The latest US CPI data surprised to the upside. Pendal’s head of government bond strategies, TIM HEXT, explains what it means for investors
- Why bonds, why now? Pendal’s income and fixed interest experts explain
- Browse Pendal’s fixed interest funds
THE inflation numbers were released this week and surprised to the upside.
Headline for January was up 0.3% (3.1% year over year) and core up 0.4% (3.9% year over year).
This meant that CPI has, for now, failed to follow the PCE (the Fed’s preferred inflation measure) below 3%.
This was only a small miss, 0.1% higher than expected, but was still against the narrative of falling inflation.
After all, the US needs monthly inflation numbers hitting 0.2% before the Fed can relax.
In the US, CPI is heavily influenced by what is called Owner’s Equivalent Rent.
Unlike most countries which only measure rents for those actually renting (in Australia this is 6% of the CPI), the US CPI tries to capture the idea that owners are ‘consuming’ their residence by putting an equivalent rent on it.
This is almost 25% of the CPI basket, on top of the 7.5% for actual rent. Together, they make up housing inflation.
Analysts use Zillow private sector rent numbers as a good lead indicator, but the downward trend there was not matched in this CPI.
Maybe next time.
There was other noise in the numbers, but the market was focused on core services.
The narrative of core goods falling (down 0.3% in this number) contrasts with core services (ex-shelter), which were up 0.7% on the month.
It’s hardly time for the Fed to declare victory.
The focus will now turn to whether core PCE can stay down around 2% annualised or drift higher towards CPI at 3%.
The PCE has a smaller weight to shelter of only 15%. This will help keep it lower than CPI for now.
Historically, core CPI has been around 0.3-0.5% above core PCE as housing has increased at a faster pace than other services.
The following graph, courtesy of Citigroup, shows that these gaps between CPI and PCE do open up quite often, especially when house prices are on the move.
Source: Citigroup, 2024
For now, the markets will grant inflation a bit of leeway.
Yes, cuts from The Fed are being pushed out and bond yields are drifting higher.
Inflation break-evens (long-term expectations) only moved 0.05% higher (from 2.25% to 2.3% for 10 years).
But the market is on notice.
If this becomes a trend in the months ahead, then risk markets will start to take notice, as rates will stay higher for longer and the chances of a recession also increase.
Goldilocks beware.
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Our view is that the overall trend to lower inflation is still intact, but the sugar hit from lower oil prices and improved supply chains we saw late last year is now entering a period of more balanced risks.
This is also helped at the margin by the small improvement in the US budget deficit, which is taking some of the steam out of the economy.
We expect the fallout from today’s numbers to persist very near term, as momentum funds lean against a vulnerable market.
This will open up opportunities to once again build exposure into long-duration positions.
The US now has less than four cuts this year (1%) and Australia less than two (0.5%), from almost six and three respectively at the end of 2023.
About Tim Hext and Pendal’s Income & Fixed Interest boutique
Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.
Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
Find out more about Pendal’s fixed interest strategies here
About Pendal
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.
Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by investment specialist Chris Adams
- Find out about Pendal Focus Australian Share fund
- Crispin Murray: Five key questions for 2024 (and how we’re going so far)
GLOBAL equity markets continued to rise last week despite another sell-off in bonds.
The market continues to see stronger economic data — and is now pushing out the expected timing of rate cuts in the US to May or June, rather than March.
Equities were supported by a good US earnings season and the prospect of higher growth to underpin positive earnings revisions. The S&P 500 gained 1.4% for the week.
There was little new insight on the US economy, though a Federal Reserve survey of US bank lending showed early signs that credit tightening was coming to an end. In addition, annual US CPI revisions produced no surprises.
Oil bounced on rising concerns about geopolitical risk but remained in its recent trading range. Brent crude gained 5.6%.
In Australia the Reserve Bank held rates steady and gave a mixed signal on the outlook, effectively conceding they do not really know which way things will break. The S&P/ASX 300 fell 0.65%.
Early half-yearly results were mixed among ASX-listed companies, but largely reflected stock-specific issues.
Sentiment on China continued to deteriorate ahead of the Lunar New Year with base metals lower, which in turn dragged on the resource sector (-3.36%).
US growth outlook
The latest Fed Reserve bank-lending survey pointed to a significant reduction in the number of banks tightening financial conditions.
Credit tightening has been an area of concern for recession bears. Easing here would support the soft-landing case.
Lending standards may be a lead on improving US manufacturing data.
Anecdotally, we are hearing of companies that have reached inventory target levels — and are now waiting on consumer signals before dialling up production.
Jobless claims continued to stay low in the US, averaging 212k per week. This indicates February payrolls will be more than 200k.
The Atlanta Fed GDPNow — a monthly forecasting model created by the Federal Reserve Bank of Atlanta —continues to signal good growth of just under 3.5% for the first quarter of 2024.
Fiscal policy — which has not tightened in the US despite low unemployment — is one factor which explains the resilience of growth.
US Inflation
Inflation news remains supportive, despite better-than-expected economic growth.
This is good for equities, since we’re still seeing the economy holding up with rates able to come down.
The Atlanta Fed’s wage-tracker continues to improve, with 12-month wage growth falling to 5%.
The US Employment Cost Index is back near pre-pandemic levels. Unlike Australia, productivity is strong in the US, which is supportive of the disinflation thesis.
The annual revision of US CPI was also helpful since it contained no surprises (unlike last year). Some feared the progress on disinflation may have been overstated. This has not been the case.
Overall, three-month annualised core CPI stayed at 3.3% with goods a bit higher (-1.2% from -1.6%) and services lower (4.8% vs 5.1%).
There are some signs to be mindful of on inflation.
The service prices component of the ISM Manufacturing Index rose materially and we continue to have freight disruption due to the Red Sea.
There are some concerns the January CPI due this week may be higher than expected. There has been a seasonal effect recently as certain industries load price increases in that month.
There are offsets to these concerns. Chinese deflation remains material, providing a very different context to the situation during Covid. At this point the market has all but given up on a March cut in US rates.
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A May cut is regarded as lineball. June is priced as a near-certainty.
China
Chinese deflation continues.
Its consumer price index (CPI) dropped 0.8% in January (year-on-year) versus -0.5% expected.
Core CPI rose 0.4%. This was the lowest since June 2022 when the economy was in the midst of its zero-covid policy.
The producer price index (PPI) was down 2.5%, in-line with forecasts.
The Lunar New Year holiday may provide some respite from bad news on the Chinese economy.
There remains a lot of speculation about whether its weak stock market will trigger a more aggressive policy response.
Last week Beijing replaced the head of its China Securities Regulatory Commission with a banking veteran who was serving as deputy party secretary for Shanghai.
This is a signal that China president Xi Jinping was not pleased with how the sell-off has been managed. Though the issues are more to do with the economy than anything the regulator is able to control.
We doubt this is a sufficient catalyst for China to become more aggressive on stimulus, since the equity market is still not widely owned and the issues are more structural (related to consumer and private business confidence).
Credit data in terms of total new loans was stronger than expected. Though this was also the case last January and did not follow through then. So we do not place too much faith in this signal.
We note that Chinese fiscal policy was not as supportive in 2023 as it could have been.
This provides room for expansion. Any announcements are likely to come out ahead of the National People’s Congress starting March 5.
Australia
The RBA stayed on hold last week.
The message from the press conference was “each way.”
On one hand Governor Michele Bullock noted inflation was too high and needed to fall. This was important because it was tied to cost-of-living pressures.
On the other, she said recent developments were encouraging. The first cut would not require inflation to be in the 2-3% range if confidence was high that’s where it was heading.
Bullock’s testimony to the parliamentary committee was a little less hawkish but with no forward guidance.
There is an expectation that the economy is slowing and there are some anecdotal signs of this, notably with talk of job cuts.
However, retailers have seen decent sales, the housing market fired last weekend and the US is holding up better than expected.
We also note New Zealand inflation data has been worse than expected, prompting expectations of another hike.
On balance, we suspect the market’s current expectation of an August rate cut may be optimistic.
Markets
Three-quarters of the way through US earnings season we are seeing positive earnings revisions.
The market was expecting 3% EPS growth for CY24 and Q1 is currently signalling around 7%. Stripping out the “Magnificent Seven” tech stocks this is still coming in around 6%.
This strength is supported by resilient margins, as input and labour costs are coming in less than expected.
On the negative side, we’ve seen a step-up in layoff announcements.
This may be a seasonal factor — we saw similar announcements in January 2023. It also has not flowed through yet into claims data.
We are seeing cash deployed. Stock buy-backs were down in the first three quarters of 2023, but began to rise from Q4 and now stand at about US$150 billion.
We have also seen a strong start to investment-grade credit issuance, which is also supportive for funding requirements.
The US market is up 5.52% so far this year. But similar to last year, much of the gains are driven by the Magnificent Seven (which are up 15% while the rest of the market is flat).
We note that gains in the “Mag 7” stocks are supported by earnings growth.
In Australia, resources were weak last week due to concerns over China.
Meanwhile a collapsed deal between Santos and Woodside weighed on the energy sector (-3.53%).
Healthcare (+1.36%) and technology (+1.01%) were the best sectors.
That reflects a benign environment for quality growth stocks with rates likely to fall while the economy holds up.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
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Here are the main factors driving the ASX this week according to portfolio manager JIM TAYLOR. Reported by portfolio specialist Chris Adams
LAST week was a big one for economic data and US company reporting, amped up by the Federal Open Market Committee’s (FOMC) meeting and Chairman Powell’s press conference.
US reporting season is tracking in-line with historical trends, and the results from five of the “Magnificent Seven” which reported were generally well received – with a strong showing from Meta crowning the week of results.
US economic data was all largely as expected and supportive of the soft-landing scenario, until the monster Non-Farm Payroll print on Friday night potentially put paid to the notion of a March rate cut.
Powell had strongly indicated at the FOMC press conference that a March cut had not been the Fed’s base case.
Commodities were generally weaker and oil gave back all of the gains from the previous week.
The week’s upshot is that expectations around the extent of rate cuts in CY2024 now look more appropriately centred.
The S&P/ASX 300 rose 1.82% while the S&P 500 gained 1.34%.
Interest rates
The Fed removed the previous reference to “any additional policy firming that may be appropriate” from its statement.
Instead, it noted that it will “carefully assess incoming data, the evolving outlook, and the balance of risks” in determining adjustments to the interest rate.
In addition, Powell noted that he didn’t think it likely that the Fed could reach a required level of confidence by March to cut rates at that time.
The market is now focused on the May 24 meeting for a potential first cut.
This gives the Fed the opportunity to see three additional PCE, CPI, PPI and employment data, as well as the first quarter employment cost index (ECI).
Elsewhere, the Bank of England voted 6-3 to keep rates steady as expected; there were two votes for a hike and one for a cut.
US economic data
It was a big week for labour-market data.
JOLTS
The JOLTS job opening data rose to 9,026k in December.
This was above the upwardly revised 8,925k openings in November and ahead of the 8,750k expected by consensus.
Importantly, the JOLTS quit rate held steady at 2.2%.
This is regarded as a key lead on the employment cost index (ECI), which is the Fed’s preferred measure of wage growth and suggested moderation here.
ADP employment
The ADP employment report delivered 107k increase in private payrolls, which was well below the 150k expected by consensus.
ECI
The ECI rose 0.9% quarter-on-quarter for Q4 2023, down from 1.1% in Q3 and versus consensus expectations of 1.0%. This is the smallest increase since December 2019.
Wage gains slowed to 0.9% from 1.2% in Q3, while the year-on-year rate fell to 4.3% down from 4.6% in Q3 and from the high point of 5.2% in Q2 2022.
While hawks on the FOMC are possibly looking for a reading below 4%, the annualised increase in Q4 came in at 3.8% while a drop in the quits rate over recent months bodes well for further slowing ahead.
Initial jobless claims
Initial jobless claims rose to 224k from 215k, and ahead of the 212k expected by consensus.
Data around layoffs suggests that jobless claims could head toward 250k in the next few months.
This is still low by historical standards during an employment slowdown, but is something that the Fed may have their eye on.
During the week, we also had UPS and PayPal – among others – announcing up to 10% in workforce reductions.
Non-farm payrolls
The market had been generally happy with the jobs data through the week.
Then came the hammer blow from non-farm payrolls, which rose 353k in January – almost twice the consensus expectation of 185k.
Net previous revisions were also up 126k.
The headline payroll gain comprises 317K private and 36K government jobs, and gains were broadly spread across the economy.
The unemployment rate was unchanged at 3.7%, which was just below consensus.
The available work force has been growing because of migration.
Average hourly earnings rose 0.6%, versus 0.3% expected, however, this data series is not as reliable as the ECI which is favoured by the Fed.
The market’s reaction was initially negative on concerns that a firm labour market could push out expected rate cuts.
However, several analysts noted that Powell had stressed in his press conference that the Fed was not looking for a fall in employment as a pre-condition for rate cuts.
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Australia
Consumer price index (CPI)
The December quarter CPI came in weaker than expected.
Headline CPI rose 0.59% for the quarter (versus 0.80% expected) and 4.05% year-on-year.
This is 45 basis points below the RBA’s forecast made in November.
The trimmed mean inflation rose 0.78% for the quarter, also weaker than the 0.9% consensus expectation.
This measure was 4.18% year-on-year and 3.12% at an annualised quarterly rate.
The result was explained by strong pressure on electricity prices from ongoing subsidies, as well as greater disinflation from tradable goods.
Strong disinflationary pressure on core goods is increasingly offsetting relative resilience in core services pricing.
Retail sales
Retail trade fell 2.7% for the month-on-month in December, worse than the expected -1.7% and reversing the 1.6% gain in November.
There were material seasonal adjustments to the December figure, without which this figure would have been a 5.3% month-on-month decline.
Weakness was broad-based across states and led by non-food spending.
Clothing and soft goods fell 5.7%, household goods was down 8.5%, and department stores were 8.1% lower. Eating out fell 1.1% month-on-month, while spending on food rose 0.1%.
About Jim Taylor and Pendal Focus Australian Share Fund
Drawing on more than 25 years of experience investing in top-performing Australian companies and a background in accounting, Jim manages our Long/Short Fund and co-manages our Imputation Fund. He is a Chartered Accountant with membership of the Australian Institute of Chartered Accountants.
Pendal Focus Australian Share Fund is managed by Crispin Murray. The fund has beaten its benchmark in 14 years of its 18-year history (after fees), across a range of market conditions. Find out more about Pendal Focus Australian Share Fund here.
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
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The latest quarterly CPI data shows inflation is on the right path. But there’s still more work to do, writes Pendal’s head of government bond strategies, TIM HEXT
- December-quarter inflation lower than expected
- Housing still needs to cool
- Why bonds, why now? Pendal’s income and fixed interest experts explain
- Browse Pendal’s fixed interest funds
Inflation on track towards 3%
THE market was not disappointed with today’s December-quarter CPI inflation data.
The theme since early November has been inflation moderating globally — and today’s Australian numbers back that up.
The headline Consumer Price Index was 0.6% and underlying 0.8% for the quarter. Annual numbers were 4.1% and 4.2% respectively.
These numbers were slightly lower than expected due to electricity subsidies and international travel.
We also got a comparison of December 2023 with December 2022. Weak fuel prices saw that number at 3.4%.
The Reserve Bank is entering 2024 with inflation somewhere around 4% annually but with the three-month annualised number nearer 3%.
Next week’s RBA statement will urge caution
The RBA will be encouraged by these inflation numbers.
Their panic rate hike in November looks like a mistake — but they will claim some credit for the easing pace.
Their caution will come from non-tradable inflation. Non-tradables are prices largely driven by domestic factors — predominately services.
The RBA can have more impact in this area than in tradables, where we are a global price taker.
Non-tradable inflation has eased from 6% to 5.4% but this is still inconsistent with the RBA inflation band.
The RBA would need to see non-tradable inflation nearer 4% if inflation was to fall closer to the 2-3% target band. Non-tradables are around two-thirds of the CPI.
The biggest driver of non-tradable inflation is wages, which are now around 4%.
Therefore there should be some optimism that over 2024 non-tradable inflation can ease further — though recent hikes in areas like education will continue to put pressure on this.
The path of inflation this year
The key battleground for inflation remains housing, which makes up 22 per cent of the CPI.
New dwelling cost growth is easing, but at a slower rate than hoped.
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Rents are still growing, though closer to 5% than 10%. Utilities are held down by subsidies that will be reviewed later this year.
The RBA won’t gain confidence in the medium-term inflation path for inflation until they see housing moderate nearer to 4% in the CPI. (Housing CPI includes the cost of a new dwelling, rents and utilities but not house prices).
The RBA is expecting CPI at 3.9% by June and 3.5% by December.
They may tweak the June number lower but are unlikely to change the December number for now.
Implications for monetary policy
The market still has cash priced for 3.85% — or two cuts — by the end of 2024, with the first around September.
This is driven more by the fact the US is priced for 4% Fed Funds or 1.5% lower by year’s end.
The US is likely to deliver these cuts since their inflation is near target (unlike the RBA).
But the RBA should eventually deliver lower rates — and we think pricing is fair for now.
Hurdles include oil prices (which have sneaked higher in the past week) and resilient employment markets.
Yes, the long-and-variable lags of monetary policy could see last year’s hikes further weigh on the economy, accelerating the need for cuts.
But we think risks lie more to the latter than the former — which makes us still positive on duration.
About Tim Hext and Pendal’s Income & Fixed Interest boutique
Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.
Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
Find out more about Pendal’s fixed interest strategies here
About Pendal
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.
Here are the main factors driving the ASX this week, according to Pendal portfolio manager PETE DAVIDSON. Reported by investment specialist Chris Adams
- Find out about Pendal Focus Australian Share fund
- Crispin Murray: Five key questions for 2024 (and how we’re going so far)
THE US market continues to hit all-time highs with the S&P 500 up another 2.38% last week. The S&P/ASX 300 gained 2.8%.
US macro data remains good, with solid fourth-quarter GDP growth and better consumer spending.
There was positive commentary on consumer resilience in US Q4 earnings season. But the ratio of companies beating expectations is running below the five-year average.
There were also concerns on electric vehicles as Tesla missed consensus expectations for both sales and margins. The lithium sector remains under pressure.
In Australia, the federal government proposed changes to the Stage 3 income tax cuts, providing extra relief to lower and middle-income earners.
This should help underpin consumer demand since these groups have a higher propensity to spend.
On Wednesday the Australian Bureau of Statistics will release the December-quarter CPI print, which may reset the tone for rates this year.
The market is now looking for two cuts this year, taking us back to 3.85%. There is some potential for a pivot, which would help markets.
Chinese authorities are looking to mobilise some US $278 billion to stabilise its slumping stock market. A recent cut to the reserve ratio requirement for banks may also boost credit.
Hopes of a China rebound from this stimulus supported oil prices (Brent crude +4.2%) which ended higher for a second straight week.
Crude also received support from a big inventory draw-down due to cold weather in the northern hemisphere as well as ongoing Middle East tensions and positive US GDP data.
US politics is pointing towards a Trump victory for Republican nomination, which the market seems comfortable with.
Treasury yields were a touch firmer last week, with yield curves slightly steeper as well.
US data and rates
Overall, US data is solid, though real-time, pulse-type information points to a slowdown.
The advance estimate for Q4 GDP growth was 3.3%, helped by surprising growth in inventories, which continued to build on a large gain in Q3.
However, Fed surveys on manufacturing, new orders, new shipment are all turning down. The Empire Fed, Philadelphia Fed, and Richmond Fed readings all imply a slowdown.
Employment data is on the weaker side with jobless claims ticking up, though that’s probably weather-dependent.
January non-farm payrolls came off the blocks strongly last year, with lots of jobs. A March rate cut from the Fed is less likely if that result is repeated.
Core PCE inflation has fallen to below 3% for the first time since March 2021.
The 6-month annualised change fell to 1.9%, matching last month for the lowest reading since September 2020, when the economy was wracked by the pandemic.
The market will keep a keen eye on any shifts in language or rhetoric from this week’s meeting of the Fed’s rate-setting Federal Open Market Committee.
The Fed’s latest summary of economic projections implied 75 bps of cuts in 2024 – a shallower cutting cycle than current market expectations. There have been big downward revisions to market expectations for central bank policy rates. This reflects faster-than-expected disinflation in major economies and a dovish pivot in central bank communication from several central banks, including the Fed.
China outlook
There was movement at the station last week when Beijing announced a US $278 billion package to support its stock market.
There was also some focus on Alibaba co-founder Jack Ma buying up the company’s stock.
The People’s Bank of China announced it would cut the required reserve ratio by 50bp from February 5. The cut was not a total surprise, but the market was expecting only 25bps.
Markets have been expecting some form of liquidity injection in the lead-up to the Chinese lunar new year, when seasonal cash demand tends to pick up. An injection of roughly CNY 1 trillion cash into China’s banking system is a positive surprise.
The market is now looking for additional stimulus packages for housing and the economy, which could be supportive for the Australian resource sector.
Changes to Stage 3 income tax cuts
The Albanese government proposed changes to the legislated Stage 3 tax cuts (to apply 1 July).
Low-and-middle-income earners (<$150k) would receive a bigger tax cut at the expense of higher-income earners (>$150k).
The rationale is that the post-Covid inflation crisis and cost-of-living pressures facing lower earners requires changes to the original package which was designed and legislated in 2019.
The changes are designed to be budget-neutral, but could be more stimulatory since lower-income earners may be more likely to spend additional disposable income. There is also focus on the political backlash, with the federal opposition continuing intense criticism of Albanese for breaking repeated promises that he would proceed with the original plan.
Australian inflation and policy
There is potential for a Reserve Bank pivot at its February 6 meeting. Recent communications indicate policy is already tight enough.
Past cycles suggest risks are skewed towards rate cuts earlier than the current market expectations.
Q4 CPI data due out on Wednesday will be important.
If the trimmed mean CPI reading is well below RBA expectations of 1% quarter-on-quarter, the RBA could revise down its forecasts for inflation to be within the 2-3% target range by the end of this year (rather than late 2025).
Lower travel and accommodation charges and lower fuel prices could all help the inflation picture.
Historical revisions to RBA forecasts have been big at times, so this has the potential to surprise on the downside in February – though the revisions will depend partly on the Q4 CPI outcome.
Recent data provides clearer signs of a softening labour market. While the unemployment rate remains low, its increase in recent months is larger than at the start of most RBA rate-cutting cycles.
The market now expects the RBA to cut rates twice later in 2024, bringing the cash rate down from a 12-year high of 4.35% to 3.85%.
Headline inflation is expected to only touch the upper end of the RBA’s target 2-3% band in Q1 2025. The RBA is likely to be the last central bank in the “dollar-bloc” countries to join the global easing cycle.
Australia’s property market has now fully recovered from the 2022 downturn, according to data from real estate website Domain.
Sydney, Brisbane, Adelaide and Perth have reaching new house price peaks, returning to pandemic-boom highs, Domain reports.
Demand is strong, but the country has a housing supply problem, with no near-term solution from rate changes.
That said, there are signs that student visa growth has peaked and is moderating. This may help ease population and housing pressures at the margin.
Markets
ASX 200 aggregate earnings are forecast to fall this year, largely due to softer resource and bank sectors.
Industrials are expected to be positive, providing some offset.
At this point the market seems quite happy to look through the earnings valley this year and seems prepared to pay higher valuations for banks (which are up 2.97% CYTD versus -0.53% for the S&P/ASX 300).
The S&P/ASX 300 Resources index gained 3.47% last week on improved sentiment around China, but remains down 4.6% so far this year.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by investment specialist Chris Adams
- Find out about Pendal Focus Australian Share fund
- Crispin Murray: Five key questions for 2024 (and how we’re going so far)
US equities (S&P 500) gained 1.19% last week and reached a new all-time high – 106 weeks after the previous peak on 7 January 2022.
This happened against a rising US Dollar, an escalation in Red Sea tensions, and despite bond yields rising as Fed Governor Christopher Waller tried to cool the market’s view on the pace of rate cuts.
A combination of positive US economic news, confidence on inflation, and cash on the sidelines beginning to chase the market were behind the move higher.
US corporate earnings season has been solid so far, with some small signs of hope from the regional banks and indications that the consumer is holding up okay.
The Australian market (S&P/ASX 300) was softer, down 1.05%, as sentiment on China continues to wane and drag on the resources sector.
Inflation
There was little incremental information on the inflation front.
The latest Expected Change in Inflation survey from the University of Michigan fell from 2.9% in November to 2.8% on a five-year view in December.
This is constructive in terms of expectations around wages and is at the lower end of the post-pandemic period, but is still above the average pre-Covid level of 2.5%.
The market is aware of the effects that Red Sea disruptions are having on freight rates as well as oil and gas prices, but it is not yet affecting bond yields.
This is probably because the impact has been mainly to Europe-Asia shipping routes.
That said, there is now some spill-over apparent in US-China routes, but the upcoming Chinese New Year may be exacerbating this.
Deflation in Chinese export prices is also acting as an offset.
Business and consumers are not yet showing any concern around the ability to access products, so we don’t see the hoarding noted during the pandemic – however, an escalation of the crisis could shift that sentiment.
Elsewhere, the Consumer Price Index (CPI) in the UK was worse than expected.
This is a reminder that the pathway to deflation may be rockier, even though the main cause was volatile components such as air fares, which are expected to reverse.
In addition, underlying economic data is soft (e.g. retail sales), suggesting inflation pressures should be easing.
Growth
Most recent signals support the view that the economy ended 2023 well and that it is not in recession.
US December headline and core retail sales were solid at 0.6% month-on-month, which is stronger than expected and reinforces the anecdotal evidence that Christmas spending picked up.
The overall trend implies real consumer spending was up 2.3% in Q4 2023, which also implies the economy is holding up.
The University of Michigan Consumer Sentiment indicator rose much more than expected, up 9.1 to 78.8.
This is the largest rise since 2005, though the overall level remains subdued.
Forward expectations of sentiment also rose; falling fuel prices and rising stock prices probably played a large role in this.
Initial Unemployment claims declined 16,000 to 187,000, indicating the labour market is holding up.
December housing starts were also stronger than expected, only falling 4.3% from November in what is traditionally a weak month.
New housing permits rose 1.9%, indicating more optimism over future demand.
Multifamily units under construction have risen to record levels, which is supportive to economic activity but also means supply should help ease pressure on rents – supporting lower inflation.
Policy
Fed Governor Waller dampened expectations on the potential scale of rate cuts for 2024.
He put a lot of store on the next CPI report, as it will incorporate seasonal adjustment revisions for 2023 which may change the rate of disinflation.
This suggests that the March meeting is “live” for a cut.
Waller reiterated his perspective that rates can fall to ensure real rates do not rise as inflation falls, but he also saw ‘no reason to move as quickly or cut as rapidly as in the past’, which reflects the starting point being one where the economy is holding up better than in previous cycles.
He also indicated no rush to slow quantitative tightening.
Bond yields rose in response, as Waller is one of the governors who triggered the shift in sentiment on rates last year.
The European Central Bank’s Christine Lagarde also reiterated the message that rates won’t be cut until the summer, with the market anticipating April as an option.
She also noted that “the risk would be worse if we went too fast and had to come back to more tightening,” highlighting central bank reticence on declaring victory over inflation too early.
One big positive for Europe is that winter has been mild and gas prices have fallen sharply, which translates into lower power prices.
Geopolitics
The Red Sea remains the most immediate issue in terms of the knock-on effects on inflation.
But elsewhere, Trump won big in Iowa – with neither Haley nor De Santis emerging as clear alternatives.
The latter subsequently withdrew from the nomination process, which places considerable importance on the New Hampshire Primary on 23 January.
It is an opportunity for Haley, as independents are able to vote; if she can run close, that will potentially give her momentum for her home state of South Carolina on 3 February.
Should she fail, however, the race could be over before Super Tuesday on 5 March.
China
A raft of data for 2023 was released last week.
Q4 GDP came in at 5.2% growth year-on-year, lower than the 5.3% expected (and having grown 3.0% in 2022).
Interestingly, the GDP deflator was -0.5%, which is the largest fall since 1998-99.
This means Chinese economy grew less than the US in nominal terms (the latter growing 4.8%) and actually declined in US Dollar terms.
Given the weakness in Q4 2022, this reinforces how subdued the Chinese economy remains.
The negative inflation and Producer Price Index highlight how the economy is being driven by the supply side, while underlying consumer demand remains weak for structural reasons.
Growth of 6.8% in industrial production and 4.0% in fixed-asset investment for the twelve months ending December 2023 was better than expected – however, retail sales were weaker at 7.4% (versus 8.0% consensus).
The property sector remains soft, with property investment falling 12.3% year-on-year (worse than the -10.9% expected and having already fallen 10% in 2022).
New home sales fell 12.7%, while the value of new home sales fell 17%.
New home completions actually rose 15.4% for the year, due partly to lagged effects and the efforts made to finish projects that were tied up with funding issues.
Unemployment rose to 5.1%.
The National Bureau of Statistics also released a new youth unemployment figure, which excludes those at university and school – this came in at 14.9% versus 21.3% in the old measure.
There were 9.02 million new births in 2023, according to official data, which was more than the market expected but which still means the overall population fell marginally.
The current lack of confidence in the Chinese economy can be seen in stock market weakness and in bond yields falling to cycle lows.
Expectations for 2024 GDP growth currently lie around 4.5%, with piecemeal stimulus propping up growth and an emphasis on infrastructure investment, which should support commodity demand.
Australia
December employment data was weaker than expected, with jobs falling 65,000 versus market expectations of a 15,000 rise, though November was revised up to 73,000.
The three-month run rate has stepped down from 30,000-40,000 to 15,000-20,000 per month and year-on-year employment growth is 2.8%.
Full-time roles fell 107,000 and part-time roles rose 41,000, while hours worked fell 0.5% month-on-month and landed at +1.2% year-on-year – the slowest since March 2022.
Unemployment was flat at 3.9%, as the participation rate fell back from a record high of 67.3% to 66.8%.
All of this indicates the economy is cooling and helped support the market’s view that rates have peaked.
Markets
The S&P 500 market broke to a new all-time high, clearing the peak we saw on 7 January 2022.
This came on option expiry day, which released the gamma overhang in the market, and had been flagged by some bears as a point where the market could roll over.
It was interesting that this occurred despite a higher move in bond yields, and suggests that there is still some scepticism on the economy reflected in positioning.
The early phase of US earnings season has been in line with normal experience, with about half of the companies reporting beating expectations so far.
Earnings revisions remain on track for a 3% uptick year-on-year.
The ASX was weaker due to continued challenges in resources due to softer commodity prices and poor sentiment on China.
We have begun to see more deferrals in mine developments, reflecting cost pressures, and weakness in base metal and lithium prices.
Growth stocks outperformed despite bonds rising, reflecting improving sentiment on the underlying economic outlook.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
Where are we on inflation at the start of 2024? And how is Pendal’s team positioned? Here’s a quick overview from our head of government bond strategies TIM HEXT
- Inflation on track in the US
- Australian inflation still above target
- Why bonds, why now? Pendal’s income and fixed interest experts explain
- Browse Pendal’s fixed interest funds
WELCOME back to those returning from a summer break.
If you’ve been off since mid-December you could be forgiven for thinking nothing happened — since bond rates are largely unchanged.
Though there was some year-end excitement as the “everything rally” pushed yields lower and risk markets higher.
A notion of lower inflation potentially allowing US rate cuts seemed to change into a stronger narrative of imminent big cuts.
The new year has now sorted that one out.
Inflation outlook in the US
As always, the main market driver in 2024 will be inflation. Here’s a brief insight into where we are now.
I will talk more about the current pulse than just annual rates — since annual rates are quite backward-looking and take longer to reflect current conditions.
In the US the Fed’s preferred inflation measure is the core PCE (personal consumption expenditure) price index. This excludes food and energy.
The Fed prefers this measure over CPI because it better reflects changes in consumer spending — instead of relying on fixed weights that only change periodically.
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It also relies on business surveys which are more reliable than consumer surveys. And it has less exposure to rents (CPI includes the notion of owner-equivalent rents, which makes up 25% of the basket).
The good news is that in the US core PCE pulse is now running at 2%.
In other words Q4 — similar to Q3 (see below) — is expected to show the three-month annualised core PCE at 2%. That’s bang on the Fed target.
It was 5% in Q1 and 3.7% in Q2.
The main reason for this move is falling margins, as now fully-open goods and services markets see businesses become more competitive again.
The final impact of the pandemic is washing through the system.
US core CPI is now moving between 0.2% and 0.3% per month, indicative of a 3% annual rate.
This should also settle lower as leading indicators on rents suggest lower levels ahead.
Inflation Outlook – Australia
Australia’s fourth-quarter CPI will be released on January 31.
Thanks to monthly data we already know roughly two-thirds of the number. Expectations are for a 0.7% headline and 0.8% underlying quarterly outcome.
Three-month annualised this would see inflation near 3% as well, though rents in Australia are unlikely to provide the same relief as in the US.
Electricity subsidies (if and when they come off) are an added uncertainty in Australia. These softened the 20% price hikes down to only 10% in recent CPI numbers.
The hope is that falling wholesale prices might offset any removal of subsidies.
The RBA forecast of 3.5% inflation by mid-2024 looks reasonable.
Unlike the US, this would leave inflation still 1% above target, making the case for rate cuts more difficult.
But if inflation can stabilise closer to 3% in the medium term — as the current pulse suggests — then the need for tight monetary policy would lessen.
The hope would be wage outcomes could then moderate from the current 4% levels.
Portfolio positioning
Growth, labour markets, geopolitical events and the usual mix of factors will, as always, be in play in 2024.
For bond markets though, inflation outcomes are now on the “good news” side of the ledger for the first time since Covid.
We are running our portfolios from the long-duration side, though adjusting positions depending on market levels and probabilities of cuts priced into markets.
It also makes us favourably disposed to risk markets.
Though we note — and caution — that the long and variable lags of monetary policy will see a slower economy and more pressure on earnings than in 2023.
About Tim Hext and Pendal’s Income & Fixed Interest boutique
Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.
Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
Find out more about Pendal’s fixed interest strategies here
About Pendal
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.
Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by investment specialist Chris Adams
- Find out about Pendal Focus Australian Share fund
- Pendal’s Crispin Murray reviews the lessons from 2023 and outlook for 2024
MARKETS kicked off the year with a small sell-off, catching their breath from the November-December rally, before staging positive returns last week.
The S&P/ASX 300 rose 0.14% and the S&P 500 1.79%.
To recap 2023:
- The ASX rose 12%, with tech (+28%) and consumer discretionary (+21%) the lead sectors. Consumer staples (+1%), utilities (+3%), healthcare (+4%) and energy (+5%) all lagged
- Globally, the US rose 26%, Europe lifted 26% and Japan gained 29%
- US 10-yr Treasury yields ended up flat for the year at 3.88%, having peaked at 5.02% in October
- The AUD was flat and the DXY (a trade-weighted measure of the USD) fell 2%
- Iron ore rose 22%, gold increased 13% and copper lifted 2%, while oil fell 10% and lithium dropped around 80%
Markets start 2024 with a positive view that disinflation is proceeding faster than previously expected, growth will hold up, and the Fed has reinstated the “Fed put”.
Investors are positioned for this with a systematic strategies limit long in equities.
However, there is still a lot of cash on the sidelines, which may be squeezed into equities.
The breadth of the market is improving, which is usually a positive signal.
The liquidity environment is constructive in the near term, with reverse repurchase agreements (or repos) continuing to be drawn down and a limit on Treasury issuance. Both these factors are likely to reverse after Q1, however.
On the data front last week, we saw slightly negative US Consumer Price Index (CPI) data brushed off by the market.
The Producer Price Index (or PPI) was more positive, while jobless claims data indicated that the economy is holding up fine.
In Australia, inflation data was marginally positive.
We also saw conflicting signals from Fed speakers on the potential for quantitative tightening to be re-evaluated, but there is a growing suspicion this will occur to offset a tightening of liquidity in H2.
Middle East tensions escalated, with the US and UK both launching attacks on the Houthis in Yemen.
This had no sustained effect on oil prices, but freight rates have risen on the need to redirect shipping, which represents a risk to the disinflationary growth narrative.
The market continues to price for six-and-a-half interest rate cuts in the US, starting in March.
Current implied expectations are that the ECB and Bank of England will both start cutting in April and May, respectively.
The market is only pricing two cuts for Australia in 2024, the first occurring between June and August.
Five key questions for 2024
In our last note of 2023 we highlighted some key questions for markets in 2024. We can now assess these in light of recent data and developments:
1. Will disinflation continue to surprise to the upside?
Recent data has been mixed but is supportive of the market’s belief that disinflation will facilitate rate cuts.
US December CPI came in a bit stronger than expected, with the headline index up 0.3% month-on-month – driven, in part, by electricity prices.
However, there was sufficient ambiguity for markets to largely brush off the reading.
Looking forward, the continued drop in fuel prices and rents should help the headline CPI continue to fall.
Core CPI rose 0.31% month-on-month.
The Goods component was flat month-on-month following six months of decline.
The question is whether this signals an end to goods deflation, which has played an important role in positive inflation surprises.
New and used car prices rose, which may not be sustainable.
The recent weakening of the USD and the issues in the Red Sea may also be factors which could lead to an end of goods price deflation, so this remains an issue to watch.
Core Services ex-rents rose 0.4% month-on-month.
This, too, was higher than expected – driven by recreation services, airfares and medical services.
Airfare increases has been seen by a number of inflation bulls as unsustainable, partly due to fuel costs coming down.
These categories are also measured differently in the core Personal Consumption Expenditure (PCE) measure that the Fed prefers.
As a result, the market has not changed its expectations for the December PCE reading, which is that the three-month annualised Core reading could drop to 2.0%.
US PPI came in below expectations at -0.1% month-on-month and 1.0% year-on-year, making this three negative readings in a row.
Some inflation bulls have also cited the potential for more competition to drive corporate profits margins lower.
These rose substantially though the pandemic, and while they are no longer rising, they have not yet normalised.
While this is good for the rate outlook, it would be negative for corporate profitability.
One countersignal is wages data, which is proving to be more stubborn; the Atlanta Fed twelve-month wage tracker held at 5.2% in early January.
The market has priced a 65% probability of a March rate cut in the US, with 165bps of easing expected for the year.
European inflation was in line with the ECB forecast, but higher than consensus expectations (headline 2.9% and core 3.4%).
This may delay the first rate cut in Europe until May or June.
We note that Europe has experienced another warmer winter so far and gas prices have come in well below the assumptions made by the ECB.
2. Will the US economy continue to grow?
This question, alongside the first, is likely to drive the outlook for rates and corporate earnings.
US jobless claims have remained very benign, with initial applications near historic low levels and continuing to hold flat.
This reiterates constructive employment data from the week before and helps underpin the economy.
Anecdotes from retailers indicate there was a late surge in Christmas spending, which held up well overall as a result.
Early January sales are on the soft side, although this may be weather-related.
The consensus expectation is 0.7% GDP growth in 2024, but the upside risk comes from higher consumer demand – benefiting from real disposable income growth combined with the support from an easing of financial conditions.
If the Fed is comfortable with inflation, then it does not need to force the economy into sub-trend growth levels.
Some estimates suggest the potential impact of easier financial conditions could go from a GDP headwind to potentially adding 0.5% to growth.
3. The impact of geopolitics and elections
Threats to shipping via the Red Sea have seen a dramatic decline in traffic, with companies opting for the longer path around Africa.
This effectively reduces supply and impacts freight rates and has raised some concerns about the flow-on effect to the price of goods and the risk of slowing the rate of disinflation.
That said, the trade between Europe and Asia is most heavily affected, with a more limited impact on US routes.
There has also been a material increase in shipping capacity post-pandemic, so the impact will be far more muted than what we saw during Covid.
In Taiwan, the Democratic Progressive Party candidate Lai Ching-te won the party’s third consecutive Presidential term, as expected.
However, the party won 51 of 113 parliamentary seats and lost its majority for the first time since 2012 (again, expected, and unlikely to move the status quo in terms of the level of tensions).
4. China’s ability to sustain moderate growth
Real-time indicators suggest the Chinese economy has started the year softer.
Consumers continue to lack confidence, with the gap between retail sales growth and the pre-Covid trend continuing to widen.
This is tied to weak property market.
Inflation data also remains weak, which leaves scope for continued policy stimulus driven by a supportive fiscal situation.
5. Australia’s ability to engineer its own soft landing
Australian monthly CPI for November was lower than market expectations, up 0.33% month-on-month and 4.3% year-on-year (down from 4.85%).
Core inflation was also lower, up 0.25% month-on-month and 4.77% year-on-year (down from 5.05%).
Housing was the main contributor to inflation for the month, along with rents and new dwellings.
Electricity prices rose to a lesser degree, helped by new Victorian government subsidies.
Services inflation rose 0.7% month-on-month to 4.71%, after a similar fall the previous month.
The three-month trend is now 3.6%.
Goods rose 0.16% to 3.95%, held down by lower fuel, clothing and recreational equipment, with food higher.
December data should see another step down as the base effects fall out, fuel prices are lower, and Western Australian power subsidies kick in.
Last week, the December Politburo meeting and the Central Economic Work Conference took place, where key economic targets are set (but not announced until March).
Signals were for policy support focused on fiscal policy, though there were no major initiatives which was seen as slightly disappointing.
Australia
Employment data was much stronger than expected (up 61,500) despite a marginal rise in unemployment (to 3.9%) given the continued rise in labour supply.
Total hours worked were flat, which implies average hours worked was lower.
This indicates that businesses are looking to save costs by lowering hours rather than layoffs – possibly due to the difficulty of rehiring in the past.
Forward indicators on unemployment still indicate it should be set to rise further, though these signals have so far not been validated.
Markets
The Fed cutting rates is not necessarily a green light for equity markets, as in the end, the economy gets the final say.
If a recession were to occur, the de-rating of earnings would overwhelm the benefits that the lower rates would bring.
This is why GDP growth next year is key.
We are also seeing some interesting shifts in market internals on the back of this. Notably, mega-caps have done their dash and market breadth is rising.
This can be tracked in the relative performance of the Russell 2000 vs the S&P 500.
For small-caps, this is a particularly positive signal for them to outperform.
Another interesting disconnect is that the market has a very different perspective on the economy than some of the traditional leading indicators of growth, shown by the rotation away from defensives to cyclicals.
This makes early 2024 interesting, as the cyclicals would be sensitive to any weak growth.
In Australia, the ASX saw a broad-based rally with only utilities underperforming.
Rate-sensitive sectors such as REITs and tech led the market.
Energy was supported by the bounce in oil and the continued fallout of the potential STO-WDS merger.
Lithium stocks also had a strong bounce back given how oversold they have become.
Lastly, this environment looks to be positive for the AUD, which continues to look good technically.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.