Macquarie’s economic update part 1 – Inflation, war and COVID
Recently, Macquarie Bank economists, Ric Deverell and Hayden Skilling, provided their much anticipated global economic update. It includes insights into how COVID and Russia’s invasion of Ukraine are impacting supply chains, inflation and interest rate expectations. It also includes their somewhat bleak views on the outlook for property and equity markets. I’ve summarised the key take-outs in four blog posts. Here is the first one.
Deverell and Skilling say they have not seen such a dynamic and complicated economic environment for several decades.
Global growth remains solid despite the war in Ukraine and COVID hit to Chinese activity. And while European growth has remained resilient to the Ukraine war, global growth has slowed from last year’s rapid rebound. Global Purchasing Managers Indices (PMIs) remain above average; however China is very weak.
Of course, the Ukraine war has seen the risk of a slowdown increase. With Russian GDP only 1.7 per cent of global GDP and the Ukraine’s just 0.2 per cent, the conflict’s real impact is the effect on commodity prices which have surged and experienced extreme intraday volatility – nickel, European natural gas, oil and thermal coal being examples. And keep in mind prices were already rising amid the post-COVID economic recovery and supply chain bottlenecks.
As an aside, accelerating inflation from the commodity shock is adding to input price pressures – something sited by Australian Food and Grocery Council chief executive Tanya Barden. Many key inputs for local food and grocery manufacturers had increased by 50 per cent before the pandemic took hold but more recent input costs surges – particularly freight, shipping, warehouse leases and COVID worksafe practices, as well as a pallet shortage – have lifted overall input prices by as much as 700 per cent in recent years.
Indeed, Deverell and Skilling noted inflation has broadened out from commodity prices across the G7.
Fortunately for commodity exporters such as Australia and the US, the trade shocks are a positive. For Europe, of course, the opposite is true.
An overheating US economy
The Macquarie Bank economists noted the US economy is overheating, citing the tight labour market in particular, where employment and payrolls growth are significant and the unemployment rate has fallen dramatically to just 3.6 per cent in March. The unemployment rate is now a full percentage point lower than just six months ago, and it is well below the natural rate of around 4.4 per cent. The ratio of US job openings to unemployed people is also well above pre-pandemic peak levels and the tight labour market is driving a greater-than-10 per cent surge in nominal wages. In other words, the US economy is “running hot.”
Further evidence of a speeding US economy has been March headline CPI, which hit a new multi-decade high of 8.5 per cent. Core inflation is now at 6.5 per cent. Perhaps more importantly, the jump in inflation, which over the first half of 2021 was narrowly based, is now very broad-based.
The reason broad-based inflation has serious implications for US economy and interest rates is that while energy price inflation should soon moderate, the US Federal Reserve will still be faced with very high inflation through rest of the year. The US Federal Reserve will need to hike considerably to bring more broad-based inflation under control.
The Federal Reserve’s Jerome Powell has already indicated that it has met its employment mandate but inflation needs to be reined in. The Fed began tightening in March and the market is now pricing in a further 265 basis points of hikes. Meanwhile the Fed has also signalled the shrinking of its balance sheet. This is called quantitative tightening. And while the balance sheet will remain much larger than prior to the pandemic, historically at least quantitative tightening has led to lower returns for the S&P500.
Are consumers still spending?
Macquarie reckons the US consumer will come under some pressure but the bank expects consumption growth to remain pretty resilient because US households have deleveraged, hold savings and benefit from very long-term fixed mortgages. Meanwhile the shift in spending to services, from reopening, should be an important source of growth through 2022.
Finally, global business investment will receive a boost from the energy shock. Mining investment in particular should grow, supported by the geopolitical impetrative for Europe to reduce its reliance on Russian energy.
You can read part 2 here: Macquarie’s economic update Part 2 – In the US, winter is coming
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
