Is the lucky country in a funk?

  • By Stephen Miller

As the recent round of lacklustre bank results highlight headwinds confronting the Australian economy, the challenge will be on how monetary and fiscal policy levers will be manoeuvred, argues GSFM's Stephen Miller

Australia’s run of 28 years without a recession - defined as two consecutive quarters of negative GDP growth - is something without precedent among advanced economies.

In recent times however, the Australian economy seems mired in somewhat of a ‘funk’. Has the “lucky country” exhausted its reserves of providence?

True, we have seen far worse economic times, but the fact remains that economic activity is soft, inflation is stuck below the RBA’s target, house prices are declining, household debt is extraordinarily high (both by our own historical standards and internationally) and wages growth remains tepid even if it has accelerated a little from the trough.

More satisfactorily is that unemployment remains low (although that perhaps reflects that tepid wages growth).

An uninspiring election campaign has done nothing to ameliorate a sense of growing melancholy about our prospective economic performance.

While elections always inject a little uncertainty into the investing environment, potential changes to the imputation system and restrictions on negative gearing appear to have made for a special poignancy this time around.

Yet the local equity market continues to price a ‘Goldilocks’ scenario having recently hit a post-GFC high.

That may have reflected a slew of good news out of the US. We saw another (mostly) positive round of earnings results adding to the renewed exuberance evident in the wake of the Fed eschewing further rate hikes and continued strong economic growth.   

However, that exuberance itself is a little surprising given an accumulating set of risks that seem asymmetrically weighted to the downside.

The IMF has forecast that the world economy will endure the lowest rate of economic growth since the GFC.

An uninspiring election campaign has done nothing to ameliorate a sense of growing melancholy about our prospective economic performance.

Europe seems mired in stagnation. China is growing but challenges are evident.

Even in the US where growth has been robust, there are concerns that underneath it all things are not so rosy, particularly once the ‘sugar hit’ from the massive growth in the budget deficit loses its potency.

Other risks include intensifying global trade tensions (incidentally, especially problematic for a small open economy like Australia), dysfunctional global politics and the rise of left/right populism.

Add to this the uncertainties of a more structural nature, including climate change, perceptions of growing inequality, cyber-attacks, and ongoing geopolitical events (the Middle-East, North Korea, Chinese hegemonic aspirations in East Asia, just to name a few), and it is clear the future is less than rosy.

This all takes place at a time when, globally, the conventional macro policy armoury is substantially depleted. In other words, there is limited room for manoeuvre on both monetary and fiscal policy.

As noted at the outset, for Australia a number of idiosyncratic domestic developments are adding to globally inspired challenges and, in a similar vein to a number of advanced economies, the room to manoeuvre on domestic monetary policy, at least, is limited.

So, with global (and local) markets pricing a ‘Goldilocks’ scenario should investors be cautious?

It was also instructive to see bank CEOs recently express clear doubts about the efficacy of rate cuts

The challenges ahead for investors were inherent in the recent round of lacklustre bank results.

They certainly reflected some (perhaps unintended) fallout from the Hayne Royal Commission.

In any case, those results presage an intensification of domestic economic ‘headwinds’ as banks retreat to low risk lending with an attendant deceleration of already low rates of credit growth.

This may not be good news for the construction sector or for bank shareholders - who are already labouring under high remediation costs - and nor is it good news for the economy.

It was also instructive to see bank CEOs recently express clear doubts about the efficacy of rate cuts with the capacity to pass on the full extent of reductions in the official cash rate hamstrung by deposit rates that are effectively at a floor.

Rather than have monetary policy “push on a string”, a judicious application of fiscal policy may more efficiently ameliorate a downturn.

However, the political process too often compromises the efficacy of fiscal policy. Were a fiscal stimulus to be applied, it would need to be efficient and immediate, unlike some past episodes where it was too drawn-out in the pursuit of ‘signature’ projects.

It should also be emphasised that this is not to deny the structural (as opposed to cyclical) benefits of government spending on productive infrastructure projects.

What is clear, is that after 28 years the “lucky country” may need more than dumb luck to continue its successful economic run.


Stephen Miller is an investment strategist at GSFM.