Hedge Clippings | Friday, 16 September 2022
In this edition: Inflation, Interest rates, and Recession
In November 1990 then treasurer Paul Keating famously opened a press conference by confirming Australia was in "a recession that we had to have."
According to Wikipedia, former Reserve Bank Governor Ian Macfarlane said that policymakers did not "set out to have a recession in order to reduce inflation, but that the recession happened because of the unwinding of the excesses of the 1980s, the international recession of the early 1990s, and the high interest rates employed to slow the asset price boom of 1988-89."
It is often said that economic history does not repeat itself, but it often rhymes. We have certainly seen an asset price boom over the last decade, much of it powered by low, and even negative interest rates. What we haven't seen (as yet) is a stock market crash to rival that of October '87, which itself was triggered by an increase in interest rates in Germany and Japan. As a result, the Dow Jones dropped by 25% in a day, and the ASX by 40%. That market crash in turn triggered the global recession, which flowed on to Australia.
Where there is some similarity is the increase in interest rates, albeit not to the level of January 1990, when they hit 17.5%. This time around inflation, which has effectively been dormant in recent times, is the key, and central banks around the world, but particularly the US under Fed Chairman Jerome Powell, are prepared to do "whatever it takes", including triggering a recession, to tame it. The causes of inflation may be different this time, in part thanks to supply chain issues out of China, and energy prices, thanks to Russia's military exercise in Ukraine. However, central banks' only available economic medicine is to raise interest rates to curb consumer spending, all with a view of taming inflation.
Compared with 1990, the world is in a very different place, with the war in Europe, tension over Taiwan and the Pacific, and coming out of (hopefully) a global pandemic. A recession in the US and in parts of Europe seems almost inevitable, and whether Australia can dodge one remains to be seen.
In Australia, with unemployment at just 3.5%, and as yet with limited flow on to wages, inflation is running at an annualised rate of 6.1%, the highest since 1990. (There's that date again). Meanwhile in the US, inflation is 8.26%, admittedly down from an earlier peak of 8.6%, but a long way north of its average of just 2.3% between 1991 and 2019. In parts of Europe, (Portugal, Spain, Italy, and Greece for instance), inflation over the 2 years from Q1, 2020 to Q1, 2022 has ranged between 10 and 20%.
For signals that the US economy is either heading into a recession, or might almost be there, consider a couple of overnight news items: Firstly the yield curve between the US 2 and 30 year bond rates has inverted (generally a reliable indicator of a recession) with the 2 year rate at 3.85%, 38bps ahead of the 30 year rate to 3.47%, the deepest inversion for 22 years. Secondly, FedEx, the global transport giant, operating in an industry which acts as a canary in the economic mine if ever there was one, withdrew its previous earnings guidance, citing softness in its latest quarterly earnings, and foreshadowing further weakness next quarter.
Meanwhile, the World Bank warned that the three largest economies - the US, China, and the Euro area - have been slowing sharply, and even a "moderate hit to the global economy over the next year could tip it into recession."
If all this seems like gloom and doom, remember there's a whole generation who have never experienced inflation, or higher interest rates, let alone an "induced" recession. Australia, as the lucky country, may just avoid one, but the signs for the US and Europe don't look as promising.
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