Will Oz's recession last?

 I talked here about how all the various "PMI" surveys in Australia are falling, and how this prolly means that Australia is already in recession.

What I've done below is to combine all series into a single indicator.  You can see the plummet during COVID in 2020, the strong rebound after, and then a renewed plunge when there was a second lockdown in 2021.  Then the economy slowed as the rebound faded and as Australia's Central Bank, the Reserve Bank of Australia, tightened monetary policy.

We started a new recovery in 2024, but this faltered late last year as the RBA raised rates, and went into free fall with the Iran War.

The chart below shows the relationship between the economy (as represented by the combined PMIs) and the Reserve Bank's "cash rate".  Because I've plotted the RBA's cash rate (which is equivalent to the Fed Funds rate in Australia) inverted, when the blue line rises on the chart, the cash rate is falling on the chart, and when it falls, the cash rate is rising.  The two move in sync except for the COVID crash, when what economists call an "exogenous factor" caused the economy to plunge.  Note that interest rates aren't the only factor shifting the AU economy up or down.   For example, in 2019 (before COVID), the economy slowed because of a slowdown in the world economy.  A tentative recovery had begun, here and overseas, when COVID hit (January 2020).

So, if the RBA doesn't raise rates again, will the economy start to recover?  It's possible.  But remember, the world economy is likely to slow, even if there is a "ceasefire" in the Iran war.  A return to normal will take months, and uncertainty will continue to hamper those famous "animal spirits".  And some countries/regions, in particular, Europe and Indonesia, have already raised interest rates because of soaring inflation.  Indeed, the RBA may yet do the same thing as Australia's inflation accelerates.  And that will slow growth.

My best guess:  growth will slow further for a few more months.  Interestingly, all the growth in Q1 was from investment in AI data centres.  If that bubble bursts, we'll all be in serious trouble.

Happy days.

No reason to raise rates in Australia

Australia's official inflation rate fell in November.  By the way, our CPI data are now monthly.  Previously, the official indices were quarterly, because not all components were sampled monthly  --- the monthly data were subsidiary to the quarterly data, and subject to revision.  Now it's the other way round, with the quarterly data now derived from the monthly series, bringing Oz in line with most other countries.

The slight fall in inflation led, of course, to the market gurus postponing their projected rise in the cash rate.  I wasn't convinced in my last report that the RBA needs to raise rates, and I remain unconvinced now -- see the charts below the inflation chart.   Although household spending is recovering, the others are all weak.  And a composite index of these five indicators, shows a post-recession recovery which has faltered.  Raising the cash rate would be a bad idea.

The only factor pointing towards a strong Ozzie recovery is metal prices, which are surging.  Coal and oil and iron ore are not (coal and iron ore are our major mineral exports), which is significant, because metals and minerals do tend to move in tandem during commodity booms.   The boom is confined to lithium, nickel, base metals and precious metals.  How sustainable is this oddly concentrated commodity price run?  How much is due to heightened risk from Trump and consequent hedging by Central Banks and investors?  One is led to suspect this because world growth is not exactly robust.  And since the oil price is falling*, not rising, the effect of the commodity cycle on inflation here and elsewhere, will be limited.  The Reserve Bank is no doubt thinking hard about all this.

However, even though I think the RBA shouldn't raise the cash rate, it certainly shouldn't cut it, until we have greater clarity on commodities.

In my last analysis, I said I would produce some charts to show that the economy is weakening, but never got round to it.  Here they are.

The unemployment rate continues to drift higher

Job ads stopped falling at the end of the recession, but they have resumed their decline

Real household spending is picking up

A composite index of the 5 indicators from the charts above
 suggests a post-recession rebound, followed by stagnation.

* The most likely reason oil prices aren't rising is because the rise in EV sales and ownership in China mostly, but also elsewhere, is reducing oil demand.

World inflation back to pre-covid levels

The chart below shows the inflation rate for the "Big 8" economies, compared with the percentage of world economies (50 in total) where inflation is above 6%.  The "Big 8" economies are: the USA, the Euro Area, China, Japan, the UK, Brazil and India, which together make up ~70% of world GDP.

World inflation is more or less back at the 1997 to 2020 levels, as is the number of countries with inflation above 4%.  

However, the world discount rate (bank rate) is still way above the 1997-2020 average (lower chart).  The implication is that world interest rates are likely entering a period of sustained decline, which will drive up asset markets (shares and property), as well as sustain growth.  What will stop that decline is a renewed surge in inflation, which obviously can't be ruled out, but given anaemic global growth rates, that does seem unlikely.  At least over the next year or two, though for various reasons, the underlying inflation rate will be higher than it's been over the last 30 years, meaning that world discount rates won't get back down to the 2009-2022 position.

World Inflation falling

 I've just updated my CPI data bank (I've been distracted by a lot going on in my life, so I haven't updated it for a few months).  

It's obvious that world inflation is continuing to fall.  It will be interesting to see how sustained this decline is.  World growth is low, but the reduction of supply chain constraints and the fall in commodity prices are also factors.  But the Covid crash and Russia's invasion of Ukraine have reduced the appetite for globalisation.  Everything else being equal, that will slow the decline in inflation.

The chart below shows the inflation rate for the big 8 countries/regions (US, UK, Euro zone, Japan, China, Russia, India, Brazil) compared with the percentage of countries  (45 countries monitored) with inflation above 6%.  The chart makes it clear that inflation cycles tend to be a global phenomenon.  When the big 8 experience inflation, it tends to be experienced by most countries.  Of course, there are some countries (Venezuela, Argentina, Turkey, for example) which have perennially high inflation.   

The chart below shows the percentage of monitored economies where inflation is below 2%.  It can be seen that this neared zero as inflation soared, but has risen steadily over the last few months.  Obviously, this indicator is inversely related to global inflation rates.

  

The chart below shows a comparison between the US's Fed Funds rate (the Fed's discount rate) and the GDP-weighted average of world discount rates, covering countries with 72% of the world's GDP.

In my judgement, world discount rates have prolly peaked, though unless the world slowdown deepens, they're prolly not going to be cut rapidly.  Central Banks will wait to see if inflation continues to decline.  However, of the bigger economies, Brazil, Chile, China, Hungary and Poland have already started cutting their rates.  Most of the rise over the last couple of months in the world discount rate has been because Turkey has pushed its discount rate up to 40%.

Why a deep recession is likely

 I wrote earlier about one reason why the 2023 recession could be deep:  the extreme rise in commodity prices (including oil)  Here is an updated and slightly amended chart showing the relationship.  Because a sharp rise in commodity prices leads to a later fall in economic activity, commodity prices in the chart are plotted with an inverted scale and with a 24-month lag.

The relationship isn't perfect, and the lag isn't consistent from cycle to cycle.  Nevertheless, it seems plausible that we will experience a recession as bad as the GFC (2008) or the recession after the first oil shock (1974-75).  Note that the covid crash (2020) distorts the relationship in that year, but of course, the crash led to a plunge in commodity prices, shown as a rise in the yellow line through 2021. 

The second reason why the recession will be deep is that Central Banks have raised interest rates sharply.  Once again, the economy falls, with a lag, when interest rates are raised, and rises, with a lag, when they are cut.  So the rise in interest rates over the last few months will only start showing up in economic growth in 2023.  Note that, even though Central Banks may have started increasing their discount rates more slowly, they are still raising them.  The red line in the chart below (falling because it's been inverted) hasn't stopped its decline.  A turn could be 3 to 6 months away.  Once again: this implies continuing and worsening recession all through 2023, prolly deeper than the GFC.

Then there's the behaviour of my US longer-leading index, which points to the deepest recession in 35 years.  The US is the world's dominant and most influential economy.   If it goes into recession, the rest of the world is likely to follow (with the exception of China, discussed below)

And in most countries, fiscal policy is tightening.  This is normal in an economic recovery---as the economy recovers, tax revenue recovers even faster.  However, the large debts built up over the Covid Crash have left less room for manoeuvre.  It will be harder for governments to stimulate activity by cutting taxes during the 2023 recession.  

What could mitigate against this possible deep downturn?  In a word: China.  China has been loosening monetary policy, not tightening, for the last year.  This hasn't led to much acceleration in growth because of frequent abrupt and arbitrary lockdowns, but after recent protests, which have obviously unnerved the Chinese authorities, these policies have been relaxed.  Yet mass deaths are bad for growth.

The steel price in China has started to rise, as have global iron ore prices.  These are classic signals that China is stimulating its construction sector to encourage economic growth, as it has done in every cycle for 40 years.  Given the slowdown in China's population growth and the rise in the percentage of pensioners, this method of stimulating the economy might not work so well this cycle.  There is a significant oversupply of flats, and ppl burnt once by property company collapses may be happy to buy pre-existing flats in preference to new ones off the plan.  Nevertheless, the Chinese economy is out of phase with the rest of the world, and it is big enough to mitigate the global downturn elsewhere.

In my judgement, and it is not new, there will be a deep global recession in 2023, but some countries will move against the tide: China, India (possibly -- it's still holding up) and maybe Australia, because of iron ore exports to China.  But plunging house prices in Australia and a reluctance to use fiscal policy to prevent recession suggest that, at best, Australia will avoid a deep recession.

I'll be updating my US and Chinese indices and indicators over the next few days.  I'll keep you posted.

So when will shares bottom?

Typically, stock markets often show a cyclical turning point when they decide that Central Banks are going to start cutting interest rates, or perhaps, going to stop raising them. Stock markets turn up before the economy turns up, and they turn down before the economy turns down.

Central bank discount rates (such as the Fed Funds rate, the Bank of England base rate, or the Reserve Bank of Australia cash rate) tend to lag behind the cycle.  The chart below shows the year-on-year change in GDP-weighted world average central bank rate, calculated for countries representing 83% of world GDP, compared with the GDP-weighted average PMI of the "Big 8" economies.  Observe how the average Central Bank discount rate goes on rising for a year after the PMI peaks.  So we might expect the world discount rate to start to peak about now, a year after the Big 8/world PMI peaked (June last year).  The problem is, the US only started raising the Fed Funds rate 3 months ago, and is nowhere near through a typical rate rise cycle.  And the European Central Bank hasn't even *started* raising its discount rate yet.  On top of which, inflation is at 40 years records, and so far, still rising.  

So the risk is that the world discount rate will keep on rising.  

In addition, the huge jump in commodity prices is setting up the world for a deep recession ― perhaps as deep as the one after the 1972 commodity price boom.  Probably as deep as the GFC (global financial crisis) in 2008.  In that crisis, even though discount rates were plummeting, the stock market didn't bottom until March 2009, when it started to appear plausible that economies would recover.   If we look at the 1974 and 2008 bear markets, which were associated with deep recessions, the share market continued to fall even though interest rates were being cut.  That could happen again.

Interesting times.

US inflation at 42 year highs

US headline inflation is back at 1980 levels. Core inflation (which excludes food and oil price movements) is only marginally lower. Commodity price inflation is back at 1972 rates. The labour market is tight. Growth is strong, though slowing. 

Expect Fed to tighten more than consensus.  

There is a high risk of deep recession in 2023.

(On a side note:  this is the first time I've used the 'inflation' tag on this blog since I started it over 10 years ago.)

World PMI falls again

 My GDP-weighted big 8 PMI slipped a little further in April.  It's composed of extreme-adjusted PMIs for the USA, China, Euro zone, India, Russia, Brazil and the UK, weighted by their percentage of world GDP.  The post-covid rebound, fuelled by fiscal stimulus and zero interest rates, is starting to fade.  As world central banks raise interest rates, this process will continue.  Current global inflation rates will likely cause CBs to over-correct, causing a recession instead of just a slowdown.  

UK business confidence

 After my analysis of Russian business confidence, I also looked at UK business confidence.  This has an even better correlation with the overall PMI  than it does in Russia.  You'd have to conclude from these data that growth is slipping, but remains at the peaks of previous business cycles.  However, *if* it keeps on slipping, you'd be looking at recession in H2 2023, entirely consistent with the rise in the Bank of England's discount rate, as extreme measures introduced to support the economy during covid are withdrawn.

World growth slows a little.

The PMI for the big eight economies, weighted by PPP GDP,  drifted a little lower in October.  (My calculation ― the PMI for each country is extreme-adjusted, weighted and then summed together.  The economies are: USA, UK, Euro zone, Russia, India, China, Brazil, Japan, and together they make up 2/3rds of the world economy.) 

But notice that this weighted average is still higher than it was in 2017/18 and also higher than the strong rebound in 2010/11 after the GFC (global financial crisis) in 2008/9.  A combination of low interest rates and massive fiscal stimulus. 

Obvious question ― how much longer will CB discount rates remain low?

The answer for the US and Europe is at least another 12 months.   But elsewhere, policy is tightening, except in China, where there is a credit crunch because of the collapse of property companies.  So, whereas there have been tailwinds driving equity markets higher, these have waned, and there are now headwinds.  And of course, renewed lockdown in countries where vaccinations haven't reached 90% of the population but case numbers are exploding, won't be well received.

World bond yields reach post-covid high

 The GDP-weighted world 10 year bond yield has moved to new post-covid highs, even though the USA's haven't yet.  This reflects rises in a number of developing countries and smaller European and Asian countries such as Poland, Portugal, Taiwan, and South Korea.  In most countries, the rises in bond yields are the result of actual or impending discount rate rises as economies recover from the covid crash.  

 

World growth slows from strong rebound

 The chart shows the GDP-weighted average of PMIs for 8 key regions/economies in the world―the USA, UK, China, Japan, the EU, Brazil, Russia and India.  Each national PMI was individually extreme-adjusted before the total was calculated.  

The rebound from the covid crash low was stronger than from the GFC low in 2009/2010, and although growth has slowed a little, it's not very much.  Implication: emergency measures to stimulate economies are likely to be withdrawn.  World discount rates (bank rates) have already started to rise.