Report Points to Recession

Dun and Bradstreet's Global Economic and Risk Outlook report points to a contraction in the Australian economy of 0.9% in 2009.

The report cited sharp falls in exports and a lack of available credit as a drag on the economy. Economic activity is created through the credit process which has the effect of growing money supply by putting more money into circulation. Given the tight credit conditions where businesses are struggling to raise funds this 'multiplier' effect will be stunted for some time.

D&B forecast gross domestic product to grow by 0.7% in 2010, and the unemployment rate to reach 8.5% by the end of next year.

In contrast yesterday the May motor vehicle sales were released showing that sales rose by 5.4% reflecting recent positive moves in consumer confidence.

Recession / Cash Rates

Centrebet has the chances of Australia entering a recession at $1.76 and the chances of not at $1.95. The advantage these bookies have is that they are a little removed from the distorting influence of the financial markets and can look at the situation objectively. It's also a long term bet and acknowledges that we still have a long way to go.

Financial markets have their own agenda and so shouldn't always to looked to as an indication of where rates are going. In the long term markets are generally right but the futures markets in the short term are controlled by traders who are making bets on movements over the next day, week or month. We've seen significant movements up, across the yield curve over the last month. Traders have been trading the momentum by shorting futures and hoping to get out before the momentum ends and the direction changes. Given our real economic pain will show up in figures released in the latter half of this year at some point that momentum will change. It could even be today given 10 year futures have rallied 15 points 3 years and 90 day bill futures in December have rallied 10 points (at time of writing).

Ross Gittins from the SMH is a commentator I've respected for a great deal of time. I was explaining the above scenario to someone last week but Ross has a similar explanation in far more detail in today's paper - link below. It's well worth reading (mainly I guess as I agree with him and believe the easing cycle isn't finished)

http://business.smh.com.au/business/official-interest-rate-more-likely-to-fall-20090621-csmj.html?sssdmh=dm16.383146

Less Hours Worked

Yesterday the Bureau of Statistics put some detail to their labour figures. In May the average number of hours worked by Australians hit a record (24-year) low at 33.7 hours per week.

Job loses were concentrated in manufacturing, mining, utilities and administrative positions in the last quarter.

Unlike the last recession employers seem to be holding onto staff and saving costs by reducing their hours. If that's the case we may not get the high unemployment rates of the last recession and current forecasts. It seems hours worked may be a better indicator to follow.

RBA Minutes - June Board Meeting

The RBA released the minutes 0f their June board meeting yesterday. The closing paragraph is below:

"Monetary policy had been eased significantly, and budgetary measures were also providing significant support to demand. Indications were that these policies were having some impact, though the full effects would take time yet to be seen. Board members did not see a pressing case for any further action at this meeting, though they viewed the inflation outlook as affording scope for some further easing of monetary policy, if that were to be needed to support demand at a later stage. Accordingly, members judged that maintaining the current stance of monetary policy for the time being would be consistent with fostering sustainable growth and low inflation, and would leave adequate flexibility to respond to developments as needed over the period ahead."

They have clearly justified the current pause by acknowledge further easings are a possibility. Here are some reasons why they may still need to ease:

* Australian dollar strength reduces stimulatory effect from better export performance due to a lower dollar

* If inflation drops this will result is real rates being higher than the economic circumstances would warrant (may also cause further appreciation in AUD)

* Business investment will continue to fall away due to tight credit.

* Globally the economic situation remains quite dire

* Rising unemployment in the latter part of '09 could be a significant drag on the economy

* Counteract banks using increased funding costs as an excuse to raise rates. The RBA do NOT want the public to get the impression variable rates are on the way up. CBA's recent 10 point move may do this.

LONG TERM RATES
Banks in Australia have raised long term rates due to wholesale rates going up. This has a minimal effect on our economy and the RBA is unlikely to be worried by it. In the US however long rates have been going up as well. Unlike Australia US mortgage rates are based on long term yields. The disaster we're currently experiencing is as a result of a housing collapse in the US. The last thing they need at the moment is to place the extra burden of higher rates on people struggling with their mortgage payments. It's likely to keep the US economy down for longer.

China

China seems to be powering along at the moment which if sustained could help cushion the global economic blow - particularly for Australia.

China's National Bureau of Statistics said industrial output jumped 8.90% in May, up from the 7.3% in April. Retail sales in China rose 15.2% in the year to May and 14.8% to April. Both May figures were ahead of forecasts.

The AUD 724 billion stimulus package and increased investment (40% ) driven by bank lending (govt edict) is clearly having an impact.

One example of how this has fed into our economy is that to March Iron Ore export volumes are up 13%, pushing the sales value up 3% despite the slipping of prices.

Unemployment Returns to 5.7%

While there was a net loss of only 1700 jobs in May, numbers of full-time employed dropped by 26,600 offset by an increase of 24,500 part time jobs. The Bureau of Statistics reported yesterday that since November, the percentage of the workforce without a job or wanting more work has risen from 11% to 13.4%. The move to part time work has clearly been forced on many workers effectively 'hiding' the real situation. At some point the move to part time wont be an option and the headline figure will start to creep up.

In the US their jobless claims fell by 24k to 601k - the lowest reading in almost six months and moving in the right direction. The number of people remaining on claims after drawing a first week rose to a record 6.82 million. Also US business inventories fell for the eight straight month, down by 1.1pct in April, while business sales also declined by 0.3pct. The inventory to sales ratio now holds at 1.43 months.

On a brighter note however US retail sales rose by 0.5pct in May - the biggest increase in the sales since January. The March and April numbers were also revised higher. Retail sales ex Auto’s also rose by 0.5pct. The increase in sales was largely due to gasoline sales (up 3.6pct). Increases were focused in necessities, such as food sales (up 0.4pct), healthcare (up 0.7pct) , and clothing (up 0.4pct).

A clear picture of recovery is still a little way off.

Steep Yield Curve / Consumer Sentiment

You have no doubt noticed the movement in the shape of the yield curve over the last couple of weeks. Look at our website homepage to see just how steep it has become www.curvesecurities.com.au.

Yields for 3 - 5 years have moved up by 30 to 50 points. As I have mentioned many times before the long end of the curve will sell off dramatically to price in feared inflation when growth returns. The 'green shoots' have got those fears started. A one basis point move of a 10 year bond is worth a lot of money - $750 odd per mill - so the long end is quite skittish in these sorts of environments. No one wants to be caught long when the long bonds sell off as it can be extremely costly. The extra supply likely from the government isn't helping but it's not the main reason. The fact that the economy is unlikely to be able to sustain this mini recovery we're experiencing means that the sell off in my mind will run out of steam soon and there are some good opportunities to get some great longer term rates - around 6% for 3 years for instance. Particularly if the alternative is the short end where we may endure another easing.

CONSUMER SENTIMENT
The Westpac consumer sentiment index soared by 12.7% which is the biggest monthly rise in 22 years. The index is now at 17 month highs. The jump is in reaction to all the talk about 'green shoots', the stock market rise and the fact that we dodged a recession as defined by 2 qtrs of -ve growth. All good for confidence. However, Westpac's chief economist, Bill Evans, on the news last night talked it down saying there is still the possibility of two qtrs of negative growth this year. "It's possible that the technical elements that worked for the last figure could work against the next GDP figures."

NAB Monthly Business Survey

Yesterday the NAB released their monthly (May) Business Survey. Business confidence rose during the 'green shoots' month by a significant 11.6 points to -2.2. It is still negative however and business conditions fell from -10 to -14.2. Summary is below:

* Business confidence improves as financial markets stabilise and Budget is stimulatory.
* Business conditions slip back with decline in trading conditions; steady profitability and sharply deteriorating employment.
* On a trend basis, however, business conditions were broadly steady.
* Forward orders also slipped back.
* Capacity utilisation fell to near cycle lows.
* April/May Surveys consistent with subdued domestic demand in June quarter.
* Global forecasts for 2009 slightly worse at -1¾% – with very large falls in Japanese activity and weaker European growth key drivers - but signs of stabilisation in the rate of fall in global activity emerging.
* Post national accounts revisions improve 2009 growth outlook to -½ per cent from -1 per cent.
* Business investment falling and consumption weak. Public investment takes up some of the slack and dwelling investment gaining traction in late 2010.
* Unemployment to reach 8% next year.
* RBA now on hold; less inclined to cut rates further, but we would not rule out late cycle cuts as unemployment rises, raising doubts about durability of growth outlook.

I saw a quote from NAB chief economist today in the paper in reaction to the markets pricing in the possibility of a rise in the cash rate "the chances of getting a rate rise this year are buckleys".

There are some good opportunities out there to take advantage of this premature exubarance. Locking in for one year for instance at 4.50% or even 2 years in the 5s will certainly help squeeze out a little bit of extra interest income.

Ireland Credit Rating Drop / Job Ads

Overnight Ireland's Standard and Poor's credit rating was lowered from AA+ to AA. In March it was lowered from AAA. S & P has maintained it's negative outlook for Ireland's sovereign debt. The credit rating drop is due to the nation's finances being savaged by a costly rescue package for the banking sector. The credit rating drop will increase funding costs for Ireland and Irish banks.

OLIVER JOB ADS
Job ads on the internet fell again but the fall was less severe than in previous months. The index fell 4.32% in May bringing the fall in Australian job ads to 51.90% over the last 12 months.

Trade Deficit Turnaround / RBA Speech

TRADE
Trade was the great saviour that kept us from a technical recession by pushing March quarter growth into positive territory. With the rest of the world remaining in a shaky state and lower commodity prices starting to make their way into results it was always going to be a big call that it could do it again. Yesterday the Bureau of Statistics released figures showing that for the month of April the trade deficit was $91M seasonally adjusted. It was last in deficit in July 2008.

RBA SPEECH
Yesterday Glenn Stevens (Governor) delivered a speech and I thought it was worth sharing two snippets:

"It is likely that activity has remained subdued in the June quarter. The rapid decline in business investment is almost certainly continuing. While consumer spending has held up quite well so far, it may be weaker over the next few months, as the one-off government payments pass and rising unemployment starts to weigh on incomes and willingness to spend.

...... the degree of spare capacity in the economy will tend to be increasing for a while, and inflation will most likely continue to decline for some time. That in turn means, as the statement following this week's Board meeting indicated, that some scope remains to ease monetary policy further, if that were to be helpful to securing a durable upswing."

Confidence

This downturn in growth (can't say recession now) was largely brought on by a collapse in confidence. With so many people telling us the world was falling apart, particularly Kevin Rudd, we had no choice but to cement our wallets into our back pockets or purses into our handbag. This is despite Australia having a completely different circumstances to the USA and Eurpoe. This doomsaying then becomes self perpetuating and results in a whole lot more needing to be done to stem the decline. The fact that 0.4% growth has kept the word recession from being blazoned in big bold letters from the front pages of our newspapers is significant. "Only advanced economy not in recession" has a better ring to it but whether it's enough to bring confidence back is yet to be known. It certainly won't make it any worse.

I'm not getting all positive yet though. There's further slowdown already in the pipeline and the damage can not be undone so easily. Private capital expenditure is down and this will take time to pick up. Unemployment will continue to rise during the year and another easing is still a real possibility although two seems unlikely now and this is being reflected by futures prices.

We're not out of the woods yet and we may not have great export numbers next qtr to keep us above the line - particularly with the rest of the world struggling.

RBA Maintains Pause - Door Clearly Open For Future Cuts

The statement from the RBA reflected some of the rays of hope we have been starting to see. They did however leave the door firmly open for further easings down the track:

Nonetheless, the prospect of inflation declining over the medium term suggests that scope remains for some further easing of monetary policy, if needed. In assessing how it might use that scope, the Board will continue to monitor how economic and financial conditions unfold, and how they impinge on prospects for a sustainable recovery in economic activity.

The economic environment is still very precarious and anything could happen. The impact of the GM bankruptcy clearly illustrates this by taking a number of very shaky CDOs closer to the brink. Parts companies affected by the bankruptcy may also collapse impacting on other CDOs. The further domino effect of these CDO becoming worthless is anyones guess.

Retail Trade Positive

Yesterday retail sales figures came out showing a 0.3% rise in April after a 2.2% rise in March. Retail sales are now 6.6% higher than a year ago - the largest annual increase since December 2007. Not bad for a recession!

The recovery in the housing sector is driving the spending with sales of furniture, carpets and tiles rising by 6.9%.

The performance of manufacturing index (PMI) rose by a record 7.4% in May, hitting a seven-month high. Also the equivalent in China has hit a 10-month high. This is all pretty positive stuff.

Also - home sales rose for the fourth straight month, up 0.5% in April; the qtly Business Indicators publication by the Bureau of Statistics had profits falling by 7.2% in the Mch qtr and inventories down 1.2% and the TD securities monthly inflation gauge fell by 0.3% in May.

It seems our economy has remained pretty flat over the last 6 months and the national accounts tomorrow is likely to reflect this. If so this will be a pretty good result compared to what's gone on in other parts of the world.

Overnight US bonds had their biggest one-day sell off (rise in yields) for 8 months as a stronger stockmarket extra supply and positive economic data reduced their appeal.