The huge week of data did not disappoint | Economic update

Last week we said that it would be a huge week for economic data and certainly it did not disappoint. Chronologically we had the Australian CPI data, BOJ interest rate decision, US ISM PMI manufacturing data, US labour productivity data and of course the US non-farm payrolls on Friday night.

Australian CPI quarterly data

We prefer the quarterly data because only in the quarterly reading is all the price data included. On a month-to-month basis the ABS does not have the capacity yet to record all the price changes so the monthly reading can be volatile with items like health insurance in one month but not others. The quarterly data is also what academics use in theory and what the RBA bases its analysis upon. The June quarter CPI showed a 1% increase and a 1-year rate of 3.8%, exactly as the market had expected. The RBA trimmed mean quarterly reading was 0.8% and a 1-year rate of 3.9%. The market had expected 4%, feared 4.1% and hoped for 3.8%. It was the slight drop in the core CPI reading that our banks and a few others leapt upon as evidence that inflation was still declining.

The following charts were taken from Consumer Price Index, Australia, June Quarter 2024 | Australian Bureau of Statistics (abs.gov.au).

There are then 2 other charts on the ABS website that are worth highlighting. The first here shows the impact of the childcare rebate at the start of the pandemic lockdowns. We have taken issue previously with this rebate, the timing and the inclusion (at all) in the CPI basket during the pandemic lockdowns. Here the chart shows the impact of a subsidy, much like the electricity rebates, is only short term.

Rather than regurgitate again what we have stated so many times since August 2020 (when we were still under house arrest in the Victorian gulag) we have added the following articles from the week’s media releases:

Those who don’t understand (and you should not believe) why the bond market rallied on the CPI data may want to read this economist as he attempts to provide some explanation.

Reserve Bank of Australia-Why the case for an August rate rise has been overdone (afr.com)

We have said now many times that once the “transitory” factors that drove up inflation abated then tradables prices would stop declining and the decline in the CPI readings would cease. In the June quarter tradables prices increased for the first time since September 2022 and non-tradables that are mostly influenced by domestic factors remains at 5%pa.

Alongside the inflation data last week there were 2 other releases that caught our eye.

Private sector credit was much stronger than expected at 0.6% for the month and 5.6% for the year. The fact that private credit, despite all the interest rate increases, is still this strong is quite odd. If the credit growth is feeding business capital expenditure then it would be positive for economic growth and labour productivity, however, in June personal credit increased 0.2% and housing credit was steady at 0.4% (for the 0.6% reading). The June private credit growth of 0.6% is the highest reading since September 2022 and shows an increase over the March quarter reading of 5.2%. The increase in private credit growth is clearly driving the increase in retail sales.

The following chart shows money supply growth feeding private sector growth and then retail sales growth. At a monetary theory level the RBA has not done enough to tighten the money supply in order to have an impact on inflation. It then follows that the decline in inflation since the September 2022 peak is entirely due to the restoration of the global supply chains post the pandemic.

BOJ interest rate decision

The BOJ increased the Japanese overnight rate to the 0.25% area and stated it would halve the level of bond buying (QE) by 2026. This should have had all the impact of being slapped with a wet lettuce, but remarkably the markets with their current theme of the US Federal Reserve cutting rates, continued to push the Yen upwards against the USD (USD/Yen rate in chart). Hard to see this being maintained for very long.

US ISM PMI manufacturing data

The US ISM PMI manufacturing fell to 46.6 in July, well below expectations of 48.8 and a reflection of a sharp fall in US factory activity in July. Some care needs to be taken here as the impact of hurricanes and bushfires in the US in July appears to have been well above normal.

US non-farm productivity and labour costs

This was the really, really, good news for the US economy last week. The fall in unit labour costs growth from 3.8% in the March quarter to 0.9% in the June quarter is astounding and then it was also reflected in the jump in non-farm productivity from 0.4% to 2.3% growth. The market wants to see labour productivity increase so that the current level of wages growth of 4% does not drive inflation higher. Again, some care needs to be taken with relying on this data because it appears that US weather factors had a large impact on July readings of employment attendance. It will be interesting to see if US wholesale inventories fell dramatically in July (data this week) as it would support a theory that factories were impacted by the US bushfires and hurricanes in July.

US non-farm payrolls

The US economy added just 114,000 in July, well below the downwardly revised 179,000 in June and expectations of a 175,000 increase. In July there was a huge jump in the number of people who said that they could not work because of the weather. 461,000 full time employed people were unable to work in July. The July average since 1976 for people unable to work is just 50,000. Worse still people with part time jobs claiming they could not work surged to 1.09m from a July monthly average of 237,000. It is hard not to see this being a result of the weather impacts with bushfires in California and the hurricanes in the southeast, however, the low level of respondents to the survey suggests that this data will be heavily revised upwards next month.

US employment began the year much stronger than expected and with the revisions has clearly softened.

Interest Rates

The fall in global yield curves, that actually commenced in Australia last week, was quite remarkable. We have seen this before (notably last December when the bond market forecast 6 Fed interest rate cuts in 2024). The timing so close to the US election with Yellen running Treasury cannot be ignored. Falls right across the treasury yield curve were dramatic, 2 years down 0.514% to 3.87%, 10 years down 0.40% to 3.791%, a YTD low.

What began as end of month window dressing after a CPI quarterly print IN LINE with forecasts, then accelerated on short covering and was then accentuated by the timely release of poor US data that pushed down US yields. Aust. yield falls were not the magnitude of that in the US, the Aust. 2-year Comm. Gov bond down 0.29% to 3.808% and the 10-year Comm. Gov. bond rate down 0.26% to 4.04% – 4% for the 10 year is significant as it was the level broken through last September and the level subsequently hit on the downside 4 times since, each time bouncing off.

Major Credit Markets

Investment grade (IG) bond spreads widened as the week progressed despite some euphoria after the Fed Chairman suggested a September rate cut. Weak US employment data stoked fears of a recession – data showing further contraction in the US manufacturing sector, as well as a decline in construction spending all suggested the US economy might be in worse shape than thought. The US IG iTraxx widened by 7bps to 58bps. Large equity market volatility also contributed to the rise. The European iTraxx also rose strong to finish at 73 points, a rise of 9 points for the week.

Australian investment grade credit margins fared well compared to offshore although large margin rises Friday night in the US will be reflected Monday this week. The Aust. iTraxx closed at 0.668%. Major bank senior bonds fared well only rising a few points, 5 years now at 0.81%. Bank sub notes however were sold off, the shorter end by a few points but longer dated (9 years plus) by 5-9 points, especially the most recent ANZ 15NC 10-year sub note, now at a 1.98% margin.

High Yield Markets

As expected, with such high rate and equity volatility, US high yield (HY) spreads rose over the week. The S&P US high yield sector index option adjusted margin jumped by 0.25% to close near 3%, a level last seen in mid-April, and still well below the year Dec 2023 close near 3.25%. Last October this margin hit 4%, suggesting that if volatility persists, spreads can rise a lot more from here.

Hybrid margins were very stable despite the large fall in the Aust. equity market on Friday. The major bank’s average hybrid margin remains near 2%. Often it takes several days until hybrids sell off after a jump in equity market volatility. In the background, banks are well capitalised (some say too much capital), bank share price performance has been staggeringly strong and hybrid issuance scarce.

A beneficiary of the bond rally last week should be AYUPA, one of the only fixed rate bond-like offerings on the ASX. AYUPA’s recent entitlements issue at $72.50 was well sought, the secondary price not hitting this level. Last trade at $79.89 gives a yield of 8.94%, well down from the 9.85% entitlements offer

Listed Hybrid Market

Hybrids – big Mac coming!

Macquarie Group announced on Friday that it is considering a new hybrid offer in coming weeks which may contain a reinvestment offer for the December call MQGPC security. The chart below shows the current major bank and Macquarie Bank/Group hybrids trading margins vs. maturities. The major banks curve is typical, a rise to year 5 then some tapering, although the 7 to 8-year issues are trading at a slight premium to the curve. The Macquarie issues are trading close to the major banks, although typically they trade at a premium, as they should. Note the longer-dated MQGPF, a 0.30% premium to the major bank curve. This indicates that a new issue post 7-years would be priced near 2.80%, historically tight for Macquarie, but in the current market of strong demand, most likely a doable level.