While the world strives to aggressively lift vaccination rates to protect populations from
coronavirus and its variants, it appears investors are convinced they are immune from any
lurking danger. As Pfizer, AstraZeneca and Moderna vaccines are being rolled out across
the globe, financial vaccines developed in the laboratories of the central banks under the
watchful eyes of monetary immunologists Powell, Lowe and Lagarde are being
administered under trademark names FED, RBA, and ECB. These are not mRNA vaccines
and do not protect against the virulent strains of greed and complacency.
Central bank vaccines have immunised investors and risk takers from the dangers
including record debt and deficits, inflationary pressures, elevated risk-asset prices, and
even lockdowns. While low interest rates appear a panacea, there are variants of
investors’ own making to which a vaccine may not be effective. Despite the seemingly
carefree and confident attitude percolating in financial markets, this is not the time to
drop one’s guard.
Bond yield manipulation and the combined central bank chorus of transitory inflation have
driven discount rates to historical lows. These rates are the drivers of discounted cash
flow valuations and the abundant liquidity provides the ammunition for risk takers to bid
up asset prices. The “there is no alternative” (TINA) narrative is still resonating, although
the “fear of missing out” (FOMO) seems to be abating to some degree. What are the
central bank timelines for inflation to change from transitory to enduring? By the time we
reach the inflection point, it could be too late.
The global liquidity dam flooded by central bank asset purchases under the quantitative
easing banner is brimming and will need to be spilled shortly. Without getting too
technical, the recent market activity of the US Federal Reserve (the Fed) has been directed
at addressing a banking system drowning in liquidity. Only a week ago, the Fed sold some
US$350bn of treasuries on one day to banks via what is termed “reverse repos”, as banks
reduced reserves and increased their holding of treasuries. Recall, the Fed has been
buying treasuries and mortgage-backed securities at the rate of US$120bn per month for
the past year and in one day the Fed effectively undid almost three months of quantitative
easing. Clearly, the asset purchase programs have passed their use by date and tapering
will follow.
After rising by 1.9% in the year ended March, the Fed’s preferred inflation marker, the core
(excluding food and energy) personal consumption expenditures index (PCE), jumped 3.1%
in the year ended April with price pressures building as economic activity recovers strongly
and disrupted supply chains exposed falling retail inventories. The headline year-on-year
reading increased 3.6%. The index was 115.97 from 80 in 2000 and 100 in 2012. Both
headline and core readings are now within the Fed’s 2-3% targeted range. The US Bureau
of Labor Statistics headline Consumer Price Index (CPI) rose 4.2% for the year ended April,
the largest yearly increase since September 2008, with the core reading up 3.0%. April’s
increase of 0.9% was the largest monthly increase since April 1982. (Exhibit 1)
Monetary policy on hold, but a peek into July?
As expected, the June monetary policy meeting of the Reserve Bank was uneventful with
no change to any settings and focus now turns to the July meeting where consideration
will be given to changing the target maturity of the market controlled 3-year yield from
April 2024 to November 2024. It will also consider the future of the bond purchase program
following the completion of the second $100bn tranche in September. Interestingly,
regarding the future of the program, the following sentence from the governor’s statement
was missing, the sentiments of which have been present for several months. “The Board is
prepared to undertake further bond purchases if doing so would assist with progress
towards the goals of full employment and inflation.” Does this change provide some insight
into July’s decision? The statement reiterated, “The Board continues to place a high priority
on a return to full employment.”
The Term Funding Facility, which ends on 30 June, still has $75bn of three-year funding at
0.10% available to authorised deposit-taking institutions (ADIs). Surely the ADIs will avail
themselves of this cheap funding. If not, does it suggest that like the situation in the US,
the banking system is awash with liquidity and credit demand is not robust enough to
absorb it?
Perhaps further evidence of the level of liquidity in the system is the excess capital
Australian banks are currently boasting. APRA’s current regulatory Common Equity Tier 1
Capital ratio of 10.5% for the four major banks is comfortably exceeded with ANZ 12.5%,
CBA 12.7%, NAB 12.4% and WBC 12.3%. In total these banks have excess capital of
$33.5bn which would support loans of around $270bn if the demand were there. Clearly it
is not. Returns on bloated equity bases will struggle and so capital management initiatives
are on the agenda, with buy backs front of queue. Proceeds from divestments have swelled
reserves as the chapter of poor management decisions of the past closes.
The Financial Aggregates for April paint a sombre picture. The growth in the demand for
credit slowed from March. Housing credit growth flat-lined, while demand for business
credit went into reverse. Total demand for credit increased at a moribund 1.3% for the year
ended April and the rate of growth of broad money continues to slow, after peaking at
12.8% in the year ended January, to 6.8%.
GDP growth slows in 1Q21 as V-shaped recovery flattens
With GDP growth of 1.8% in the March quarter (1Q21), Australia’s economy is now marginally larger than its pre-pandemic level. Annual growth to March was 1.1%. While a solid result, growth slowed from 3.4% in 3Q20 and 3.1% in 4Q20. No one would have annualised the robust growth of 3% plus in the previous two quarters, and similarly should not do so with this number. Multiplication and extrapolation can lead to fascination, but also disappointment. (Exhibit 3)
While consumer spending was still relatively solid, not surprisingly the pace of growth had
to soften from the frenetic levels of the last half of 2020. Growing at 1.2% it contributed 0.7
points to GDP growth. There was a fall of 0.5% in spending on goods, while spending on
services increased by 2.4% held back by intermittent lockdowns (Victoria) and flooding
(NSW). However, private investment did more of the heavy lifting growing by 5.3% and
contributing 0.9 points to growth. Dwelling investment, both new construction and
renovations, and business investment, boosted by budgetary tax incentives on equipment,
were encouraging. The latter may prove fleeting, while dwelling investment may also be
peaking.
Despite a merchandise trade surplus of $24bn in the quarter, net exports were a drag,
detracting 0.6 points from GDP growth. The continued absence of contributions from
inbound tourism and lack of international students hurting services exports. The household
savings ratio eased from 12.2% in 4Q20 to 11.6% providing firepower for the remainder of
2021. I had expected a sharper fall.
With the economy regaining its pre-pandemic level in 1Q21, Australia beats the
performances of the developed economies including the US, the Euro Area, Germany,
Japan, the UK, and Canada. The still developing China shows a clean pair of heels to all
economies, developed, developing or otherwise, having recovered its pandemic-driven lost
ground in 3Q20. A cursory look at China’s infrastructure and transport network should
provide some insight into whose economies are developed or developing or just plain
embarrassingly outdated. We should not forget everything, including the kitchen sink, has
been thrown at households and businesses to support and stimulate economic activity and
while some of the cost is transitory, much will be enduring.
The 2021 federal budget is now part of history, the forecasts are not. Most have accepted
Australia will not record a surplus for a decade. But it could well be much longer. The
pandemic has surfaced many short comings and inequities within Australian society. Those
coupled with the ever-increasing rise of the entitlement culture and promises of selfinterest driven politicians have loaded government debt-funded expenditures well into the
future. The important NDIS and Aged Care programs have been added to with a generous
Child Care impost. Protecting and caring for everyone in these three categories is almost
impossible and the cost enormous and likely permanent. No political party will go to an
election promising to cut expenditure in any of these three programs.
Possible energy generation shortages
The almost frenetic urgency to replace traditional automobiles with electric vehicles will
also add to Canberra’s red ink. Australia’s annual consumption of petrol and diesel is
around 60 billion litres, mostly used in transport. Currently a fuel excise of 42.7 cents per
litre is loaded on every litre representing a near $26bn spilling into government coffers
annually. The renewable energy industry is in receipt of generous subsidies which mask the
true cost of renewable generation. The current free ride of those owning electric vehicles
will ultimately have to be eliminated and would need to equal the revenue currently being
collected by the fuel excise. And God only knows how much energy needs to be generated
to keep all electric vehicles on the move. With coal-fired power stations to be shut down
and nuclear not on the table, energy generation will be increasingly dependent on more
unreliable renewable sources while demand increases meaningfully. I hope someone has
the solution.
In recent days there has been news on interconnectors between Tasmania and Victoria and
New South Wales and South Australia. These interconnectors, like batteries do not
generate energy. They transmit or store. APA management suggests Australia’s transition
to renewable energy will require the investment of $68bn over the next 20 years of which
$40bn will be on generation and storage. With the move to the electrification of all
transport, the closure of all coal-fired power stations and probably most gas-fired ones and
with no nuclear options on the horizon, blackouts could become part of daily life.
The red telephones under the CEO’s desks at Tomago Aluminium and BlueScope’s Port
Kembla Steelworks, similar to those in the Oval Office and the Kremlin, are likely to be used
more frequently. On the other end of the line will be the boss of the National Electricity
Market asking for production to be cut, so lights can remain on.
Written by Peter Warnes, (reproduced from Morningstar)
Peter Warnes is Head of Equities Research,
Morningstar Australasia. Contribution by Mark
Taylor, Senior Equity Analyst, Energy and
Mining Services. This is a financial news article
to be used for non-commercial purposes and
is not intended to provide financial advice of
any kind.
Recent Comments