Macquarie’s economic update part 3 – Will mining save the Aussie economy?

Macquarie’s economic update part 3 – Will mining save the Aussie economy?

As highlighted in the preceding two articles, Macquarie Bank economists, Ric Deverell and Hayden Skilling, see darker times ahead for the US economy and equity market. But their outlook for our economy and equities is more nuanced. Australia will benefit from the race to decarbonise, with some commodities doing particularly well. For investors, it means careful stock selection will be the order of the day.

COVID is everywhere. People are over it. The pandemic has eased to an epidemic and unless a new dangerous mutation emerges where death rates rise meaningfully, the economy will remain open. As an aside, I do wonder whether China knows something the rest of the world doesn’t, which might explain why they are continuing to lock down their cities with nothing less than official ferocity.  

Inside the Australian economy

The Australian labour market is tight at 4 per cent unemployment and it is tightening further. The Macquarie economists, like many other sell-side economists, believe the RBA is a long way behind the curve and will hike rates this June.

While the RBA is still resisting market pricing of an aggressive tightening cycle, the RBA will have to move, according to Macquarie.

With respect to the housing market, interest rates were kept so low for so long, house prices were pushed up to the point affordability constraints and this is even before rates are hiked. Prices in Sydney and Melbourne are already falling. A 200 basis point increase in mortgage rates would see capacity to pay fall by more than 15 per cent. And we note the RBA’s Financial Stability Report contained a prediction of a 15 per cent decline in house prices over two years if interest rates rise by two per cent.

The report further suggested the majority of mortgagors would manage higher interest rates, but some households would struggle with the transition to variable rates or higher fixed rates when fixed rate mortgage terms ended.

Unless inflation comes through strongly in Australia, however, the RBA will back off more significant rate hikes given the vulnerability of the housing market. This prediction, however, flies in the face of a meeting a friend of mine had in 2021 with the RBA where they stated, unequivocally, a recession would be engineered if required.

Wages growth of course is not as strong in Australia as the US so the RBA might get away with fewer rate hikes. As we have previously noted, if a major surge in wage growth occurs in Australia, the RBA would need to hike rates more aggressively, resulting in a housing bust.

Before you run to your real estate agent, however, remember during the COVID’s pandemic’s first lockdowns when millions were out of work, the banks gave everyone repayment holidays, preferring that over a mortgagee-in-possession housing Armageddon. If there was ever a time house prices should have fallen amid forced sales, it would have been then. The banks put the stability of the financial system above their short-term profits and I would expect something similar in the event of rising rates that would otherwise force a large portion of borrowers to put their houses on the market.

Views on oil and gas

Ultimately, Australia wins from Ukraine, particularly from oil and gas investment. Australia’s big vulnerability, however, is the housing market which the Macquarie economists see as a policy mistake.

Australia may avoid a recession even if the US has one. But next year – if the S&P is down, the ASX will be down too. Short-term, commodity stocks, however, look mis-priced.

Deverell and Skilling noted high prices kill high prices and a weaker US economy next year could see oil go to $50 from $100.

Iron ore, however, should be well supported by China’s stimulus. Europe can move away from Russian oil quickly but not gas because it takes time to build LNG terminals. Thermal coal is unlikely to sustain these extraordinary highs. Coal will be used more than it otherwise would to reduce reliance on Russia. Prices, however, could come down heavily but that would be a couple of years away.

The decarbonisation transition we have written about extensively will, according to Deverell and Skilling, accelerate on the back of the war. 

Next: Macquarie’s outlook for China.

Read part two here: Macquarie’s economic update Part 2 – In the US, winter is coming

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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.