Monthly Update – June 2022

US recession risks grow but are still not the base case

It has been a busy month in the media, with many commentators anticipating a recession in the US. Yet, there are also good reasons to dismiss this scenario.

Several factors point to a US economy that can be resilient in the face of the current interest rate tightening. These include:

  • To date, the US economy is travelling reasonably well and is weathering the worst of the fiscal contraction.
  • US household income (predominantly wages income) remains very strong, rising by 4% in real terms over the year to the March 2022 quarter. The outlook is that growth will slow in the latter half of this year. However, inflation is also expected to ease, so this will support households’ real spending power.
  • US households have substantial excess savings built up from the pandemic, as government transfer payments exceeded the ability of locked-down consumers to spend them. Consumers are now starting to dip into that kitty.
  • The US housing sector is clearly affected by rising interest rates (as in Australia), but after a decade of under-building, the rental vacancy rate is now at an all-time low. Housing will therefore likely be a drag on economic growth – but not a bust.

With the correction in the US share market, long-term value is emerging in its equity markets, including the larger US tech stocks and the broader S&P 500.

Whilst picking the bottom of any correction is a fool’s game, investors need to consider that by the end of this year inflation in the US could be falling; the FED may be pausing its interest rate increases; and continued positive growth is possible.

The headwind to the US economy is already being felt. The expectation of tighter policy has shifted up longer-term interest rates, which have battered equity markets and slowed spending growth. Sharply higher mortgage rates are impacting the housing market. 

By year’s end inflation in the US could be falling; the FED may be pausing its interest rate increases; and continued positive growth is possible.

US mortgage interest rates see substantial historical increase

Last week the US FED sped up the pace of lifting the official cash rate, with an increase of 0.75%. This resulted in the biggest one-week jump in mortgage interest rates in 35 years.

In mid-June the average new US fixed-rate mortgage was issued at an interest rate of 5.78%. This compares with twelve months ago, when the rate on the same mortgage was 2.93%. (The majority of Australian banks currently offer variable mortgage rates around the 2.8% to 3% range).

The jump in mortgage borrowing rates in the US sets the scene for Australia, where mortgage interest rates are set with reference to the overnight cash rate.

Last week the Reserve Bank of Australia surprised the market with a higher-than-expected increase in the cash rate. All major banks quickly passed on the 0.50% increase in full to variable-rate mortgages.

With the cash rate now at 0.85% and the RBA hinting this week that its target rate is 2.5%, mortgage holders in Australia will have further adjustments to accommodate.

Sources: Minack Advisors, Bloomberg, Reuters, Harvard Business Review, ASX, Top Down Charts

Kauri Wealth Management is a Fee for Service investment advisory business and as such my advice is built around ongoing personal relationships with my client base. Personalised independent advice is backed up by a breadth of industry knowledge.

I accept a limited number of new clients each year and would be happy to discuss this further with you. Please don’t hesitate to contact me.

Russell Lees
Senior Adviser
Phone: +61 439 852 963
Email: russell@kauriwealth.com.au

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