IRAN SHOCK WILL LOCK IN THE DOWNTURN WE HAVE TO HAVE

Reserve Bank governor Michele Bullock is navigating waters made more choppy by the Iran conflict, the AI revolution and the wobbles in the private credit sector.

David Rowe

The former Reserve Bank official is best known as the local chief economist for HSBC.

But he also has a global role as chief commodities economist, giving him a close-up view of how the real-world energy shock caused by the conflict is spilling over into economic growth.

And it’s not a pretty picture.

Bloxham’s latest forecast is that Australian GDP growth will fall in the June quarter as twin shocks smash the economy: first two interest rate hikes, and then the higher cost of fuel and other oil-related products.

HSBC expects higher rates and fuel costs will knock around 1.8 percentage points off household disposable income in the June quarter, and the impact on the broader economy may be compounded by a drop in consumer confidence.

For Bloxham, the historic fall in the noisy consumer confidence survey last week, and the softness in auction clearance rates over the last fortnight, tell the story of a looming pullback by Australian households.

The government’s decision to halve the excise on fuel for the next three months is another sign of how worried it is about consumer spending rolling over.

While Australian balance sheets are fairly strong, and Barrenjoey argues momentum in the economy will stay solid for the next six months or so, Bloxham says the household sector’s reaction to the current crisis is likely to be different from the previous energy shock around Russia’s invasion of Ukraine.

Back then, household bank accounts were flush with unspent pandemic stimulus cheques; the household savings rate was a staggering 23 per cent.

Today, it’s 7 per cent, suggesting the buffers for many families look different.

HSBC’s base case is that the hit to consumption from surging energy prices more than offsets still modestly positive business investment, solid growth in public demand, and steady net exports.

The overall result is that June-quarter GDP slides into reverse.

Which prompts the obvious question: could we get two quarters of falling GDP, which is the definition of a technical recession?

It’s not Bloxham’s base case, but he says it is possible under an ugly scenario modelled by HSBC’s global economist team where oil prices spike to $US140 a barrel in the short run, as the conflict continues running through April and May, and then stay above $US100 a barrel over 2026.

A lot can happen between now and then, of course, and predicting the path of this war has become a tortured exercise.

On Monday, US President Donald Trump gave another baffling interview, this time to the Financial Times, in which he claimed his preference would be that the conflict in Iran ends with the US assuming control of Iranian oil supplies, which would seem to suggest a much broader war in which America would need to seize Iran’s oil export centre of Kharg Island.

“To be honest with you, my favourite thing is to take the oil in Iran but some stupid people back in the US say: ‘Why are you doing that?’ But they’re stupid people,” Trump said.

“Maybe we take Kharg Island, maybe we don’t.

We have a lot of options.

It would also mean we had to be there [in Kharg Island] for a while.”

Brent spiked 3 per cent in trade on futures markets to above $US116 a barrel on Trump’s comments, and is within spitting distance of the conflict high of $US119 a barrel set a few weeks ago.

But even at these levels, plenty of experts on or close to commodity trading desks doubt that oil prices in financial markets really capture the mayhem in the real world.

Prospects for a short war are dwindling

Helima Croft, a former CIA analyst who is now head of global commodity strategy at RBC, says the grim truth is that there are few quick ways to end the war.

Fresh US attacks on Iran will probably prompt the Iranians to attack Middle Eastern energy infrastructure, worsening the conflict.

Trump could pull out completely, but that wouldn’t sit well with Israel or several other Iranian neighbours, not least because it would leave Iran in complete control of the Strait of Hormuz, able to extract a heavy toll to allow ships through, and keep oil prices high to fund the rebuilding of its economy.

Meanwhile, the entry into the war of the Houthis creates further risk to supply routes in the region, while Ukraine has stepped up its attacks on Russian energy infrastructure to try and prevent Russia economically profiting from higher oil prices.

“We believe there is still considerable room to run for prices in an extended war scenario, and that the paper market is still pricing early exit options that will result in a major resumption of maritime traffic,” Croft says.

“Leading energy executives with operations in the region have indeed indicated that the delta between the physical and paper market is unsustainable and that the economic impact of an extended disruption could be calamitous.”

In other words, Bloxham and HSBC’s “ugly” scenario isn’t exactly crazy, and a recession in Australia is possible.

HSBC sees unemployment spiking from 4.3 per cent to 5.5 per cent under its ugly scenario, which underscores Bloxham’s central point: a downturn, whether engineered by RBA rate hikes, the growth shock from the war in Iran, or a combination of the two, is now locked in.

Given the numerous definitions of a recession, the label matters less than the outcome – to sustainably defeat inflation, and prevent inflation expectations becoming entrenched in the economy, the RBA is likely going to have to accept that some damage needs to be done to employment.

This time, there is no narrow path.

Rising concern about a growth shock meant another tough day for the ASX 200, which fell as much as 1.4 per cent, before recovering slightly to be down 1.2 per cent.

Asian markets also tumbled as oil prices shot higher, with Japan and Korea down about 3 per cent.

It was another tough day for those stocks most leveraged to the Australian economy – the big banks.

Westpac plunged more than 5 per cent, while Commonwealth Bank, ANZ and NAB all tumbled about 3 per cent.

While we’ve spent the past 18 months very worried about the concentration in US tech stocks, Australia’s sharemarket concentration – 10 stocks account for almost 49 per cent of the entire ASX 200 – is not proving to be a real risk to local investors.

BHP is now down 15 per cent from the start of the war, Wesfarmers is down 9 per cent, Macquarie is down 9 per cent, Goodman Group is down 14 per cent, NAB is down 14 per cent, ANZ is down 9 per cent and Westpac is now down 9 per cent.

Read more on the Middle East conflict fallout

War-driven cost surge threatens to blow out Victoria’s ‘big build’

‘It will affect everything’: This was the week the war hit home

Analysis | Jessica Gardner: Wall St plunge, bond ‘crisis’ show investors are losing faith in Trump

Opinion | Christopher Joye: Prepare for synchronised global hikes

Opinion | Tim Hext: The war has made inflation bonds the red-light special for retirees

VanEck chief executive Arian Neiron argues that overcrowding is hurting local investors, particularly passive investors who herd into the most common market-weighted index funds and super funds who, thanks to the Your Super, Your Future performance tests are similarly focused on benchmarks.

These investors, Neiron says, “are carrying more single-stock and single-sector risk than most of them realise and the current drawdown is making that visible”.

If Bloxham’s ugly scenario plays out, then the local market’s overcrowding problem could get a lot worse.