed has been aggressively lifting rates in the period since.

A similar story in Australia with the Reserve Bank not starting to lift interest rates until May 2022. But the 2.75 percentage points lift in cash rates in six months ranks alongside 1994 as the most aggressive rate hiking cycle on record.

Why the rush? Central banks are worried that the size and speed of the lift in global inflation rates must be met with the same aggression by central banks in quickly moving to tighter policy settings.

The issue now for central banks is judging when the rate hikes should stop. Unless central banks get on top of the inflation problem quickly then the high rates of inflation may become locked in.

But if they lift rates too high, too quickly – and leave rates too high for too long – then economies could face recessions.

The US Federal Reserve got a positive surprise on November 10 when the October consumer price index results printed well below forecasts.

But clearly, 2023 is going to be a long year mixed with successes and setbacks. Central Banks will have to be vigilant with their actions and verbal commitment to push inflation down to levels closer to 2-3 per cent.

What is the ‘normal’ or neutral rate?

Central banks generally say that they don’t know for certain where the ‘normal’ or neutral policy rate sits. That is, the level of interest rates that neither speeds up nor slows down the economy.

The Reserve Bank is apparently working on a ‘neutral’ cash rate near 2.5 per cent. At the current cash rate of 2.85 per cent, the RBA believes that rates are close to where they need to be to appropriately slow the economy to a sustainable growth path as opposed to ‘crunching’ the economy.

Commonwealth Bank Group economists believe the ‘normal’ rate is closer to 1.5 per cent. The level of debt taken on by home borrowers as well as significant upcoming fixed rate home loan maturities, should lead to a sharp slowdown of consumer spending in 2023.

The US Federal Reserve has lifted the federal funds rate to 4 per cent and shows few signs that the ‘pause’ level for rates is close by.

At some point central banks need to refrain for lifting rates to judge its impact on the economy. Finding that ‘sweet spot’ for cash rates will be the key to getting on top of inflation and not sending economies into recession.

Inflation expectations: The key battleground

Many in the community must be asking “What’s the rush?” Why are rates being lifted so quickly and so aggressively? It gets down to the fact that our economy recovered so quickly from the pandemic-driven slowly. And it has been a somewhat similar story in other countries, although arguably our improvement has been stronger and faster.

Effectively, central banks and governments were successful in keeping economies moving. And the development of a vaccine in super-quick time was also a key factor in the recovery, and then the emergence, of supply-chain difficulties.

So central banks had to quickly get interest rates back to normal. But that is only part of the story. If central banks dragged their heels, then there was a greater chance of inflation getting locked in at higher levels.

If businesses and landlords see that inflation is 7 per cent and then lift prices and rents accordingly then there is a greater risk that inflation gets locked in near 7 per cent.

Central banks must not just lift rates to slow down the economy, but they must constantly warn that they will do what it takes to get inflation back to desired levels. In Australia, that is 2-3 per cent. In the US, it is 2 per cent.

In 2023, all eyes will be on inflation readings, but also they will be very much focussed on surveys or financial market indicators of inflation expectations. If inflation rates and expectations of inflation stay stubbornly high, the central banks will lift rates even higher, raising the risk of recessions occurring.

And then there is the tight job market…

Before the pandemic – back in December 2019 – the jobless rate sat an 8-year low of 5 per cent. In the pandemic, the jobless rate quickly rose, hitting a 22-year high of 7.5 per cent in July 2020. But then the massive stimulus kicked in, especially JobKeeper. And the vaccine enabled economies like Australia to re-open.

By June 2021 the jobless rate had returned to 5 per cent. And it didn’t stop there, quickly falling to 4 per cent in the next eight months and then hitting 48-year lows of 3.4 per cent in July and October 2022.

The tight job market is a reflection of the cyclical strength of the economy, absence of migration and people leaving jobs voluntarily (such as the “great retirement”). However there is also a key broader structural issue – the ageing of the population.

In the US, UK and Australia, unemployment is near the lowest levels since 1974. The ‘baby boomers’ cohort continues to leave the job market, with another 5-7 years before the process peaks. The problem is that other generations such as GenX, GenY and Millennials are not filling the void left by the ‘baby boomers’.

The generational transition provides a complication for governments and central banks. But Australia is looking to alleviate the shortfall of workers by upping the 2022/23 migration program to 195,000 visa places. The question is – in the ‘living with Covid’ world – will the workers come?

The good news element of the structurally-tight job market is that aggressive rate hikes may not lead to soaring unemployment rates. Economies may slow, not slump, but still cause inflation rates to ease.

And higher wages…

Central banks are rightly concerned that high rates of inflation can become ‘locked in’ via a change in inflationary expectations. That is, the higher the rate of inflation, and the longer that it remains above the inflation goal, the greater chance that it will become accepted.

One of the other great fears associated with high rates of inflation is a ‘wage-price’ spiral. For instance a supply shock like the supply-chain issue that pushes annual inflation to 7 per cent. Unions and other employee groups then press for a wage increase above 7 per cent on the fear that their standard of living could be de-graded.

The 7 per cent wage growth then fuels ‘demand-driven’ inflation by forcing up prices even further on goods in short-supply. As a consequence, the inflation rate may rise to 8 per cent or higher, sparking fresh wage claims.

So far, Australia has not experienced significant, economy-wide agitation for higher wages in response to headline inflation rates above 7 per cent. But the longer that inflation rates stay high, the greater the fear by employees that they are falling behind, or they would be likely to fall behind in the near future.

Couldn’t happen in Australia? In March quarter 1975 the annual inflation rate stood at 17.6 per cent. In the previous quarter the average wage (male wage at that time) hit a stunning annual growth rate of 28.3 per cent before easing to 26.9 per cent in the March quarter.

It took the recession of 1990/91 to bring the inflation rate down to around 2 per cent. In fact in September quarter 1992, annual inflation stood at 0.8 per cent with wage growth at 3.1 per cent.

Will this indeed be one of the frequently-discussed issues of 2023? It really depends how quickly inflation rates respond to rate hikes and ‘jawboning’ (open mouth operations) to quickly bring down the inflation rate to ‘normal’ levels.

And finally…complications

In theory, central banks should be successful in reducing inflation rates to target levels. In Australia, that is the goal of reducing annual inflation to a 2-3 per cent range. That is a flexible range. The goal is a medium-term goal – to be achieved on average over time. Inflation can undershoot and overshoot the range but should be broadly in the range on average over time.

The US Federal Reserve wants to get inflation back to near 2 per cent. And other central banks have broadly similar goals with a few tweaks thrown in.

But what if a new issue came around that complicated the goal of getting inflation effectively ‘back to normal’. As with most things, businesses, governments, central banks and investors must have contingency plans.

What happens if Covid re-appears – indeed the discussion at present is that a fourth wave of the virus is taking hold. In the ‘living with Covid’ world, that means treating it like a cold. If you can go to work, then good. If not, you take a few days off.

But if new strains become deadly, that complicates the situation. Do you bring back restrictions on movement, work, sport, hospitals and crowded areas more generally? How does monetary policy respond? Inflation is high – do you stimulate or constrain growth of economies?

This introduces the element of stagflation – slow economic growth and relatively high inflation – last seen in the 1970s. Can you have both economic growth and low inflation in a world where supply is again restrained but where the starting point is generationally-high inflation and still relatively low interest rates?

It is a scenario that no one wants to see played out.

Rewind: The Big Issues for 2022

As we noted at the start of this report, we have been producing the Big Issues report annually for the past 21 years.

It is interesting – and perhaps even instructive – to rewind over the past year and assess what we had on the radar in December 2021.

Looking ahead into 2022, we highlighted eight issues. And the first issue was “Living with COVID-19”.

And while that was a key focal point in 2022, if we had our time over we would selected “Inflation” as issue number one. Inflation was issue number seven on last year’s list, but clearly it became a global concern very quickly. The implications have spread across the globe. Supply-chain issues became dinner party conversation and a new war between Russia and Ukraine sent commodity prices soaring.

Issue number two for 2022 was “Winding back stimulus” and indeed that quickly became a key consideration as inflation took over, and it became clear that the price hikes were unlikely to prove transitory.

Issue number three was “Regional Renaissance” and it attracted plenty of discussion, especially in the context of “Living with Covid” as people decided the new lifestyle that would work for them.

“China” has never been too far away from the top of our Big Issues reports. And in 2022 there was much discussion about the ‘zero Covid’ policy adopted by China that has led to sharply slower economic growth. Again, the implications of its policy has been widespread, with knock-on effects across companies and continents.

Numbers five and six on last year’s Big Issues list were “Climate Change” and “Jobless Rate: How low can it go?” Climate Change will always be a focal point while there are problems to be solved – so that issue is ongoing – especially with Australia’s east coast hit by persistent flooding.

But in terms of the jobless rate, it fell from 4.2 per cent to a 48-year low of 3.4 per cent in July and then again in October. So, quickly the discussion has progressed to whether “full employment” has been achieved. And as we’ve discussed in this year’s report, the discussion is on-going.

As mentioned, issue number seven for 2022 was “Inflation: Just transitory?” The question did the rounds in the early couple of months of the year. But it was then replaced by questions about how high could inflation lift and how quickly interest rates needed to rise to get it under control.

Finally “Migration” was heard more and more as the jobless rate fell and supply-chain issues abounded. On September 2, 2022 the new government did announce that the planning level for the 2022/23 permanent Migration Program would increase to 195,000 places.

“Migration” was even included in the economic forecasts for the October 2022 budget with the government forecasting net overseas migration of 235,000 for both this 2022/23 year and the following year.

Last year we also highlighted a raft of topics we called “Talking Points”. Indeed the issues popped up over 2022, although for some, just for brief periods of time.

The purpose of Big Issues is to highlight topics or themes that could have implications for businesses, budgets and investments. Still, there will always the ‘X-factors’, highlighting the need to be alert as well as agile.

The post The Big Issues of 2023 appeared first on AdviserVoice.

• The US Nymex oil price fell by 10 per cent last week. The S&P/ASX 200 Energy sector fell 1.3 per cent.
• According to the Australian Institute of Petroleum, last week the average Australian pump price for unleaded petrol fell by 5.2 cents a litre to 193.7 cents a litre (wholesale price 178.8c/l), down from 17-week highs.
• The retail discounting cycle began two weeks ago in Sydney, Melbourne & Brisbane and prices have fallen by between 13-22 cents a litre. Adelaide recorded the cheapest petrol price on average over the past three months, 10c below that of Melbourne.

The Big Picture

• Two key developments last week. US Federal Reserve presidents have turned “hawkish” (favouring higher interest rates to combat inflation). While this may just be jawboning or “open mouth operations” (OMO) to drive down inflation expectations, there is still scope for further significant rate hikes in the months ahead. Higher interest rates are likely to lead to less spending and slower economic activity, crimping demand for energy and transport commodities such as oil.
• The second factor last week was news of an increase of Chinese Covid-19 cases, raising worries about future fuel demand. In fact, current demand is falling faster than OPEC+ production cuts. But the move will be short-lived if OPEC+ decides on larger supply cuts when it meets on December 5.
• Over the week oil prices fell sharply – good news for inflation, the cost of living and consumer spending, but bad news for energy producers. Last week energy sector shares fell by 1.3 per cent while the ASX 200 and All Ordinaries indexes were broadly flat.

The Equity Lens: What does it mean for investors?

• The energy sector has out-performed massively over 2022 but a re-assessment by investors may be underway. A global recession or further weakness of the Chinese economy would serve to reduce demand for energy commodities like oil and gas. The fly in the ointment is what OPEC producers decide to do on production quotas.

What do you need to know?

Weekly oil market update

• Global oil prices fell by around 2 per cent on Friday. Investors are worried about the potential for further aggressive US rate hikes. And investors are concerned about the likelihood of weaker Chinese oil demand with Covid cases still rising.
• The Brent crude oil price fell by US$2.16 or 2.4 per cent to US$87.62 a barrel. And the US Nymex crude oil price fell by US$1.56 or 1.9 per cent to US$80.08 a barrel. Over the week Brent fell by US$8.37 or 8.7 per cent. And Nymex fell by US$8.88 or 10 per cent.
• The Singapore benchmark gasoline price fell by US$2.82 a barrel or 2.8 per cent last week to US$98.58 a barrel. In Australian dollar terms, Singapore gasoline fell by US$6.10 or 4 per cent to a 7-week low of $147.05 a barrel.
• According to the Australian Institute of Petroleum (AIP), the national average unleaded petrol price fell by 5.2 cents a litre last week to 193.7 cents a litre (c/l).
• Metropolitan pump prices fell by 7.6 cents to 193.6c/l and regional prices fell by 0.4 cents to 193.7c/l in the past week.
• The national average wholesale (Terminal Gate Price or TGP) petrol price rose by 0.2 cents last week to 178.8c/l. Today, the TGP is near 175.2c/l, down 5.9 cents on a week ago.
• MotorMouth records the following average retail prices for unleaded fuel today: Sydney 192.8c/l; Melbourne 189.7c/l; Brisbane 190.9c/l; Adelaide 171.8c/l; Perth 179.9c/l; Hobart 194.5c/l; Darwin 189.3c/l and Canberra 188.5c/l.

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Reserve Bank Board meeting

• The Reserve Bank (RBA) Board has lifted the cash rate by 25 basis points (quarter of a percent), taking the cash rate to a 9½-year high of 2.85 per cent

The Big Picture

• The Reserve Bank Governor has indicated that the normal or neutral range for the cash rate is 2.5-3.5 per cent. The question now is where do we go from here? At some point the Reserve Bank needs to pause and assess the impact of the near decade-high cash rate on the broader economy – and inflation in particular. The aim is to push inflation back to the 2-3 per cent target band while keeping the economy ticking along and holding on to the hard-won gains of the lower unemployment rate. Over the last few days, there have been encouraging signs of a slowing of price pressures – from the monthly Melbourne Institute inflation gauge and the S&P Global manufacturing index. And the NAB’s September business survey also showed an easing in price pressures.
• The Reserve Bank has indicated a preference for ‘normal’ 25 basis point (bp) rate hikes. Not only can rates be lifted modestly, finessing the slowdown of the economy. But the announcement effect of rate hikes – or the threat of rate hikes – adds power to the rate move. Larger 50bp hikes from here are riskier – a sledge hammer rather than hammer – and likely to mean that the interest rate objective is achieved too quickly, resulting in a move to the sidelines for a number of months. As a result, the added power of announcement effects is lost.
• Also, in recent communications, RBA speakers have expressed some concerns about the deteriorating global economic outlook and reservations about the yet unknown impact of restrictive policy on consumer spending. In fact, there is typically a 3-month lag between when the official cash rate is hiked and when household mortgage repayments materially increase. The full effect of this transmission to household budgets won’t be known for a few more months. Also, the RBA meets 11 times per year, unlike other central banks, affording it more time to incrementally lift rates by smaller amounts.
• Commonwealth Bank (CBA) Group economists expect the Reserve Bank to lift the cash rate another 25 basis points at the December Board meeting to 3.10 per cent. This gives the RBA time over the Christmas/New Year period to assess the impact of Australia’s most aggressive rate hiking cycle.

Perspectives on interest rates

• The RBA lifted the cash rate by 25 basis points (bp) or a quarter of a per cent to 2.85 per cent – a 9½-year high. This follows a 25bp increase in October, 50bp rate increases in June, July, August and September and a 25bp increase on May 3, 2022. The RBA last cut the cash rate from 0.25 per cent to 0.10 per cent on November 3, 2020. Before the Covid-19 health and economic crisis, the official cash rate was 0.75 per cent on February 5, 2020.

The Equity Lens: What does it mean for borrowers, depositors and investors?

• Consumer spending is slowing and will slow further once a key cohort of fixed rate borrowers move their loans to those with markedly higher interest rates. Investors need to reflect on sales and earnings announcements from retailers and other consumer-focussed businesses – they could prove even more illuminating than the constant stream of economic indicators.
• The Reserve Bank Governor has identified consumer spending as the indicator to be closely watched over coming months. The hard part is to gauge price and quantity components when there is discussion if consumer spending.
• The sharemarket has already priced in a slower expansion path for Australian and global economies. Once the upward path of inflation is halted, and central banks pause rate hikes, then investors will focus on the recovery path. This transition may be already underway. But there are always setback risks, so investors must be ready to pivot. Investors should expect an even greater focus on earnings and profit margins as economic activity slows.
• Returns on residential property are now easing whereas the slowdown in annual decline in returns on shares is nearing a trough. Annual returns on residential property is 1.8 per cent while the annual decline on sharemarket returns is 3.5 per cent. So investors have choices to be made.

The Statement

• Below is the statement from today’s November 1, 2022 meeting (emphasis added by CommSec):

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Media Release No: 2022-36 Date: 1 November 2022 Statement by Philip Lowe, Governor: Monetary Policy Decision At its meeting today, the Board decided to increase the cash rate target by 25 basis points to 2.85 per cent. It also increased the interest rate on Exchange Settlement balances by 25 basis points to 2.75 per cent. As is the case in most countries, inflation in Australia is too high. Over the year to September, the CPI inflation rate was 7.3 per cent, the highest it has been in more than three decades. Global factors explain much of this high inflation, but strong domestic demand relative to the ability of the economy to meet that demand is also playing a role. Returning inflation to target requires a more sustainable balance between demand and supply. A further increase in inflation is expected over the months ahead, with inflation now forecast to peak at around 8 per cent later this year. Inflation is then expected to decline next year due to the ongoing resolution of global supply-side problems, recent declines in some commodity prices and slower growth in demand. Medium-term inflation expectations remain well anchored, and it is important that this remains the case. The Bank’s central forecast is for CPI inflation to be around 4¾ per cent over 2023 and a little above 3 per cent over 2024. The Australian economy is continuing to grow solidly and national income is being boosted by a record level of the terms of trade. Economic growth is expected to moderate over the year ahead as the global economy slows, the bounce-back in spending on services runs its course, and growth in household consumption slows due to tighter financial conditions. The Bank’s central forecast for GDP growth has been revised down a little, with growth of around 3 per cent expected this year and 1½ per cent in 2023 and 2024. The labour market remains very tight, with many firms having difficulty hiring workers. The unemployment rate was steady at 3.5 per cent in September, around the lowest rate in almost 50 years. Job vacancies and job ads are both at very high levels, although employment growth has slowed over recent months as spare capacity in the labour market has been absorbed. The central forecast is for the unemployment rate to remain around its current level over the months ahead, but to increase gradually to a little above 4 per cent in 2024 as economic growth slows. Wages growth is continuing to pick up from the low rates of recent years, although it remains lower than in many other advanced economies. A further pick-up is expected due to the tight labour market and higher inflation. Given the importance of avoiding a prices-wages spiral, the Board will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms in the period ahead. Price stability is a prerequisite for a strong economy and a sustained period of full employment. Given this, the Board’s priority is to return inflation to the 2–3 per cent range over time. It is seeking to do this while keeping the economy on an even keel. The path to achieving this balance remains a narrow one and it is clouded in uncertainty. One source of uncertainty is the outlook for the global economy, which has deteriorated over recent months. Another is how household spending in Australia responds to the tighter financial conditions. The Board recognises that monetary policy operates with a lag and that the full effect of the increase in interest rates is yet to be felt in mortgage payments. Higher interest rates and higher inflation are putting pressure on the budgets of many households. Consumer confidence has also fallen and housing prices have been declining following the earlier large increases. Working in the other direction, people are finding jobs, gaining more hours of work and receiving higher wages. Many households have also built up large financial buffers and the saving rate remains higher than it was before the pandemic. The Board has increased interest rates materially since May. This has been necessary to establish a more sustainable balance of demand and supply in the Australian economy to help return inflation to target. The Board expects to increase interest rates further over the period ahead. It is closely monitoring the global economy, household spending and wage and price-setting behaviour. The size and timing of future interest rate increases will continue to be determined by the incoming data and the Board’s assessment of the outlook for inflation and the labour market. The Board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that.

 

 

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Implications for borrowers

• The following table shows current monthly repayments on a range of mortgages and projections if rates are increased by major lenders in response to the higher cash rate. The Banks Standard Variable owner-occupier rate is currently 7.02 per cent. And the Banks Discounted Variable owner-occupier rate is currently 5.95 per cent

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• Bonds are defined as fixed income investments issued by corporations or governments to raise funds to finance projects and operations. When investors lend money to companies or governments (the bond issuer), they typically receive regular interest or coupon payments with the ‘face value’ paid at the bond’s maturity, but the investment is subject to interest rate, default and credit risk.
• It has been a difficult year for bond market investors encountering the worst downturn since at least the 1970s, as global central bank policymakers lift interest rates aggressively to combat the highest inflation rates in four decades. Heightened geo-political risks and global economic growth concerns have also influenced bond prices.
• With bond prices falling and yields increasing, the Bloomberg Global Aggregate Bond index (unhedged) has declined 23.8 per cent from its record high in early 2021 in US dollar terms. For Aussie investors, the Bloomberg AusBond Composite 0+ Year index has dipped 9.1 per cent in Aussie dollar terms since the beginning of 2022 through to October 28, 2022. And 10-year government bond yields are hovering around 4 per cent in both the US (4.01 per cent as at October 28, 2022) and Australia (3.77 per cent as at October 28, 2022).
• With global central banks aggressively ‘front-loading’ interest rate hikes, most investors expect the current monetary policy tightening cycle to conclude sometime in 2023 as price pressures ease. With the increasing potential for recessions increasing, investors may turn their attention back to ‘safe haven’ bonds, with prices expected to stabilise and recover. Also, bond valuations have cheapened, while potentially offering higher income to investors.
• Investors considering an allocation to bonds can access the asset class through a broad range of Exchange Traded Funds (ETFs) listed on the Australian Securities Exchange (ASX). The portfolio of bonds typically consists of investment grade corporate and government bonds, offering yields above the official cash rate, and are often negatively correlated with shares and other asset classes, providing diversification benefits to investors.

What is a bond?

• Aussie bond or fixed income markets typically garner less media and investor attention in Australia than their better-known sharemarket counterparts.
• So what is a bond? Well bonds are defined as fixed income investments issued by corporations or governments to raise funds to finance projects and operations.
• When investors lend money to companies or governments, (who issue the bonds), they typically receive regular interest or coupon payments with the face value paid at the bond’s maturity. The bond is issued with a face value and length or term of maturity with a promise to repay the issue price at a specific time. Interest or coupons are usually paid quarterly or every six months at either a fixed or floating rate or return.
• Fixed-rate bonds will typically receive the same income payment for the life of the bond. Floating Rate Notes (FRNs) pay a fixed margin above a reference rate, for example the Bank Bill Swap rate (BBSW), irrespective of where the reference rate is set.
• Importantly, a bond’s market price prior to the maturity date can vary from its face value. But the bond’s price will be affected by factors including changes in interest rates, the credit or default risk of the issuer, the level of liquidity, and the time to the bond’s maturity.
• Bond prices and yields move inversely and in opposite directions. The yield is defined as a bond’s internal rate of return (IRR), expressed in percentage terms, accounting for both the income, or coupon paid with the difference between the current market price and face value of the bond to be paid at maturity.
• Another useful measure to value bonds is the Yield to Maturity (YTM). The YTM calculates the average annual return of a bond from when you buy it at market value until maturity, assuming that you reinvest coupon payments in the bond at the same interest rate the bond is earning.

How can investors gain access to bonds?

• The primary issuers of bonds in Australia are governments and companies. Investors can gain access to unlisted bonds through several channels, including
• Australian Government Bonds (AGBs) represent sovereign debt issued by the Federal Government. The bonds typically guarantee a rate of return if held until maturity, and can be bought on the Australian Securities Exchange (ASX) at market value with a brokerage fee incurred.
• The Federal Government also issues inflation-linked or indexed bonds with coupon payments and the face value of the bonds increasing in-line with changes in the Consumer Price index (CPI).
• Semi-Government bonds (semis) are semi-sovereign debt issued by Australian states and territories, bought and sold through treasury corporations.
• Corporate bonds are primarily issued and traded on the over-the-counter (OTC) market. The minimum amount required to trade is typically up to $500,000. As with government bonds, investors will recoup the face value of the corporate bond at maturity unless the issuer defaults. But investors should consider the credit risk of corporate bonds before they buy, while consulting  the issuer’s prospectus and product disclosure statement (PDS).
• Investors can also gain access to ASX-listed Exchange Traded Bonds (XTBs) and Exchange Traded Funds (ETFs).
• XTBs are securities backed by an underlying or specific bond issued by one listed company. The coupon and principal payments from the bond usually flow through to the XTB investor. XTBs are usually tradeable in the same way as shares and offer a known maturity date, coupon amount and payment schedule.
• ETFs provide investors with exposure to a professionally-managed portfolio of sovereign or investment grade bonds and aim to track the performance of a particular bond or index. An ETF is an investment fund that is bought and sold on the stock exchange. Investors can buy or sell units of an ETF using an online broker or through a financial adviser.
• While most ETFs are passively managed with an aim to replicate the performance of an index, ETFs are playing an increasingly expansive role in portfolio construction. In fact, global asset manager State Street Global Advisors recently conducted a survey – “Preparing for the Big Shift” – where it was found that 50 per cent of investors were making significant use of ETFs to construct their core fixed income portfolio allocations, such as government bonds and investment grade credit or corporate bonds.
• And as volatility increases, in 2021 net inflows into actively-managed bond ETFs were the largest on record in the United States, according to Emerging Portfolio Fund Research (EPFR).

Why invest in bonds?

• Bonds can play several key roles in an investment portfolio, providing diversification, stability and income, while potentially acting as a deflation hedge.
  • Steady income stream: Bonds can provide a steady stream of income to investors, with coupon payments made on a quarterly, half-yearly or annual basis. Bonds also have fixed maturity dates when the principal amount or face value is repaid, enabling investors to either spend or reinvest with some certainty.
  • Capital preservation: Bonds can provide capital stability, enabling an investor to preserve capital with the face value returned to the investor at maturity, provided the issuer is creditworthy and doesn’t default.
  • Diversification: Bonds are generally less volatile and uncorrelated with riskier asset classes, reducing overall investor portfolio risk, while providing defensive qualities during sharemarket declines.
  • Deflation hedge: As the rate of inflation falls, bond yields also fall and bond prices rise making them an effective deflation hedge.
• At the same time, investors should also be aware of several key risks when investing in bonds, such as liquidity, interest rate, duration, market, inflation and credit risks.
  • Liquidity risk: The liquidity of some bond or fixed income securities may be lower than other ASX-listed securities, such as shares.
  • Interest rate risk: For fixed income securities that pay a fixed return, there is a possibility that the rate of interest received may not be in line with the market rate at the time. Changes in interest rates and the accrual of interest since the last coupon payment may also impact the price of the fixed income investment. In an environment where interest rates are rising, the bond would lose value in the secondary bond market if sold or mark-to-market on a daily basis like share prices.
  • Duration risk: Similarly, duration risk is the risk that changes in interest rates will either increase or decrease the market value of a fixed income investment. Because payments are typically fixed, if the interest rate changes, then the market value of the investment will change.
  • Credit and default risk: Credit risk is the risk that the bond issuer may not be able to repay the promised return or the principal amount at the maturity date. This is partially reflected by the different rates of interest paid. Should a company declare bankruptcy, bondholders may have a higher claim on company assets than do common shareholders. Importantly, bonds with credit ratings below BBB are of lower quality and considered below investment grade or ‘junk’ bonds.
  • Market risk: If the bondholder sells the bond prior to its maturity through a broker or financial institution in the secondary market, the investor will receive the current market price at the time of the sale. But the selling price could result in a gain or loss on the bond investment depending on the underlying corporation, the coupon interest rate, and the current market interest rate.
  • Inflation risk: Rising rates of inflation typically reduce fixed income investment returns. For example, if fixed-rate debt security pays a 4 per cent return and the inflation rates is 6 per cent, the investor receives a -2 per cent total return in real terms.

Aussie bond allocation – a global outlier

• Australians have a relatively low average allocation to bonds when compared to other OECD countries. In fact, the latest OECD data to 2020, shows that the average bond allocation across all OECD countries is 44.8 per cent, yet Australia’s allocation is just 14.7 per cent.
• Among OECD countries, Australians are actually third from bottom of the pile, above only Poland and Sweden in terms of portfolio allocation to bonds. Every single other OECD country has a more balanced allocation between shares and bonds.
• And data from the Australian Bureau of Statistics (ABS) shows that bonds account for just 3.5 per cent of total consolidated funds under management (FUM) as at June 30, 2022.
• But a new report from BetaShares shows investor demand for fixed income ETFs is increasing, with the ETFs receiving the largest share of industry flows in September 2022 at $322,357,620. The Australian bond ETFs received $285,286,661 of these flows. This easily surpassed Australian equities ETF inflows of $114,216,091 last month. In fact, BetaShares reported that floating-rate Australian bond exposures saw the strongest level of interest in September with ETF investors increasingly cautious about equities as bond yields continue to rise.

Are bonds back in vogue?

• Over the past four decades, developed market government bond yields have fallen sharply. Lower yields have broadly led to much lower levels of bond allocations in investment portfolios, despite strong returns. From 1990 to its peak in January 2021, the Bloomberg Global Aggregate Bond index (unhedged) had delivered an aggregate total return of almost 470 per cent.
• But then came the Covid-19 pandemic in early 2020. In a co-ordinated approach to the health and economic crisis, central banks cut benchmark policy rates to near zero. They also bought trillions of US dollars worth of bonds to anchor borrowing costs a very low levels (that is, ‘Quantitative Easing’) to support businesses and households through lockdowns and a global recession. In 2021, a massive amount of policy stimulus saw a huge rebound in global economic activity, with world gross domestic product (GDP) rebounding by a record 6 per cent, according to the International Monetary Fund (IMF).
• But in 2022 combined monetary and fiscal stimulus, strong consumer demand, supply chain snarls, soaring commodity prices and tight labour markets have all pushed up consumer prices.
• It has been a difficult year for bond market investors, encountering the worst downturn since at least the 1970s, as global central bank policymakers lift interest rates aggressively to combat the highest inflation rates in four decades.
• Heightened geo-political risks and global economic growth concerns have also influenced bond prices. And sparse liquidity and balance sheet ‘normalisation’ by central banks (that is, ‘Quantitative Tightening’) has triggered price dislocation in sovereign debt markets with credit spreads also widening.
• With the US central bank, the US Federal Reserve (‘the Fed’), increasing interest rates by 300 basis points since March 2022 and the Reserve Bank of Australia hiking its cash rate target by 250 basis points since May 2022, both Australian and US government bond yields have soared.
• In fact, the short-end of the yield curve – which is most sensitive to interest rates – has seen the fastest run-up in yields. For example, the 2-year US Treasury yield has lifted almost 400 basis points to a near 15-year high of 4.60 per cent year-to-date to October 21, 2022, before easing back to 4.40 per cent. And in Australia the 3-year AGB has surged almost 290 basis points to around 3.80 per cent over the same time period, though has since eased back to 3.30 per cent.
• Longer-dated 10-year US and Australian government bond yields have both jumped above 4 per cent, up by 270 basis points and 255 basis points, respectively over the period. The US yield is near the highest level since June 2008 with its Aussie counterpart is just below 10-year highs at 3.80 per cent. The US 2s/10s yield curve has inverted, signalling a potential recession.
• With bond prices falling and yields increasing sharply, the Bloomberg Global Aggregate Bond index (unhedged) has declined 23.8 per cent from its record high in early 2021 in US dollar terms. For Aussie investors, the Bloomberg AusBond Composite 0+ Year index has dipped 9.1 per cent since the beginning of 2022 to October 28, 2022 in Aussie dollar terms.

Outlook

• Fears of a global recession are mounting.  Global central banks are aggressively ‘front-loading’ interest rate hikes, core or underlying inflation remains elevated, tensions in the Russia-Ukraine war are intensifying, energy prices are soaring in Europe and China’s property sector remains under pressure.
• In this environment, a global economic slowdown caused by restrictive monetary policy will eventually weigh on consumer demand and business activity, leading to higher unemployment and a weakening of household spending. Housing activity is already waning with home prices declining sharply from recent peaks. With economies slowing, inflationary pressures should eventually ease, enabling central banks to conclude their monetary tightening cycles with a policy ‘pivot’ expected within the next 12 months.
• Within fixed income, there is still some room for bond yields to move higher and prices to fall in the near-term, as central banks continue to hike rates to combat elevated inflation. While negative portfolio returns are unnerving for investors in the short-term it is important to focus on a longer-term investment horizon of three years or more.
• The manager of the fixed income portfolio – which is actively managed – is unlikely to sell the bonds before maturity. And if the bonds don’t default the investor will get their par value principal back. As the current bond market correction continues in the short-term, now is probably not the time to crystallise mark-to-market paper losses.
• In fact, investors should consider the higher yields now on offer in the fixed income asset class, but duration positioning (that is, positioning for interest rate sensitivity) remains critical to preserving capital. Bond prices are expected to eventually stabilise and recover after a period of heightened volatility caused by central bank bond buying programs and rapid moves in interest rates. In fact, Commonwealth Bank (CBA) Group economists expect the Aussie 3-year government bond yield to ease to 3 per cent by June 2023 with the 10-year falling back to 3.5 per cent.
• In our view, developed market government bonds are approaching an ‘equilibrium level’ – near long-term fair value – after several years of being expensive. The sell-off in bonds has cheapened valuations, making fixed income more attractive both in absolute and relative terms, while potentially offering higher income to investors.
• From an Australian perspective, the expected relative outperformance of the domestic economy over the next 12-24 months combined with a shallower rate hiking cycle relative to overseas could mean that the Aussie bond market is considered  a ‘safe haven’ relative to its global peers. While Australia isn’t completely immune from a global recession, outside of the early part of the pandemic it hasn’t recorded two consecutive quarters of economic contraction – the technical definition of recession – for 31 years. If policymakers are able to engineer a ‘soft landing’ for the economy, Aussie corporate bonds could perform quite well.
• As always, investors should consult their financial adviser, who can assess their personal financial circumstances and appetite for risk, before making an investment in the fixed income asset class.

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• How are Australia’s states and territories performing?
• Each quarter CommSec attempts to find out. Now in its 13th year, the report also includes a section comparing annual growth rates for the eight key indicators across the states and territories as well as Australia as a whole, enabling comparisons in terms of economic momentum.
• The challenge for federal, state and territory governments over the next year is to support economies at a time when the Reserve Bank is aggressively lifting interest rates to get inflation under control.
• After slipping to third in the previous survey, Tasmania is again Australia’s best performing economy.
• Tasmania was consistently ranked at high levels across all indicators. Tasmania ranks second on both equipment spending and housing finance.
• Across all the indicators, Tasmania is ahead of Queensland, the ACT and Western Australia. Then there a gap to South Australia and Victoria. There is another gap to NSW and the Northern Territory.
• Queensland is now in second position—its highest ranking in the 13-year history of the surveys—lifting from fourth spot to second position. The previous best ranking was equal third in January 2014.
• The ACT has eased from second spot to third.
• Western Australia is in fourth spot, from South Australia and Victoria. Then follows NSW and the Northern Territory.
•  In terms of the leading positions on the economic indicators, Queensland leads the rankings on relative population growth and relative unemployment.
• The ACT leads on housing finance, equipment investment and dwelling starts.
• Western Australia leads on relative economic growth.
• South Australia leads on construction work done.
• Victoria is top ranked on retail spending.
• When looking across annual growth rates of the eight economic indicators, Queensland had annual growth rates that exceeded the national average on five of the eight indicators.

Analysis

• For some time we have noted that there is little to separate the best performing states and territory economies. But the rankings were more defined in the current survey. Tasmania is back on top of the overall economic rankings with consistently high rankings across the eight indicators.
• In the latest report, Tasmania bounced from third to first. While previous No.1, Victoria, fell from first to sixth.
• Queensland lifted from fourth to second. The ACT fell from second spot to third. Western Australia improved from fifth to fourth. South Australia lifted from sixth position to fifth from Victoria, NSW and the Northern Territory.
• Any of the top four economies could top the leader-board in the next survey. But momentum still lies with Queensland as per the previous two surveys. When looking at annual growth, Queensland had annual growth rates that exceeded the national average on five of the eight indicators.
• Further, Queensland and the Northern Territory recorded the fastest annual growth rates on two indicators.
• But also of note is the ACT, leading the overall performance rankings on three indicators.
• In terms of future economic performance, much will depend on how economies support their consumers and businesses at a time of rising inflation rates and higher interest rates.

Methodology

• Each of the states and territory economies were assessed on eight key indicators: economic growth; retail spending; equipment investment; unemployment, construction work done; population growth; housing finance and dwelling commencements.
• The aim is to find how each economy is performing compared with ‘normal’. And just like the Reserve Bank does with interest rates, we used decade-averages to judge the ‘normal’ state of affairs. For each economy, the latest level of the indicator – such as retail spending or economic growth – was compared with the decade average.
• While we also looked at the current pace of growth to assess economic momentum, it may yield perverse results to judge performance. For instance retail spending may be up sharply on a year ago but from depressed levels. Overall spending may still be well below ‘normal’. And clearly some states such as Queensland and Western Australia traditionally have had faster economic growth rates due to historically faster population growth. So the best way to assess economic performance is to look at each indicator in relation to what would be considered ‘normal’ for that state or territory.
• For instance, the seasonally adjusted jobless rate in the ACT stood at 3.1 per cent in September with Queensland’s jobless rate at 3.7 per cent. However, Queensland’s unemployment rate was 38.6 per cent below its decade average, while the ACT jobless rate was 22.0 per cent below its decade average. So Queensland ranks above the ACT on this indicator..
• Except for economic growth, seasonally adjusted or trend measures of the economic indicators were used to assess performance on all measures. While preference was for trend measures, in many cases these have been suspended in the wake of the COVID-19 crisis. Rolling annual nominal data was used to assess economic growth.

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