Bushfires headwind for GDP, Confidence and Government

Australia, the world’s driest inhabited continent and home to fragile ecosystems like the Great Barrier Reef, is ground zero for climate change and particularly vulnerable as our planets temperature rises. Australia's climate alone has heated by greater than 1 degree Celsius since 1910, causing an increase in the frequency of extreme heat events, drought and fires. In fact, 2019 was the hottest and driest year on records dating back to 1910, according to the Bureau of Meteorology.

The current bushfire crisis will present a headwind for GDP growth in the near term for Q4/19 and Q1/20, factoring the damaging disruption to tourism, regional trade, construction activity, agricultural productivity and retail/eating out, against the backdrop of an already cautious consumer. The final impact is difficult to gauge at present but will cost the economy billions of dollars. Notwithstanding that a continued increase in frequency of extreme weather related events poses a long term risk for the economy. This at a time when the underlying economy is already sluggish and confidence has been dented. Consumption remains pressured as stagnant wages, concerns about the economic outlook and job security combined with high leverage levels amongst Australian households, sees the consumer reigning in their discretionary spend and saving more in an attempt to deleverage. The average level of household debt is just under 2x average household income, amongst the highest in the world. The labour market is also likely to deteriorate over the year ahead, further pressuring the consumption outlook. The devastating fires are also hitting confidence, which was already subdued, hard and no doubt only adds to pressure on the outlook for consumption. The ANZ Roy Morgan weekly consumer confidence index slipped to the lowest level in 4 years, as fires and thick smoke engulf Australia, leaving the air quality worse than Delhi, Mumbai and Beijing. Current views on the economic outlook subindex was the weakest read since the GFC and the future outlook hit lows unseen since 1994.

Several quarters of below trend economic growth, along with weak consumer spending , poor business conditions and a private sector in recession presents a deteriorating outlook for the labour market and employment growth. Other forward look indicators of labour market health like ANZ job ads and vacancies also point to weakness in the labour market ahead and reduced demand for labour. December’s ANZ job ads decline of 6.7% m/m and 18.8% y/y implies November’s labour force survey, which delivered an unexpected drop in the unemployment rate, was a one off and points to a potential drop in hiring ahead, indicating unemployment will rise. This whilst unemployment at 5.2% remains well above the RBA’s full employment estimate of 4.5, the level of tightness beyond which wage pressures materialise, which is likely lower if we look to international examples (e.g. US, UK, NZ). Therefore, even before accounting for the impact of the devastating bushfires, with unemployment set to remain elevated and labour market conditions to deteriorate in 2020, further stimulus will need to be injected into the Australian economy for the RBA to progress toward their full employment and inflation objectives, particularly whilst the government remain reluctant to loosen the fiscal purse strings. Even before the economic impact of the bushfires presented a headwind for GDP growth and economic activity, we expected the RBA to ease again in February and once more later in 2020. The present disruption only adds to the board’s impetus to deliver another 25bp cut in February, particularly whilst the government remain reluctant to loosen the fiscal purse strings leaving the heavy lifting to the central bank. Meaning the domestic outlook will continue to place downwards pressure on the currency and bond yields. Aussie 10-year bonds have underperformed US treasuries over the past month, but as the odds of an RBA rate cut rises Aussie 10-years should reverse relative underperformance.

The probability and impetus to increase the fiscal spend beyond bushfire relief has no doubt risen, and will continue to rise as the impact of the bushfires weighs on an already languishing economy. Scott Morrison needs to unify the country and restore faith in his leadership, which is in tatters. Unless his political legacy is to stand by and watch Australia burn whilst a grass roots movement pales at the lack of empathy and denial, he has to step up and come forward with credible climate policy and drop the surplus fixation with a fiscal package that goes beyond disaster relief and endeavours to reignite business and consumer confidence and a sustainable recovery in economic growth. We are fast approaching an inflection point where the cost of inaction on climate change is outweighing the cost of action. Australia sadly and catastrophically has likely reached that tipping point and the crisis is defining a new generation of Australians as young people are being mobilised to face the challenges and secure a future that is not hampered by the burden of climate change, ensuring the prosperity of future generations. For the Morrison government, it is likely the political and economic cost of increased extreme weather events incites change or alternatively, defines its downfall. But for policy makers across the globe, the cascading effects resulting from supply constraints like food price spikes, water security concerns and other severe disruptions induced by the increased incidence of extreme weather events will see credible climate policy debate and action in an attempt to minimise climate related risks. Food prices (UN FAO) are already rising +10% y/y and will be further impacted by the incidence of severe weather events, which will have a direct effect on public policy through levels of social unrest.

A food price spike and ensuing aggregate demand shock could be especially dangerous if there is a sustained spike that proves the tipping point for the consumer, given where we are in the cycle and that consumption has been the white knight propping up most major economies. An average household in the US dedicates about 13% of its budget to food, but in developing countries this can be well over 50%. If the price of food increases, the trade-off is a greater share of household budgets are spent on food, reducing the amount that can be spent elsewhere. This can be especially disastrous for poorer developing countries, and therefore a risk factor for EM performance.