Recession fears are now “back with a vengeance”, particularly in the US, and the path ahead for the Australian economy remains worth a close watch, according to AMP’s chief economist, Shane Oliver.
In his latest market note, Oliver observed that, while the US economy has been stronger than expected, more recession indicators are now “flashing red”.
Particularly, he pointed out, resilience thus far could be attributed to the long and variable lags with which monetary policy impacts economic activity, with the hit of rate hikes stretched out by the reopening boost from the pandemic and household saving buffers.
Strong labour markets, too, were partly reflecting a shortage of workers, he suggested.
However, now falling labour demand is showing up in higher unemployment and, historically, once increases in US employment go beyond 0.5 percentage points, it tends to keep rising and become associated with a recession, Oliver explained.
Last week, on 2 August, these concerns were triggered by July jobs data in the US, which saw unemployment spiking to 4.3 per cent, up from a low of 3.4 per cent.
Conceding the trend “has a perfect track record”, he acknowledged “relationships that work in the past don’t always work in the future” and it may have been distorted by a “lumpy” 420,000 rise in the labour supply in July.
“That said, it’s hard to ignore and suggests along with the still inverted US yield curve and the slump in the US leading indicator that recession risk is now very high in the US,” Oliver said.
In light of this, while Australian economic indicators have not been as weak as those in the US, he suggested there are several reasons for concern that Australia may follow.
“We put the risk of recession here at 50 per cent,” Oliver said, outlining six key considerations.
Interest rates have gone up by more in Australia than in the US as measured by the mortgage rates people actually pay, he pointed out, while Australian real household spending has slowed to a crawl.
Household debt servicing costs, too, are now at a record share of household income in Australia, which is not the case in the US, and Australia has far more overvalued housing than in the US.
“The boost to Australian economic growth from record population growth looks set to slow over the year ahead by at least 1 percentage point. This will more than offset the boost from tax cuts,” Oliver said.
Additionally, job vacancies have been falling in Australia for two years, as has been recorded in the US, and this will likely “feed through to a sharp slowdown in jobs growth and rise in unemployment which is already up to 4.1 per cent from 3.5 per cent”, he said.
A recession in the US, Oliver continued, also runs the risk of dragging down global growth, “which will mean less demand for our exports and indirectly impact via confidence”.
Looking at all these factors, the economist conceded “the risk of recession is high”.
Should the RBA revisit rate cuts?
On Tuesday, after the Reserve Bank of Australia (RBA) held rates at 4.35 per cent for the sixth straight meeting, governor Michele Bullock signalled rate cuts are likely off the table in 2024 as the central bank stays vigilant to potential upside risks.
A near-term reduction in the cash rate “doesn’t align with the board’s current thinking”, she said, clarifying that “near term” meant the next six months or the end of the year.
However, in his market note, Oliver posited the central bank “should be considering cutting interest rates”.
“The global monetary policy easing cycle is now underway. However, while lower interest rates are good for shares, this is less so initially in a recession and share markets are signalling increasing concern central banks may have left it too late,” Oliver said.
“Central banks, including the RBA, may not have allowed enough for the ‘long and variable lags’ with which rate hikes impact growth and inflation and so overtightened or left rates too high.”
Likely, this has been worsened by the pause in progress getting inflation down over the last six months in the US and then in Australia, he said.
“Because central banks never know when they have raised rates enough to control inflation, they often go too far – resulting in recession,” Oliver said, adding this was the case prior to recessions in Australia in the early 1980s and 1990s.
“While the RBA still faces inflation that’s too high, given the US experience, it should now be giving consideration to a cut in interest rates as it now risks much higher unemployment and inflation falling below target,” he said.
