The stronger than expected 1.8% March quarter GDP growth rate in Australia on top of nearly 7% growth in the second half of last year has delivered a Deep V economic recovery that has taken GDP above its pre pandemic level and Australia is one of only a few countries to have done so. It reflects a combination of better virus control and better government support measures. It also makes a nonsense of the claim that we should have just let the virus rip as countries that were far laxer in controlling it ended up with a bigger economic hit and a slower recovery. This quarter will likely see slower growth as the easy reopening gains are behind us and as the Victorian lockdown impacts. The strong economic recovery is underpinning a strong rebound in profits which is being magnified by the impact of past corporate cost controls and combined with continuing low interest rates will drive a further rise in Australian shares.

 

There were no surprises from the RBA with the key messages remaining that rate hikes are a long way off - as they are rightly determined to see 3% plus wages growth which is also a long way off, but they will review some of their other easing measures in July.

 

US non-farm payroll data showed an additional 559,000 new jobs in May. This was better than April, but was still well below the jobs growth that many expected with the recovery. There are still 7.6 million fewer jobs than before the pandemic. There is a view that on-going federal unemployment insurance top-up payments are discouraging people from job hunting. These payments are due to roll off in September. A buffer of excess savings accumulated in the past year is also likely to be playing a role. The result is a falling workforce participation rate at a time of huge jobs supply. Leisure and hospitality account for about 40% of the gap in jobs compared to pre-Covid. Education and health make up another 15% or so.

 

Wages are a big focus given latent concerns on inflation and people’s reluctance to return to work. Wages grew faster than expected in the latest data. But the year-on-year rate is still subdued at 2% growth. The composition of wage growth is distorting headline figures to a degree. We have seen a faster return in lower-paid jobs which is depressing the headline figure. Interestingly, leisure and hospitality is bucking this trend, with 8.8% wage growth. This highlights labour supply issues in the sector. The debate is whether labour supply issues will be resolved relatively quickly or whether this will seed wider spread inflation. Another point to note is that productivity is high.  

 

The US has returned to pre-Covid GDP, with far fewer workers. This clear gain in productivity reduces the importance of unit labour costs. These issues will play into the Fed’s policy deliberations. At this point most expect the Fed to start talking about tapering in the June meeting, without drawing any firm conclusions. The focus is on clear signalling to avoid a “taper tantrum” in markets.  We won’t return to the trend of long-term job growth until mid-2023 based on the current jobs growth rate. This is consistent with the Fed’s message of no rate tightening for two-to-three years. 

 

This helps explain why bond markets have so far seemed comfortable with the Fed’s stance — and the benign reaction to signals around tapering.  This is supportive for equity markets, as is the ongoing growth pulse.

  

Shares remain vulnerable to a short-term correction with possible triggers being the inflation scare, US taper talk and rising bond yields, coronavirus related setbacks and geopolitical risks. But looking through the inevitable short-term noise, the combination of improving global growth and earnings helped by more stimulus, vaccines and still low interest rates augurs well for shares over the next 12 months.

 

Australian home prices are on track to rise around 18% this year before slowing to around 5% next year, being boosted by ultra-low mortgage rates, economic recovery and FOMO, but expect a progressive slowing in the pace of gains as government home buyer incentives are cut back, fixed mortgage rates rise, macro prudential tightening kicks in and immigration remains down relative to normal.

 

Cash and bank deposits are likely to provide very poor returns, given the ultra-low cash rate of just 0.1%.