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Share markets mostly rose again in the past week as the rebound from oversold levels continued partly on hopes that some cooling in demand will take the pressure off inflation and central banks, and as China has started to reopen.
European shares were little changed but US, Japanese, Chinese and Australian shares rose. The gains in Australian shares were led by resources, consumer staples and industrials offsetting falls in utilities where surging energy prices weighed. However, bond yields rose as did oil, copper and iron ore prices. The rise in the oil price came despite OPEC agreeing to increase oil production by 648,000 barrels a day for July and August and reflected scepticism that all members will be able to achieve it at the same time that US oil stockpiles fell and the EU announced a partial ban on Russian oil imports. The AUD rose as the USD fell.
Source: Goldman Sachs Investment Research
The Inflation Pipeline Indicator is based on commodity prices, shipping rates and PMI price components. Source: Macrobond, AMP
Reliable indicators of recession have yet to signal one is on the way – eg in the US the 10 year less Fed Funds rate yield curve is yet to invert and the Fed Funds rate is still less than nominal GDP growth. It’s the same in Australia.
Forward price to earnings multiples have fallen sharply since the start of the year – down from 22 times to 17 times now in the US and down from 19 times to 15 times in global and Australian shares – making shares cheaper. This has been due to falling share prices and rising earnings.
The bottom line is that while shares are likely to be higher on a 6-12 month horizon, it remains too early to be confident that we have seen the highs for bond yields and the lows for shares in the near term.
As Australia’s new Treasurer has pointed out Australia has lots of challenges – high inflation, falling real wages, surging energy prices, rising rents, skill shortages and a high budget deficit and public debt. And we urgently need to implement policies to boost productivity. Since this may require some pain it makes sense to openly acknowledge the challenges – as Hawke and Keating did in the 1980s. That said, Australia’s economic problems on these fronts are mostly minor compared to many comparable countries and there is also a danger that too much negative talk will only weaken confidence and make the situation worse.
The last thing we want to do is “talk ourselves into a recession”.
On this front, Australian March quarter GDP data was far more good news than bad. Sure, it highlights some of the problems facing the economy. But to have the economy grow 0.8%qoq in the quarter after 3.6% growth in the December quarter and despite the hit from Omicron in January, supply constraints, floods and reopening driving a surge in imports (which knocked 1.5 percentage points off growth) is good news. It was better than we and many - including the RBA’s implied forecasts - were expecting.
Cost of living pressures and rising mortgage rates will constrain growth but ongoing reopening, still high household savings with a roughly $250bn excess saving buffer, strong business investment plans and a big pipeline of residential construction to be completed leave us continuing to expect 3.5-4% GDP growth through the course of this year.
Source: ABS, AMP
Put simply, coal drives about two-thirds of electricity generation in the Australian electricity grid. Coal prices are up something like fourfold on a year ago reflecting global recovery and more recently the war in Ukraine.
At the same time, numerous coal-fired power generators are out of action for maintenance. The combination has led to more demand for gas at a time when its international price has also skyrocketed because of the issues in Europe. So the wholesale cost of electricity has gone up fourfold or so since January. This drives about one-third of the retail price of electricity and the Australian Energy Regulator is allowing energy retailers to raise prices to their customers with 10% plus increases. And of course, the gas price has also skyrocketed. If sustained this could all add roughly 0.5-0.75% to inflation this year.
Getting the out of action coal generators back online will help but it’s likely the pressure will continue at least through winter. The longer-term solution is to get cheaper sustainables (with adequate “battery” storage into the mix) with the new Government targeting that to be 82% of electricity supply by 2030. Of course, we should have started much earlier!
In the US, CPI inflation data for May will be watched for further evidence of “peak inflation”. The CPI is expected to rise 0.7%mom thanks to higher energy prices, but this will still see yoy inflation fall slightly again to 8.2% from 8.3% in April. Core inflation is expected to slow further to 0.5%mom or 5.9%yoy from 0.6%mom and 6.2%yoy in April. Of course, this will still leave inflation too high and won’t stop the Fed from hiking by 0.5% at each of the next two meetings but it may not add to expectations for more aggressive Fed hikes. The renewed rise in oil prices is the main threat though.
The ECB is expected to confirm on Thursday that quantitative easing will stop at the end of the month consistent with President Lagarde’s recent blog. This will leave it on track to start raising interest rates at its July meeting. While it's likely to acknowledge risks to the growth outlook it's likely to be more focussed on the blowout in inflation and may intimate that a 0.5% hike could be on the table for July.
Chinese data for May is likely to show a pick-up in export and import growth (Thursday), a slight rise in CPI inflation to 2.2%yoy due to higher food and energy prices, but a fall in producer price inflation to 6.5%yoy.
In Australia, the Reserve Bank (Tuesday) is expected to raise its cash rate by 0.4% taking it to 0.75%. The clear messages from the RBA since its May meeting are that:
Since the last meeting:
As a result, RBA concerns about rising inflation psychology are likely to have increased arguing for a step up in the pace of tightening in June in order to get on top of inflation – just as we have been seeing in New Zealand, Canada and likely soon in the US – and so we expect a 0.4% hiking taking the cash rate to 0.75%. There is a risk it could even opt for a 0.5% hike. Either way, by year-end we continue to see the cash rate rising to between 1.5% and 2% with a peak of 2-2.5% next year.
All prices and analysis at 06 June 2022. This information was produced by Switzer Financial Group Pty Ltd (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of WealthHub Securities Limited.