You must admire the skill with which Wall Street and the bond market twist a narrative on adverse economic data to spin anything as good news. Seemingly, everything guides the Federal Reserve to cutting rates.
Friday night’s nonfarm payrolls once again confirmed that the US economy remains robust and in no need of stimulus at a fiscal or monetary level. Payrolls in November grew by 227,000 and have averaged 173,000 over the past three months, despite the severe hurricanes in October. This is a remarkable outcome and speaks to the underlying economic strength that is driving the equity market to new highs.
It needs to be remembered that the US economy is operating at a neutral level with jobs equal to an average of 125,000 per month, so the current numbers are quite strong. Employment growth has eased from the post pandemic surge, but it has only returned to long term levels – some would argue sustainable, but even there it needs to be appreciated that the US economy has, since the pandemic, absorbed an enormous immigration influx (3m versus 1m pre-pandemic) and the vast majority of this number is unskilled labour.
Wall Street now sees the strong jobs growth as an economic positive that will support company earnings growth. They are correct; however, Wall Street is delusional when it interprets the jobs data as justifying any rate cuts (yes, both the last 75 basis points and any foreseeable rate cuts). The price for this delusion will be a resurgence of inflation with wages growth of 4% feeding into higher prices. We have seen this before. The following chart shows the path of inflation from 1972 to 1983 in blue and the current path since 2020 in red. It depicts the way inflation becomes in embedded in an economy after an external price shock (oil in this example in the 1970’s) and where a wages-price spiral develops if inflation is not brought back to the target level in a reasonable time frame. We are now at that pivotal point where inflation will either continue to recede or begin to climb again. Wages growth of 4%, even with US labour productivity very strong at 2.6%, is simply not consistent with inflation continuing to decline.
French Budget
The French Budget debacle is now a lot more important for the global bond market than the outlook for the US economy. France is not Greece. It is a much, much bigger economy and central to the concept of the Euro. Economists and politicians can try and argue this point, but the simple fact is, that without France the Euro Area shrinks into Germany plus the Benelux countries. It is the French economy that builds the Euro Area into a size where the PIIGS need to be part of it. No France, no PIIGS and no Euro.
Australian GDP data
The media have made a great deal of last week’s GDP data, making mostly political points and quoting conflicted economists that appeared to universally interpret the data as very weak. Rather than use this description, we would point out that after a surge in growth, post the pandemic, GDP quarterly growth has returned to its long-term trend level. While that might be a depressing outcome from the perspective of offshore investors, here in Australia where the economy is being gradually and consistently converted into a command economy through regulation, growth in government, and most importantly the crowding out of private investment by the frightening Federal and State combined debt levels, we should be relieved to see any growth at all.
The second aspect of the reporting of the GDP data was the focus on the GDP per Capita level. Again, depressing from an offshore perspective, but when you live in Australia where 85% of the workforce is not a net taxpayer after welfare received and many workers choose part-time over full-time employment so that welfare can be accessed, such an outcome should be no surprise.
Looking forward, the strength of the retail sales data since the end of the quarter suggests that households had saved the July tax cuts and energy rebates to begin spending again in the December quarter. We need to remember that in an economy as simple as Australia’s, much of the economic growth is driven by government payments to the household and the household spending it.
Finally, and with a growing frustration with our stupid media organisations, we must point out that the claim that the RBA is responsible and in some way in control of the inflation and employment outcomes in our economy, is ridiculous. The size of our government sector and the level of welfare in Australia make any impact by the RBA through monetary policy largely irrelevant, but surely, with a little commonsense, anyone could conclude that our banking oligopoly has a much larger impact on the economic outcomes than the RBA. With this in mind, it is disappointing to see the banks under pressure from a small group of activists financed either by the government, or a group of ‘elite’ investors pushing the major banks away from lending to farmers and mining companies. Agriculture and mining are the two areas in which Australia retains a global comparative advantage. Without these industry sectors the economy cannot sustain the current level of government spending, cannot service its debts, and must radically change its approach to economic management with a much smaller government sector.
The fact that the ALP cannot reach this level of comprehension is truly frightening but even the LNP have failed Australians by not keeping them better informed on the true economic drivers and gradually allowing the so called ‘elite’ to influence public policy outcomes.
Interest Rates
US treasuries were range bound for most of the week waiting on employment data. Payroll numbers rebounded and the 4% wages growth rate was ignored. After the reports markets increased the probability of 0.25% cut in December to 85% and now a 30% chance of a January cut. Chairman Powell has defended the cuts so far in the face of a strong economy. For the week, 2-year treasuries fell by 0.065% to 4.096% and 10-year by 0.03% to 4.15%. Both these levels are well below that of a month ago. US CPI and PPI data is out this week. It would take a large jump to upset the markets expectations.
Australian bond rates mirrored moves in the US last week, however, for the past month have shown larger falls than US rates. The Australian 10-year rate is now only 0.07% above the 10-year treasury whereas it was 0.30%+ above in early November, and no wonder given the poor Aust. GDP numbers released last week, the Q3 national accounts showing GDP up just 0.3% for the quarter and 0.8% year on year.
Major Credit Markets
US investment grade (IG) markets remained tight as the market waited on Fridays labour and unemployment data. In the end the data did not move markets which are confident on the economic outlook. IG issuance remains very strong.
Australian credit markets remained firm on the back of offshore leads, despite the poor GDP numbers. Amongst the IG issues last week, the standout was the $1.2bn WBC 1-year senior at 40bps. We don’t often see a 1-year issued at this size and it had followed $300m 1-year senior issued by BOQ earlier in the week at 65bps margin. QUBE issued a 7-year $250m at 5.65% and a $350m 10-year 6.01% rated BBB.
High Yield Markets
US high yield (HY) markets also remain in a steady state however primary issuance has dropped. November HY issuance was the lowest by more than 50% for the year and the lowest November for three years. In contrast the leverages loan market in the US is showing record primary issuance.
Hybrids performed well last week aided by a large number of hybrids going ex-dividend. Turnover has returned to normal levels after being elevated for November. Short-term WBCPH dominated trading, continuing the theme of demand for short-term hybrids. WBCPH is still cum-dividend whereas CBAPG and AN3PH went ex-dividend with volumes back to normal levels. NABPH also saw elevated turnover. The market still waits on APRA’s hybrid review.
MQGPC and AYUHC both ceased trading last week being repaid at face value.
Listed Hybrid Market
Hybrids: volumes up in December quarter
Hybrid volumes have been elevated since the APRA paper in mid-September, flagging no more hybrid issuance. Volumes have been elevated as investors look for the best way to play the news; either buy now as hybrids will become scarce and the intention of APRA for all to be call at the first cash optional date or sell into the buying given hybrid spreads are historically tight and that there are many twists in this tale to come. The chart below shows average volumes in the Dec quarter vs the YTD for the major bask issues, ranked by volume. All issues have elevated volumes especially NAB and ANZ issues. The lower the overall turnover the turnover the smaller the increase in volume.
Forward Interest Indicators
Australian rates
Large swap-rates falls in line with global bond rates.
Swap rates:
- 10-year swap 4.25%
- 7-year swap 4.10%
- 5-year swap 4.01%
- 1-month BBSW 4.31%
