Market Update: At the inflation crossroads

As we speed into the second half of 2023, this year has mainly focused on inflation and the debate about global interest rate increases' effectiveness. To give you a glimpse into what’s happening in the markets and the economy, here’s our latest quarterly market update.

Inflation is (slowly) becoming subdued

Looking at recent inflation data, including the Consumers Price Index (CPI) here in New Zealand, there’s hope that inflation is finally slowing with economies starting to slow across the developed world. This has been confirmed by the Reserve Bank’s latest OCR decision on 24 May. In short, the RBNZ increased the Official Cash rate by ‘just’ 0.25% this time, signalling that inflation may have peaked and we’re nearing the end of the tightening cycle.

New Zealand’s annual inflation rate in the March 2023 quarter was 6.7% - lower than the RBNZ’s expectations and an improvement from the peak of June 2022 (7.3%).

In their latest decision, the RBNZ highlighted that the economy is finally slowing, and even though the labour market remains tight, there are signs that labour shortages and vacancies are beginning to ease as well. From consumer spending growth to construction activity and demand for goods and services, key factors indicate that inflation may continue to drop from its peak, and with it the need to increase the OCR further.

This is potentially good news for mortgage holders, who may start to see lenders reduce their mortgage rates at some point next year. How fast inflation will ease depends on a number of factors, and there’s still a bit of conflicting information there.

Key factors driving inflation

Resilient corporate earnings and high employment levels have been adding to the inflationary pressure of late. Let’s start with the latter.

Over the past two years, persistent labour shortages have kept up demand for wage increases. While there are signs that shortages are easing and net migration is starting to pick up again, it’s not yet clear how long it will take to reverse this trends. What’s more, this issue may be deeper and more systemic than anticipated. According to a recent report from BusinessNZ, if current trends continue, New Zealand will be short 250,000 workers by 2048. It’s not just a continuation of the “Great Resignation” phenomenon, or a New Zealand-specific problem. Globally, an ageing population and declining birth rates mean that we could soon have more people approaching retirement than joining the workforce.

Here in New Zealand, while tradable inflation (influenced by international markets) was down in the past quarter, non-tradable (internal) inflation has proven to be really stubborn, again due to labour shortages but also the impact of floodings and cyclones.

On top of this, corporate earnings have been remarkably resilient. According to some US economists, thanks to widespread knowledge of rising costs, business have been able to raise their prices and ‘pad their profits’, and consumers have been unusually willing to accept these increases. Following the RBNZ’s OCR statement, however, it seems that things are starting to change and consumer spending is finally losing momentum. It will be interesting to see if the next OCR statement on 12 July confirms this sentiment.

What’s happening in the US

In early May, the US Federal Reserve increased interest rates by 25 basis points, signalling that it would study the economy in the coming weeks to potentially pause further increases.

At the moment, the US investment markets are essentially focusing on two things. One is the stability of the banking system, particularly with regards to regional banks. After the fallout from recent bank failures, we’ve seen a couple of US regional banks get taken out by big players. US officials are assessing the possibility of market manipulation, but while financial regulators are on the case, this situation is creating a bit of uncertainty in the markets.

Meanwhile, a debt limit stand-off between Republicans and Democrats in the US Congress is also adding to the uncertainty. If the debt ceiling is not raised, the US Government may run out of money between June and September, which would trigger a number of economic implications.

In our view, the probability of a default occurring is very low, but until the negotiations are finalised and the cap is lifted, market volatility may persist as it awaits good news.

Where to from here?

Despite uncertainty, investment markets have performed well this year so far. Over the past three months, most market indicators – including the MSCI, NZX50, S&P500, NASDAQ, Nikkei, Shanghai composites, and Europe – were up.

This is not a bad result at all, considering the current economic backdrop. And the one-year numbers are also looking better than they were this time last year. Plus, despite oil-producing nations trying to hold price up by limiting supply, the price of oil has come back significantly, easing inflationary pressure.

The critical question, at this point, remains whether interest rate increases will lead to a recession, and how severe that will be. Here in New Zealand food prices are soaring, and with many homeowners rolling off low fixed-rate mortgages, Kiwis’ spending habits will likely be significantly affected in the short-to-medium term.

When it comes to investment markets, we anticipate short-term volatility, but it’s crucial for investors to keep focusing on the long-term and hold the line. Overall, for long-term investors who have funds to invest, there are good opportunities in this market. The key thing is to have a highly diversified portfolio with quality assets.

Do you have any questions for us? Please don’t hesitate to contact us. We’re in your corner.

Lastly, a word of caution

Recently, a number of clients reported receiving emails and phone calls about good investment opportunities. There seems to be a proliferation of sophisticated investment scams, many looking quite convincing at first sight. Unfortunately, it can be too easy to fall for these and lose money.

Remember: if it sounds too good to be true, more often than not it is. And if people are putting pressure on you to make a decision, that’s another red flag as no investment is time-critical. Our recommendation is to get in touch with us whenever you come across an investment opportunity, no matter how credible it may look: we can help you check that it comes from a legitimate source.‍

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The information contained in this publication is intended for general guidance and information only. It has not been personally prepared for you. Therefore, you should not act on this information if you have not considered the appropriateness of this information to your personal objectives, financial situation and needs. You should consult with us before making any investment decision. Historical market performance may not be indicative of future market performance.