Australia’s only PMI reading is the S&P PMI badged as the Judo Bank PMI. We have found both the S&P and ISM PMI readings have given false signals since the pandemic lockdowns. One of the reasons that the PMI data has been giving false signals, notably in mid-2022 when it signalled a sharp economic contraction in early 2023, is that the extended lockdowns induced businesses to hold excess inventories of durable goods. The following chart shows the absolute level of inventories (growth reflects increase GDP growth and inflation) and the more important rate of change. When the rate of inventory build peaked in 2022 business gave contractionary signals through the PMI survey. The fact that the rate of change in inventories is now increasing makes the current PMI readings more relevant in Australia.
In a US context where there is a broad industrial base the PMI data has a long track record of forecasting contractions and expansions 6-9 months ahead, however, in Australia where the economy rides on only two ponies, housing construction and mining, the PMI data is hardly relevant. The enormous size of the government sector in Australia has made the political cycle more relevant. That said, the Judo PMI readings point to a contraction beginning in either the March or June quarters or 2025.
Judo PMI readings August:
Inflation in Australia
Due to the temporary government subsidies of electricity, it is necessary to think about inflation on an ex-subsidy basis. We have already seen one example, in Tasmania, of the electricity price moving back to where it was pre-subsidy in May, and we expect much the same outcome when the very large $1000 one off QLD subsidy and the WA subsidy are removed. The Federal subsidy of $75 each quarter for 12 months will linger a little longer, but its impact was small next to the State government subsidies.
The August monthly headline CPI data:
- 12 months to August 2.7% versus 2.8% expected.
- Electricity prices post one off subsidies from Qld and WA fell 17.9%.
- Fuel fell 7.6% due to oil price decline flowing through to pump price.
- Food 3.4%
- Education 5.4%
- Health 5.3%
- Excluding volatile items (food and fuel) the CPI rose 3%pa in August
Subsidies do not impact medium/long term prices. In fact, they encourage and increase in demand that results in the price of a good actually increasing faster and by more when the subsidy is removed. Then there is the impact on other goods and services. The QLD large $1000 one off electricity subsidy has had a big impact in August on the CPI; however, households are likely to spend this money on bidding up the price of other goods and services. The data does not yet show an increase in either consumption or savings (as it should show in at least one by November) but we have seen a sharp rise in Consumer Sentiment that has been depressed for some time.
The RBA kept rates on hold at its September meeting citing many of the points we have made for some time. The RBA now does not meet util the first week of November (Cup Week). By then we expect the pickup in broad money growth in July to begin materialising in higher inflation readings (Monetary Theory) and without the $1000 QLD electricity subsidy a sharp jump in electricity prices.
Underlying Inflation may already be increasing again. Private wages growth at near 4% remains well above a level consistent with the RBA inflation target, but it is inevitable that an increase in public sector wages needs to occur to catch up with actual inflation over the past 18 months. Rising public sector wages growth is now offsetting the decline in private wages growth and we are yet to see the Victorian government increase State employed workers wages.
Interest Rates
The key US 5-year yield rose all week only to fall back to where it began at 3.5% after a lower-than-expected monthly core PCE price index reading at 0.1% (0.2% expected). The yearly core PCE price index arrived at the expected 2.7% from 2.6% the month before so the fall in yields probably owes more to dovish speeches by several Federal Reserve Governors on Thursday. The 2-year Treasury closed at 3.55% and 10-year at 3.749%
The RBA meeting had very little impact on bond yields. The RBA’s messaging and rhetoric largely unchanged to recent speeches with recent data affirming its stance. Continued concern around upside risks to inflation recognising that wage levels are generally still too high with inflation expected to reach the middle of the target band only in 2026. The 2-year closed at 3.548% and the 10-year at 3.927%. The 5-year yield finished the week at 3.62%, relatively unchanged after a sharp rally for the CPI data faded very quickly with the realisation the decline was all smoke and mirrors (political electricity subsidies).
Major Credit Markets
US credit spreads were steady with economic news such as weekly jobless claims falling more than anticipated and consumer spending showing resilience. Investment grade (IG) trading volumes remain very strong, and monies continue to flow into IG funds whether they be mutual funds or ETFs.
It was a very quiet week for the investment grade section of the Australian market with most investors set for the end of the quarter so not looking to trade. The Aussie 5-year iTraxx finished the week at 61.85 down from 64. Credit margins did contract slightly with funds supported by the maturity of Santan/Mufg/HSBC Senior bonds. Issuance by Australian companies was concentrated offshore with ANZ and NBN Co both issuing into the US.
High Yield Markets
The start of monetary easing in US this month has fuelled a burst of issuance in the primary market for US high yield (HY), pushing monthly volumes to their highest levels in three years (Reuters). Investors still have money to put to work amid continuing flows into the asset class, which has seen about US$8bn enter high-yield funds and ETFs over the last two months, according to Lipper data. Further, the historically low margin levels give incentive for companies to raise now.
Hybrid margins were very stable last week with little movement in the average major bank margin. Volumes however remain elevated. The new MQGPG traded $10m with the margin steady at 2.35%. WBCPJ, CBAPJ and NABPH all traded well above their weekly average volumes. The hybrid margin curve has flattened from four years on with no value to be gained from long-dated issues except for credit duration from any expected rally.
Listed Hybrid Market
Hybrids – yields set to fall
After a huge performance so far in 2024 (+19.25% to 19 September including dividends), major bank share prices retreated last week by nearly 6%. Not alarming but a quick share price reversal usually impacts sentiment towards hybrid securities. One measure of the market’s risk attitude towards a stock is implied volatility of option prices. Major bank implied volatility jumped last week as shown by the red line in the chart below, from 15% to 20%. This is quite a significant rise and reflects the speed of the bank share price falls. Meanwhile, hybrid margins are slightly off lows. There is a good relationship between implied volatility and hybrid margins. If volatility continues to rise hybrid margins would be expected to rise as well.
Forward Interest Indicators
Australian rates
Swap rates steady with market rates.
Swap rates:
- 10-year swap 4.00%
- 7-year swap 3.84%
- 5-year swap 3.71%
- 1-month BBSW 4.30%
