The Australian share market closed sharply lower in June, falling 9.5% for the month, with the All-Ordinaries index closing at 6,745.5 points. With the June result, the Australian share market closed the financial year down 11.1%. The Australian Dollar also fell 3.9% for the month, with 1 Australian Dollar currently buying 69.0 United States cents.
The Reserve Bank of Australia (RBA) increased the official Cash Rate by 0.50% per annum in the month, following on from the 0.25% per annum increase in May. The Cash Rate now stands at 0.85% per annum, and with the 10-year government bond yield breaking through 4.00% in the month (before retreating to 3.62%), further cash rate increases are expected.
Global share markets were generally sharply down in June, with the United States Dow Jones index falling 6.8%, the London FTSE falling 5.8%, the Japan Nikkei 225 gaining 3.3%, and the Hong Kong Hang Seng Index bucking the trend, gaining 2.1% for the month.
The broad-based share market sell-off came on the back of United States inflation recording an annualised result of 8.6% for the month of May. This was a shock result after inflation had peaked at 8.5% in March, then fell to 8.3% in April. The increase in inflation caused widespread fear that the United States’ central bank will struggle to rein in inflation.
Unlike in Australia where inflation results are released quarterly in-arrears, United States’ inflation results are released monthly in-arrears, with the next result due to be released on 13 July. As this is currently a key driver both in the share market and in bond market returns, a reduction in annual inflation would be desirable from an investment market stability perspective.
With negativity dominating the headlines, the idea that the Federal Reserve in the United States will induce a recession (and the RBA will go close to doing the same) to bring inflation down, seems the consensus view among media commentators.
With this negativity in mind, I have noted below three reasons to be optimistic that things will not be as bad as they seem in the press:
1. Part of the United States inflation result must be “transitory”.
Looking at the May inflation data from the United States, energy costs rose by nearly 35% and were the biggest contributor to the inflation result. This is a direct result of rising commodity prices following Russia’s invasion of the Ukraine (and the economic sanctions against Russia which were imposed).
Barring any further supply disruptions, this is a one-off event and not likely to continue year-on-year. This is important to remember as inflation just compares prices from one period to another.
Furthermore, COVID-19 induced issues in both supply chain blockages (which are now easing); a tight labour market, and a pent-up demand for individuals to spend money after being “locked-down” for parts of the last 2 years.
During COVID-19 we had deflation (i.e. falling prices), however inflation is now the concern. The increase in demand as consumers are spending the money that they couldn’t spend in lockdown will undoubtably ease over the coming months.
2. History tells us that increasing interest rates will control inflation.
Higher interest rates have the effect of reducing demand in an economy. Prices of goods and services typically increase when demand outstrips supply – however the reverse is true when demand eases.
With a record level of household debt in Australia, interest rates do not need to move anywhere near the extent of previous periods in history (think the early 1980’s when 10-year bond rates were over 16% per annum) to reduce demand in the economy.
Indeed, I expect that the “fear” of increasing interest rates alone in Australia will have the effect of people spending less on consumer products, delaying renovations and so on. All this should ease domestic inflation pressure.
3. If central banks go too far, it is easy to reverse.
If there is to be a recession induced by central banks increasing interest rates, it is an easy recession to resolve.
Unlike the global financial crisis (whereby there were structural issues in financial markets) or COVID-19 (whereby we were unsure how deadly the virus was and how to control its spread) this recession can be resolved by simply not increasing interest rates – or potentially even cutting rates in 2023.
For more information, please contact Ryan Love on 1300 856 338.
This article is general information only and is not intended to be a recommendation. We strongly recommend you seek advice from your financial adviser as to whether this information is appropriate to your needs, financial situation, and investment objectives.