The rubber is now starting to hit the road. Economic reality is sinking in fast. Global and local interest rates are still moving up. At the time of writing the yield on a United States 10-year bond had risen to 4.6%.
Calls for a soft landing for the global economy and immaculate disinflation are wide of the mark in my view. Inflation is not going away without real economic pain. Most of the workforce has not seen real economic pain. You need to go back decades.
Geo-strategic issues are compounding inflation pressures with oil prices going from US$70/bbl to $90/bbl. Onshoring, near-shoring and friend-shoring are replacing offshoring.
Just-in-time and efficiency are being usurped by just-in-case and resilience.
Eyes are on industrial action globally as workers demand higher wages and the return of benefits lost over the past decades.
This is not a central bank-friendly or immaculate disinflation world.
If inflation is the disease, higher-for-longer interest rates are the antidotes. The effects take time to diffuse across the economy. That argues for caution. Inflation’s persistence argues otherwise.
Central banks are seeing some progress in areas where it’s needed.
Falling business profits are being reflected in the tax take. The 2022 Budget projected corporate tax of $21.2 billion in the 2022/23 fiscal year. The unaudited actual is $18.6bn. Corporate tax is projected to fall further in 2023/24. When firms make less money, attention turns to costs.
The number of people on a benefit is 17,000 higher than a year ago, now rising by around 800 per week though most of the uplift is not coming from those who are categorised as work ready. That is an annual run rate of more than 40,000. Cue more social fracturing over the coming year, though.
Meanwhile, core inflation is still around 6%, barely budging in the past year.
Facing economic challenges, both the main political parties are backing migration. Better quality and settings will help, but the dividend from migration (growth) also carries a cost (housing, infrastructure and health pressure). The Reserve Bank cannot afford to let the housing market reflate and add to inflation pressure. You dent that with interest rates.
A complex web of cyclical and structural forces are now colliding. The playbook we have been conditioned to over the past 30 years is being challenged.
Navigating inflation presents growth and commodity price challenges. Interest rates look to be moving up not just due to monetary policy moving into a restrictive phase, but neutral interest rates (where central banks have the foot on neither the accelerator nor the brake) are moving higher too. The era of incredibly low interest rates is ending.
Geo-strategic and geo-political shifts are extensive and present both challenges (China versus the US, Russia) and opportunities (India, the Gulf Co-operation Council).
Artificial intelligence, climate change and the path to net zero, cyber security, demographic and digital transformation, rising demand for care and support services … the list of change is extensive.
I suspect we could see a major shakeout across management teams and boardrooms.
The election campaign has been notable for a lack of debate on key issues, one of which is New Zealand’s place and strategy in a rapidly evolving world. Both main political party leaders have stumbled when asked about derivatives of a changing world, including China’s place and influence.
Every exporter and importer should read the Ministry of Foreign Affairs and Trade’s report Navigating a Shifting World. NZ has benefitted from open markets, founded on a trusted, rules-based trading system. That system is being challenged on multiple levels.
Australia recently released an intergenerational report that noted: “Financial shocks, extreme weather events, the pandemic, malicious cyber activity and intensifying competition for resources such as food, water and critical minerals have further highlighted the importance of security and resilience for economic prosperity.
“Geo-strategic competition in the Indo-Pacific is rising – a major conflict would have far-reaching consequences for the Australian and global economy.
“These events require unprecedented co-ordination between domestic and foreign policy and between economic and security settings to keep Australians safe and ensure our economic strength.”
NZ has a massive point of vulnerability with energy (diesel), but an opportunity with food and water.
The government needs to play point and lead NZ’s navigation through a shifting world. I’m scratching my head thinking who the next trade or foreign affairs minister should be.
The rural community will be tested over the coming two years. Weak business models will be exposed. Good balance sheets will absorb poor balance sheets. Capital destruction is often needed to drive innovation and real change.
Do not go to banks with a problem ex post. Be on top of risks, how they will be managed, how the bank can help if risks manifest into reality, the support needed, and how they will be repaid.
This is not a cycle where central banks look set to come to borrowers’ rescue as they did in the Asian crisis and Global Financial Crisis.
There are two overarching themes to remember. First, the recent economic expansion was unsustainable, and the coming decade will require a stronger focus on earnings-sector growth, with the primary sector an important cog, and a sustained lower currency helping. A change of government will not be a game-changer; businesses will need to adapt.
Second, do not get weighed down by absolutes. Rather think about the coming years as a game of chess and our relative position in the production of food, and how we leverage nations seeking security in food supply as a point of advantage.
