Thankfully, China’s stock market is closed for the rest of the week. So everyone can just pretend the problems facing the world’s second largest economy don’t matter, for the time being.
That was certainly the attitude in the US overnight. US stocks rose nearly 2% in Wednesday’s trading session. Why? Who knows? The most logical thing to say is that after the late August sell-off, there’s a bit of tug-of-war going on between the bears and the bulls. Economic data is secondary…sentiment is the driving force.
Despite the occasional sharp rallies, sentiment remains fragile. The August mini-crash came as a shock to many, and as we head into the historically volatile September/October period, investor nervousness remains.
Aussie stocks actually led the global rebound yesterday. After trading to a low of 5,015 points by lunchtime yesterday (down nearly 80 points), the ASX 200 rebounded to close slightly higher.
The 5,000 level on the index is a strong area of support right now. In the two times the ASX 200 has approached that level in the past few weeks, stocks rallied strongly.
Why did stocks bounce from there yesterday? Well, China’s stock market rebounded after an initial sell-off, which helped. But my guess is that after the market digested Australia’s poor economic growth numbers, it began to price in an interest rate cut sooner rather than later.
Let’s talk about the economic growth numbers…because they were pretty ordinary. The headline growth number for the three months to June was 0.2%, and just 2% over the past year.
But even that poor number flatters reality. You see, the widely reported headline number measures the amount of production in the economy. But it ignores the prices received for that production. So while you see the benefit of higher volumes of iron ore, for example, the headline GDP figures don’t show you the effect of falling prices received for that production.
For that, you need to look at ‘real net national disposable income’. This better measure of living standards fell a large 0.9% for the quarter and contracted 1.1% over the year.
If you look at the numbers on a per person basis, it’s even worse. Real net national disposable income per person fell 1.2% for the quarter and contracted 2.3% over the past year. Even the headline growth figure declined 0.2% in the quarter on a per person basis.
In other words, our living standards are falling. A deliberate high immigration policy is masking this fall, but it is still only producing tepid headline growth.
I’ve pointed out before that the only drivers of real economic growth are gains in productivity and population growth. Productivity growth is weak and will remain so while the government refuses to put genuine reform on the table.
That leaves population growth as an easy lever to juice headline economic growth. But with the mining boom ended, a weak labour market and Australian housing costs amongst the highest in the world, immigration isn’t as easy to manufacture as it once was.
If it wasn’t for strong household and government consumption, even the headline rate may have registered negative growth for the quarter. Together, they contributed 0.7 percentage points to the overall growth rate of 0.2%.
Let’s look at the household spending numbers in greater detail. Households have the largest impact on economic growth, but this sector is very vulnerable right now.
In current dollar terms (not adjusted for inflation), household disposable income increased by a robust 6.7% p.a. in the June quarter. This boost to disposable income came about because of a 10.9% annualised fall in interest expense.
Thank you, Glenn Stevens!
That’s right. The 25 basis point cut to interest rates in May kept households spending. Household consumption spending increased a decent 4.6% p.a. in the June quarter. This was less than the increase in disposable income, so the household savings rate actually increased.
On the surface, it looks like households are in good shape. And with strong house prices in the main centres of Sydney and Melbourne, I would expect the wealth effect to maintain reasonable household spending for the rest of the year.
But there is a longer term problem brewing. Lower interest rates ease the burden on highly indebted households. But they also encourage more debt accumulation. Eventually, the interest expense on this higher debt level grows, defeating the earlier benefit of lower interest rates.
Before long, everyone clamours for another interest rate cut to ‘spur growth’. But all it does is repeat the futile cycle.
The market looked at the weak headline growth number yesterday and bet on another interest rate cut. I’ve no doubt another one will come. It’s just a matter of timing.
There are a few things Glenn Stevens will have to consider though before he pulls the trigger again. Most obviously, household consumption remains decent enough. He’ll probably want to see it slow before committing to another rate cut.
The other major concern is the blowout in the current account deficit for the quarter. It came in at a massive $19 billion. Put simply, this means Australia had to borrow $19 billion from the rest of the world to produce 0.2% economic growth.
It’s a worry, isn’t it?
That we are able to borrow so easily is in part due to the relative attractiveness of our interest rates. If Stevens keeps cutting to try and manufacture a few more quarters of growth, that relative advantage will no longer exist.
That means our dollar will continue to fall. This is good news for some industries, but it will result in higher inflation via more expensive imported goods.
In other words, it’s a balancing act. My guess is that Stevens won’t act until he has to. He knows monetary policy has reached the limit of what it can do for the economy. He knows that any cuts will only mask Australia’s structural problems for another few quarters.
Take a look at housing construction. It received a nice boost from the 2011–13 interest rate cutting cycle, but is now declining. Capital spending on ‘Private dwellings’ contracted 1.1% in the quarter, after contributing strongly to economic growth over the past few years.
There’s not much left in the interest rate arsenal. Unfortunately, it’s the only weapon we have.
Editor, Markets and Money