Investment Matters

The Federal Budget: still on Team Australia.

The individual line items in Tuesday night’s budget did not come as much of a surprise.

A lot of the big-ticket items, including the extension of the low- and middle-income tax offset, as well as aged care and mental health subsidies, were flagged prior.

However, the government took several additional steps in the right direction.

Additions to aged care spending were welcome. However, they may struggle to cover the costs of implementing the recommendations of the recent Royal Commission.

Likewise, the removal of childcare subsidy caps and a larger 2nd child subsidy represent progress in improving the workforce participation rate.

However, we felt the circumstances of COVID and the health of our sovereign balance sheet provided the means (and political cover) for considerably more reform. There is more work to be done.

We did however welcome the death of the “debt and deficits” mantra, a political analysis never backed up by economic reality.

While ‘big government’ has been antithetical to the government’s policies, the budget in totality was an acknowledgement that the economy requires continued support.

We were encouraged that ideology and politics have not got in the way of the willingness of the government to help drive the economy. This is critical at a time where monetary policy has reached its limits.

On the bigger question of debt and deficits: regardless of where you fall (between the Austrian or MMT camp) Australia’s net debt to GDP is expected to remain under 60% at its peak.

This is a level of debt that many acknowledge is unlikely to be problematic.

While the media placed much of its focus on the quantity of spending and debt burden, it is the quality of spending and the benefits it will bring in years to come, relative to these costs, that will ultimately matter.

A big budget signals big government remains. For now.

Budget 1

Budget 2

Source: Australian Government, UBS

US CPI: are we there yet?

On Thursday night the Bureau of Labor statistics posted US CPI figures for April.

Inflation has arrived, in a big way. Headline CPI rose by 4.2% year-on-year and, more importantly, 0.8% in April alone – significantly higher than expectations.

Core CPI (which excludes volatile items such as food and energy) rose by 3% year-on-year and 0.9% in April alone.

However, the consensus is that much of this impact will be transitory.

Looking at the composition of the core figure we can see why.

The impact of supply chain issues was evident: the market for used cars jumped as semi-conductor supply constraints curbed new vehicle sales. Prices rose 10% for the month, contributing to about a third of the rise in inflation over the month.

Figures also showed that the travel sector is recovering. Airline fares increased by 10.2%, while hotel rental rates increased by 7.6%.

Stimulus cheques also continue to butt heads with supply constraints. There were very strong price increases in information technology goods (+3.6%), recreation commodities (+1.2%), and household furnishings and supplies (+0.9%)

We can see how many of these may be transient, however they may not. Another question is how ‘transient’ will ‘transient’ inflation be?

One way of answering this is by gauging the shift in expectations. To do this, we look at breakeven inflation rates (inflation implied by bond rates).

While breakeven inflation over the next year moved north by approximately a quarter of a per cent, medium- to longer-term breakeven inflation rates (5-10 years) did not move much at all.

Therefore the (albeit heavily orchestrated) bond market does not appear to be concerned.

However, equity investors are wary of the possibility that inflation may not be so transient after all.

The US market sold off by more than 2% on Thursday, with the tech-heavy NASDAQ (-2.67%) falling further than the S&P500 (-2.14%), as expected.

We continue to watch this space.