Markets
Local: The ASX200 index gained 6.0% over October, as investors responded to a more dovish than expected RBA 25bps hike to 2.60% and 2.85% in November.
Global: The S&P 500 rebounded in October after months of declines. Finishing the month up 8.0%.
Gold: Spot price for Gold continued to trend lower, moving down US $24 to US $1,648 amid US dollar strength and higher real rates continuing to weigh on prices.
Iron Ore: Iron Ore prices dropped US $16 to US $82/Mt due to seasonally lower steel demand and higher supply levels.
Oil: Brent Oil prices increased US $7 to US $95/bbl amid EU trade embargos lowering supply and production.
Property
Housing: CoreLogic’s national Home Value Index (HVI) moved through a sixth month of consistent declines, as values fell a further -1.2% in October.
Across the capital cities the month-on-month decline ranged from a -2.0% fall in Brisbane to Perth where dwelling values nudged -0.2% lower. Across the rest-of-state regions, monthly falls of more than -1% were recorded in Regional NSW (-1.7%), Regional Victoria (-1.4%) and Regional Queensland (-1.3%).
Although more regions are recording a fall in housing values, the rate of declines remain diverse. The pace of falls has eased over the past two months across Sydney and past three months in Melbourne but has gathered momentum in Brisbane where home values are now falling the most rapidly of any capital city or rest-of-state region. The changing dynamic across the largest cities has seen the rate of decline across the combined capitals index ease from a -1.6% drop in August to -1.4% in September and -1.1% in October.
Economy
Interest Rates: The RBA Cash rate has now had 7 consecutive rate rises. Slightly more conservative increases of 0.25% at the start of October and November has pushed the cash rate to 2.85%. With more rate rises likely before year end.
Retail Sales: Australian retail turnover rose 0.6% in September 2022. The September increase was the ninth consecutive rise, following a 0.6% rise in August 2022 and a 1.3% rise in July 2022.
Bond Yields: Australian government 10-year bond fell by 13 bps to 3.76% following a previous gain. The US 10-year bond rose again by 28 bps to finish the month at 4.07%.
Exchange Rate: The Aussie dollar fell again over October against both the American dollar, at $0.642, and the Euro at $0.644.
Inflation: The annual inflation rate in Australia climbed to 7.3% in Q3 of 2022 from 6.1% in Q2, above market forecasts of 7.0%. This was the highest level since Q2 1990.
Consumer Confidence: The Westpac Melbourne Institute Index of Consumer Sentiment fell by 0.9% from 84.4 in September to 83.7 in October. The Index remains in deeply pessimistic territory at a level comparable to the lows briefly reached during the pandemic and the extended weakness experienced during the Global Financial Crisis. The key drags on confidence continue to come from a surge in the cost of living, rising interest rates, and concerns about the near- term outlook for the economy.
Employment: Australia’s unemployment rate stood at 3.5% in September 2022, unchanged from the previous month, and matching market estimates. The number of unemployed climbed by 8,800 to 499,400, with the number of people looking for full-time jobs rising by 1,300 to 336,400.
US Employment: Total nonfarm payroll employment increased by 261,000 in October, and the unemployment rate rose to 3.7 percent. Notable job gains occurred in health care, professional and technical services, and manufacturing.
GDP: For GDP the revision to Q3 consumption sees a print of 1.3% q/q and 0.9% for overall GDP growth. In year-ended terms this points to growth of 2.8% in 2022 (reflecting the rebound from 2021 and ongoing healthy growth), before slowing to well below 2% over each of the next two years.
Purchasing Managers Index: The Australian Industry Group Australian Performance of Manufacturing Index (Australian PMI®) eased slightly in October, dropping 0.6 points to a broadly stable 49.6 (readings below 50 points indicate contraction in activity, with lower results indicating a faster rate of contraction). This is the third month of flat conditions, following positive results between February and July.
Sources: ABS, AFR, AWE, BLS, CoreLogic, Macquarie MWM Research, RBA, TradingEconomics, UBS.
Comment
The Housing Market Downturn
Sydney home values have reported a drop of -10.1%, equivalent to approximately $116,500 since the city hit peak value in February 2022. The double digit decline has come hand in hand with six successive cash rate hikes by the RBA and record low affordability. This follows the 27.9% surge or roughly $252,900 increase in the city dwelling values from the COVID-trough to peak.
The daily index shows Melbourne’s values are second to Sydney, falling -6.4% since 14 January 2022 while Brisbane is down -6.1 % since its 19 June 2022 peak. Adelaide and Perth have both declined less than -1% since their August peaks.
Furthermore, following research conducted by the RBA, record house price growth last year could be almost completely wiped out by the end of 2024, according to previously secret modelling done by the Reserve Bank of Australia earlier in the year.
Prices could fall 20 per cent from their peaks if people become increasingly pessimistic about the property market, either due to rising interest rates or because falling prices spark a downward spiral in the market.
The documents showed that a slump in the property market in the June quarter surprised RBA economists, given it came before most households began feeling the financial burden from rising interest rates.
It further showed that when the central bank started tightening policy in May, it did so assuming that the enormous circa 2.5% interest rate increases required to get back to what it believed was the minimum level of the “neutral” cash rate would have little impact on house prices.
It specifically forecast quarterly house price changes only very slightly below zero per cent over 2023. This was a remarkable leap of faith given that the 1.4% of interest rate cuts between June 2019 and November 2020 were a key contributor to the subsequent 3% increase in Australian house prices.
It should have been an obvious thought that changing the single biggest driver of household purchasing power (mortgage rates) would have a material impact on the price of properties.
Furthermore, the bank’s deputy governor, Michele Bullock, last week indicated that rates would keep rising well into next year and a move to smaller increases at the October board meeting was not because the job was almost done.
Ms Bullock said inflation in Australia was still too high, and people “should be in no doubt” rates would continue to rise.
Interest rates need to rise to ensure inflation returns to the 2 to 3 per cent band over time and inflationary expectations remain anchored, she told the Australian Finance Industry Association annual conference in Sydney.
“We still feel there is a path for us here where we can get inflation down, not go into recession, and preserve most of the gains in employment we’ve had.”
Sources: AFR, CoreLogic, RBA
Australia’s reliance on China
In 2007 China displaced Japan as Australia’s largest trading partner. In 2009 it became Australia’s largest export market, and in 2019-2020 we sold A$167.6 billion worth of goods and services to China – 35.3% of our total exports. In comparison Japan, still our second most important market, only took 11.8% of our exports.
On the flip side China supplied us with 21% of our imports worth A$83.4 billion. Our total economy, as measured by GDP, was worth around A$2 trillion at the time, so our two-way China trade made up about 12% of our economic activity. That may not make us totally reliant on China for our economic health, but any major disruption to that trade means Australia will have many billions of dollars less to run our schools and hospitals, pay pensions and wages, and to maintain our high standard of living.
Should we be looking to other markets?
In times of smooth sailing a high dependence on one trading partner may not be a cause of great concern. However there are many events that can disrupt trade, from natural disasters and pandemics to political tensions. In such times having a range of export markets helps to reduce the impact of interruptions to trade with one partner.
Achieving greater diversity of export markets is easier said than done however, particularly when seeking to replace demand from what is the biggest market for many of our goods and services. For example, China takes 100% of the nickel ore, 95% of the timber and 83% of the iron ore that we export. It also takes time to build trust and develop the personal relationships that underpin trade.
Looking at the big picture, China accounts for around 15% of global GDP. That leaves 85% in which to seek out new markets.
When relationships sour
The political and diplomatic relationship between China and Australia might be described as ‘challenging’ at present, with trade being used as a weapon of influence. Still, there’s more to Australia’s economic story than China, and many Australians may not experience much fallout from these trade tensions. They may even benefit from a surfeit of cheaper lobsters! On the other hand, and in the worst case, the farmers, winemakers, coal miners and timber workers who have seen the fruits of their labour hit with huge tariffs or denied entry into China face potentially catastrophic losses. This would place a general drag on the economy, potentially spark a recession and lead to an increase in unemployment.
The importance of trade
Nations engage in trade because it creates wealth. Our iron ore and coal helped to modernise China, build its infrastructure and allow it to make a huge range of manufactured goods, many of which we then import at much lower cost than we could make them for here.
In support of trade, Australia is currently a party to 16 free trade agreements (FTAs), including one with China. Much of the focus of these agreements is to reduce or remove the tariffs that increase the cost of our goods in our export markets, and where possible eliminate other barriers to trade. For example, the China-Australia Free Trade Agreement provides Australian businesses with better access to Chinese markets for legal, education, financial and tourism services, amongst others.
Perhaps the most comprehensive FTA is the Australia-New Zealand Closer Economic Relations Trade Agreement. Aside from eliminating all tariffs between the two countries, it also harmonises food standards, which minimises regulatory red tape, and removes impediments to the movement of skilled workers between the two countries. Unfortunately, as the recipient of just 3.6% of our exports, it will take a lot of New Zealand’s trade to significantly reduce our reliance on China.