Caton’s Corner - October 2010
A mood change in markets?
Share markets did better in September. Investors breathed a sigh of relief, since September is a notoriously poor month. The US market, as measured by the S&P500 index, rose by 8.8%, while the Australian ASX200 index was up by 4.1% in the month. It is still down on a year-to basis, by 3.4%.
The issues hanging over financial markets won’t go away, but they haven’t become any worse in recent weeks. Greek debt is still an issue and there were whiffs (nothing more) of “contagion” in both Spain and Ireland in the month. For those interested, there is a fascinating article by the prolific Michael Lewis in the October edition of Vanity Fair (I knew my subscription would come in handy one day!). Lewis details just how Greece got into its current mess. As one illustration, he tells the tale of the state-run railway system. It is so inefficient, and its staff so highly-paid, that it loses 6 euros for every one euro paid in fares. It has been calculated that the railway system would lose less money if it simply paid taxi fare to all of its would-be passengers!
There have been no significant developments in the “China slowdown” story. In the month, and RBA Deputy Governor, Phillip Lowe, gave a speech on the topic of the increasing importance of China and India to Australia. He produced statistical evidence that the Australian business cycle is now more closely aligned to variations in Chinese growth than it is to the US economic cycle. This may not seem like startling news, but it has become true only quite recently.
Concern about a double-dip recession in the US has receded somewhat, and rightly so. There has been just one such episode (in the early-1980s) in the past 70 years. Put simply, and somewhat paradoxically, all of the “usual suspects”—the cyclical components that drag an economy into recession-- are currently so weak that they could not possibly fall far enough to lead the economy into renewed recession. The US did clearly have a slow spot, but it was probably already over by August. The signs others point to as portending a double dip, I see as signs of an ongoing slow recovery. At the current pace, for example, it will take about 7 years for the US to get back all the jobs that it lost in the recession. But even slow, troubled recoveries generate earnings growth, which is the lifeblood of share markets. The Federal Reserve has made it clear that it will engage in more “unconventional easing” if required, although the members of the FOMC currently seem split on the issue. The fear that any such easing will inevitable lead to inflation is unjustified, held only by those who have read Milton Friedman too closely! Indeed, the Fed has openly expressed concern that inflation in that economy could become too low.
A little over a year ago, I wrote in Caton’s Corner that the NBER, the official arbiter of such matters, would announce around mid-2010 that the “Great Recession” ended in mid-2009. I was both right and wrong. That announcement has now been made, but just in the last month. This, of course, does not rule out a “double dip”. In fact, it makes one possible. Without an official end to the 2007-2009 recession (the longest in the post-war period), any renewed weakening would be interpreted as part of the same episode.
We should be grateful we no longer follow the US as closely as we used to (% change in GDP from year earlier).
In the month, the Labor Party managed to stitch together enough votes to continue in Government. It is, of course, one by-election away from oblivion (or for an increased majority!). While this may mean that it is short-lived and fails to achieve much, it certainly doesn’t guarantee it. The Coalition lost the “two-party preferred” in 1998 at the end of its first term. It held office for a further 9 years. The Hawke government lost a lot of support at the end of its first term in 1984; Labor governed for a further 12 years. And way back in 1961, the Menzies government won by just one seat. The Coalition (not its name then!) held office for a further 11 years.
The trouble with success
It is universally agreed that Australia weathered the GFC remarkably well. One has only to look to 3.3% growth in the past year, and an unemployment rate of 5.1%, for evidence. One price of our success is that we cannot justify the artificially low levels of interest rates prevalent in most of the developed world. That said, the RBA is still capable of surprising. Having done a good deal of groundwork in the previous month to prepare markets and the public for higher rates, the Bank decided at its meeting on 5 October to keep the cash rate steady for now. It did, however, add the following: “it is likely that higher interest rates will be required, at some point, to ensure that inflation remains consistent with the medium-term target”. While this sentiment was expressed by Governor Stevens in a speech recently, it is a new addition to the monthly Statement. The RBA also repeated the key phrase that the current level of rates is appropriate “for the time being”. In the recent past, that has usually meant “until next month, when we’ll have an opportunity to reassess”. A rate rise now looks likely to be the 2:30 event on Melbourne Cup day.
There is some speculation that the major banks were poised to increase the standard variable rate by the amount of the cash rate increase plus a bit extra. It will be intriguing to see if they do now initiate and “out of cycle” rate hike. It will also be interesting to see which bank, if any, is prepared to tick its head above the parapets first!
Chris Caton
Chief Economist
The views expressed in this article are the author’s alone. They should not be otherwise attributed.
