On the other hand | Structural versus macro... flying (a little bit) blind

The US government shutdown has made for a paucity of data with which to analyse how the US economy is evolving.

That said, markets do not seem overly fazed. In some measure, and as has been discussed elsewhere, that might reflect the notion that macroeconomic data has taken second place to emergent structural mega-trends as a driver of equity market performance.

Whether, and for how long, that remains the case is an open question.

In terms of the official data, inflation looks “sticky” even as activity appears to have held up well. Indeed, the Atlanta Fed GDPNow estimate is around a robust 4 per cent for the September quarter, while consensus forecasts are settling at around a satisfactory 2.5 per cent.

Having said that, the data still admit the possibility of a ‘stagflation-lite’ scenario, without that case being overly apparent.

The Institute of Supply Management (ISM) manufacturing index (PMI) paints a weak manufacturing picture: the index slipped to 48.7 (consensus 49.5), marking an eighth consecutive month of contraction. The prices component remained at an elevated 58.0 (indicating accelerating inflation in the sector) while the employment component slipped to 46.0, consistent with ongoing manufacturing job losses.  (50.0 is the neutral point between expansion and contraction).

The ISM non-manufacturing index released overnight paints a better picture, with the overall index remaining consistent with expansion at 52.4 (up from a neutral 50.0 in September). However, the price component remains elevated at 70.0 (again consistent with a further acceleration – even marked acceleration – in inflation) and while the employment component improved a little to 48.2 from 47.2, it remains consistent with some modest cooling in the non-manufacturing labour market.

Meanwhile, the ADP October private payrolls report released overnight suggests some ongoing softness in the labour market, increasing by a modest 42k (versus an expected increase of circa 32k) and follows a fall of 29k the previous month.

Overall, those numbers – particularly the price reads – are hardly flashing a green light for a further Fed rate cut in December, despite such a cut being implied by the median “dot plot”. Markets have grown a little more circumspect regarding that prospect, with the current implied probability of a rate cut in December around 60-65 per cent.

An environment of “sticky” inflation and attendant elevated bond yields, combined with the prospect of slowing economic activity and employment, is not a cocktail that equity markets would ordinarily find palatable.

However, as mentioned above, equity markets have by and large been focused on structural elements – the so-called “mega forces” – that can be big drivers of equity market performance.

Arguably, it is these structural “mega forces” led principally (but not exclusively) by the AI revolution that are the principal drivers of equity market performance this year, at least since the “Liberation Day” tariff announcements.

There are others: a fracturing world has buoyed defence stocks; a tendency toward “oligopolisation” / “monopolisation”, particularly in emergent tech industries (think Meta, Google, Uber, Amazon, Nvidia).

Structural forces might still be the dominant theme going forward, particularly given the paucity of official data. But an increasingly fraught macro picture that appears to indicate emergent ‘stagflation-lite’ may well yet assert itself.

RBA: flatlining or be careful what you wish for…

As was universally expected, the RBA Monetary Policy Board left the policy rate unchanged at 3.60 per cent when it met earlier in the week.

However, the tenor of the accompanying Statement, and certainly Governor Michele Bullock’s refreshingly direct media conference, very carefully sought to manage expectations to a more “neutral” footing.

That not only makes a December policy rate reduction unlikely but also that any policy rate reduction now looks to be closer to mid-2026. The caveat is the direction of the labour market: a “big miss” on employment/unemployment (sharp deterioration in the labour market) may bring reductions forward.

The Governor and the Board appeared wary of overemphasising the increase in the unemployment rate from 4.3 per cent to 4.5 per cent revealed by the September labour force report, noting that a range of other labour market indicators suggested the labour market was in a satisfactory position.

The Governor was careful to articulate the notion that the Board did not have a bias. She noted that it was an “interesting question” whether there were more policy rate reductions to come.

Further, while at pains to note that the Board was alert to risks on both sides of the RBA’s dual inflation/ labour market mandate, she indicated that in the near-term the Board were a little more focused on getting inflation back sustainably within the 2-3 per cent target band, and more specifically as close to the middle of that band as possible.

Interestingly, she noted (properly in my view) that having low and stable inflation is an important prerequisite for sustained employment growth.

As I have noted elsewhere, there is now more than a hint of “last mile” complications in getting inflation back to the middle of the target 2-3 per cent range. There are elements of those “last mile” complications over which the RBA has limited influence.

Federal and State governments have long averted their eyes from meaningful structural reform and indeed have reversed some of the progress made during the Hawke-Keating and Howard eras.

In an opinion piece (link above), I instanced recent regulatory forays into wage-setting arrangements and the industrial relations arena.

The motivation for such forays is unobjectionable: benefits such as higher wages and increased job security, etc. But those benefits might amount to nothing more than short-term palliatives that dissipate into the ether of abject productivity growth, higher inflation, higher interest rates, and do nothing to aid employment.

That those forays have produced a framework that is inimical to productivity growth is clear, and by weakening the link between productivity and nominal and real wage growth, such measures imply a risk of entrenching higher inflation in Australia.

In the long run, that framework might also increase the non-accelerating inflation rate of unemployment (NAIRU). The NAIRU is essentially a function of the current structure of the economy, which is in turn very much influenced by the prevailing regulatory regime. It follows, therefore, that by reforming the regulatory regime, governments can reduce the NAIRU.

As the Governor implied in her media conference, lowering the NAIRU is not something that is within the remit of monetary policy. Monetary policy (at least in theory) is more or less about the diminution of cyclical amplitudes. In that sense, it is about managing the inflation/unemployment trade-off around the existing NAIRU.

Labour cost growth remains elevated, at least relative to productivity, and was always consistent with upside risk to prior RBA price projections, exemplified by unit labour cost growth of around 5 per cent.

Wage increases are digestible in times of reasonable productivity growth. However, productivity growth in Australia remains abjectly poor, reflecting, inter alia, the lack of application to structural policies that enhance economic flexibility.

That the non-market sector has been responsible for the resilience in the labour market in the face of tepid private sector activity growth is well-established.

With growth in public spending set to slow, there will likely be an attendant slowdown in non-market sector employment. With private spending showing only tepid rates of growth, it is questionable whether the market sector employment is in a position to pick up any slack.

The RBA is optimistic on that front. I hope that optimism is borne out. I have my doubts.

If the cycle leads to a softening of the labour market at the same time as the NAIRU drifts higher, the RBA faces an acutely difficult “high wire” act in meeting the requirements of its dual mandate.

Will there be further rate cuts in this cycle? Maybe, even probably in my view, but multiple and proximate cuts will only occur if the labour market is much weaker than projected by the RBA (and most other forecasters).

It might be a case of “careful what you wish for”!

Bank of England; not just yet…

Unusually among the “Anglo” economies, UK inflation has surprised on the downside.

Core inflation was flat in September, up 3.5 per cent over the year from 3.6 per cent in August and compares with a consensus expectation of 3.7 per cent. Headline inflation came in at 3.8 per cent compared with an expected (by both the market and the BoE) 4.0 per cent.

However, inflation remains well north of the target 2 per cent.

And it is the case that services inflation remains elevated at 4.9 per cent while labour cost growth is close to 5 per cent.

However, the BoE may take some heart in the undershooting of the expected cyclical peak of 4 per cent that was expected to arrive in September, but, on balance, not enough heart to enact a cut at tonight’s meeting..

The September inflation report follows on from a higher-than-expected unemployment rate of 4.8 per cent in August, and that is something that will exercise the Bank.

So while a cut is unlikely, it is a reasonably close call. NAB economists’ takeaway from public statements by the nine BoE Monetary Policy Committee members is that three favour a cut, three favour a hold, and three are “swing” voters (including Governor Bailey).

Although markets priced in the probability of a reduction at last week’s meeting, the BoE narrowly decided to keep interest rates unchanged.

Stephen Miller is an Investment Strategist with GSFM. The views expressed are his own and do not consider the circumstances of any investor.