Financial Advisors & Planners Perth I Westmount Financial I Rick Maggi

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Investment outlook Q&A...

Introduction

Last year shares climbed a “wall of worry” as inflation fell leading to prospects for lower interest rates ahead. But can it continue? After participating in a webinar on the investment outlook this note takes a look at the main questions investors have in a simple Q&A format.

Are high interest rates working to cut inflation?

The evidence of this is overwhelming. Inflation has fallen from highs around 8 to 11% in major developed countries, including Australia, to now around 3-4%. This reflects a combination of the improved supply of goods and services as well as cooler demand (evident in cooling economic growth and slower labour markets) and higher interest rates have been a key driver. There has further to go and it will be bumpy as we saw with the January US CPI, but central banks are likely to start cutting interest rates in the June quarter with the Fed and ECB expected to cut 5 times this year (by 0.25% each time) and the RBA 3 times.

But aren’t high rates unfair? Isn’t there a better way?

Relying on higher interest rates is not the only or fairest way to slow inflation because it particularly hits 25 to 45 year olds with big mortgages. Ideally the medicine should also involve a mix of tighter fiscal policy (tax hikes and public spending cuts) and structural policies to boost productivity and hence the supply of goods and services. But it’s clear governments don’t want to tighten fiscal policy because it’s not politically popular (if anything they want to provide “cost of living relief”) and supply side policies take time to work and aren’t popular these days either. So after the experience of high inflation in the 1970s, it was concluded that central banks are best placed to control inflation and they really only have one main tool – i.e. higher interest rates.

What is the risk of recession?

Global and Australian growth has held up far better than expected a year ago helped by a combination of savings buffers built up through the pandemic, reopening boosts, resilient labour markets and in Australia far stronger than expected population growth (which has masked a per capita recession). Consequently, while global and Australian growth has slowed it has remained positive. Our base case is for a further softening in growth but for it to remain positive ahead of lower interest rates providing a boost from later this year.

However, the risk of recession remains high after what has been the biggest rate hiking cycle since the 1980s and this being reflected in inverted yield curves (short term rates above long term bond yields), falling leading economic indicators and tighter bank lending standards all of which warn of the high risk of recession particularly as some of last year’s supports like saving buffers, reopening demand and very strong population growth in Australia start to fade. So we put the risk of recession at 40% in Australia and the US. Europe is already close to recession having been stagnant GDP over the last year. China is also a risk. Fortunately, if a recession does occur it’s likely to be mild as most countries have not seen a boom in consumer spending, business investment or housing investment that needs to be unwound.

Will Taylor Swift shake off Aussie consumer gloom?

For the next two and half weeks it will certainly help for the roughly 630,000 concert goers and the retailers, hotels, and food outlets that will get some extra spending. If each attendee spends a total of $900 on average (which sounds generous) it will mean spending of $570m which is a lot of money. But it won’t take us out of the woods because Taylor is an import and so maybe only $400m of that will stay in the country. And $400m is just 0.02% of our economy. And as Governor Bullock implied it will likely come at the expense of other things. So maybe a two-week blip and then back to where we were. In other words, if you are all excited about Swiftonomics you need to calm down. That said I am excited about finally getting a ticket…even if it is one of the partially obscured seats.

What happened to US bank problems?

Quick action by US and Swiss authorities settled the banking problems seen last year and the tightening in lending standards associated with it has eased. In the US, the Fed’s December quarter bank lending survey…

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