Will the yield curve curb Australian growth?

Hello and welcome to Talking Finance, I’m Alan Kohler and this week we’ve got an interesting interview with Brett King who’s the best selling author and futurist, an Australian guy based in New York and his specialty is the future of banking, so well worth listening to.   On the economy, we’ve got Sally Auld, Chief Economist at JP Morgan Australia.  On the markets, it’s Julia Lee this week, Equities Analyst at Bell Direct.  And on politics, Malcolm Farr, National Political Editor for News.com.au.

Listen to the podcast or read the full transcript below:

And now for this week’s technology interview, here’s Brett King who is an adviser to the new bank Xinja, but also he’s an Australian guy who now lives in New York, he’s started a bank in New York, writes a lot of books about the future of banking and now he’s branching further into now the future of AI and technology generally, so he calls himself a futurist.  Here’s the New York-based Australian, Brett King.  Well, Brett, you’ve written four books about banks, Bank 2.0, Bank 3.0, Bank 4.0, Breaking Banks.   I presume that means your view about what’s happening to banking has evolved over time.  Could you just bring us up to date with where your thinking is at now and what you’re advising Xinja?  

BK:  Xinja is of course a challenger bank in Oz and having started my own challenger bank in New York, Moven, back in 2011, we’ve had a fair bit of experience at it.  Those guys are doing well.  I know many of the team, so it made sense for me to advise them.  But the big shift – if you follow the sequencing, 2.0, 3.0, 4.0 – or even if we start with Bank 1.0, banking has evolved from the Medici’s in the 13^th and 14^th Century in Italy, and you follow that through today, you’ve got two main factors that are influencing how banking will change structurally and how it’ll change in relation to customers lives.  The first is this global shift from physical distribution to digital distribution, the Amazon’s, Uber’s of the world – so this shift towards anytime, anywhere, instant gratification available through e-commerce.

Then the other aspect is from a high-friction, high-touch environment, to low-friction, low-latency, expectations around banking.  If you were to sort of track that on a graph, you could see that 2.0, 3.0, 4.0 were all on that trajectory where ultimately banking just becomes a core piece of utility embedded in your world around you for when and where you need it. 

Yes, I was going to ask you about that.  I mean, what you’ve been talking about is how banking is going to become embedded and I wonder if you could expand on that, what do you mean by that?

BK:  If you think about a lot of where we go to banks for today is just to help us to get other stuff done.  We walk into a store, we pull out a card to pay, that is a bank artefact that helps us with the utility of moving money from our bank account, into the merchants' bank account so we can buy the goods or services.  When you’re shopping for home around Melbourne or Sydney and you’re looking at a place there, ultimately you will have to stop that process of buying a house at some point and go to a bank to get a mortgage and then when the bank – if the bank approves you and if you’re lucky to be their customer – then they’ll let you go back and continue to buy the house.  Whereas, in actual fact most customers don’t want to buy a mortgage, they want to buy a home and the mortgage facilitates that.  So, the least friction possible in enabling us to do these things where banks currently involve in our lives is ultimately where we end up, where a bank is there but helps you buy the home, but the best bank is one that helps you buy it when you want to buy it immediately with the least friction, same for payments, same for a bank account that coaches you, that helps you save money instead of encourages you to spend money to get reward points or cash back.  This is essentially how we see banking involving and becoming part of your life to help you when and where you need it.

I suppose from our point of view, from the subscribers and listeners’ point of view, what’s important is do you think that the current banks that people are invested in are going to be able to deal with these changes?

BK:  Well, here’s the historical precedence.  You know, if you look over the last 250 years and you look at technologies and how it’s changed industries.  We take maybe the steam machine or maybe a better example as a combustion engine.  The combustion engine comes along, it dramatically changes personal transportation, moving from a horse and cart to a motor vehicle.  That had a whole lot of flow-on effects but the guys who were invested in the horses and carts, they weren’t terribly good at making the transition to motorised automobiles. 

The same when the internet came along, the companies that today lead the world in terms of internet enabled businesses are not the leading blue chip companies that were on the stock market in the 1950s and 1960s.  Then when you look at something like the iPhone, when Apple came along with the iPhone, they were able to disrupt traditional players in the mobile space, the Nokias, the Blackberries, the Motorolas… because they thought very differently about that.  When you see technology disruption attack an industry like banking, in almost all instances over the last 250 years, the incumbents haven’t survived primarily because they don’t change their business model until they’re disrupted because that inertia around their traditional way of doing things is too hard to change. 

When do you think this disruption is going to happen?  When I look at a business like Xinja or the other disrupter banks, neo-banks that are starting up here, they’re going to be miles off taking market share, serious market share off the existing banks. 

BK:  Well, I guess it happens at different phases in different markets.  In China of course, Alipay and Tencent have already been extremely disruptive to the traditional banking space.  Starting off with payments but then moving into things like savings and credit and other things.  And so the answer is it really depends on the market.  If you’ve got a market like the US, where I am for example, the market’s heavily protected by existing regulations, so it has moved slower than in other markets.  The reason the APRA has come up with this new digital bank charter is really not a result of the fact that Australia’s a really progressive banking nation.  But a lot of nations around Australia – Hong Kong, China, Singapore – even if you go to the UK and London and the EU – had already had this type of regulatory structure for a new type of bank.

But in the UK where there’s 40 challenger banks, they have moved the needle.  Now customer’s expectations around how you should sign up for a bank account has dramatically changed.  If you’re a bank in the UK today and you say to a customer, you have to come into a branch to sign a piece of paper to open an account, they’re probably going to go to a challenger bank to open an account instead of going to that bank branch.  We’re already starting to see this happen in other areas and as a category or as a class banks are going to have to adapt.

Just finally, Brett, your website says you’re working on a new project, new book, about the impact of AI and technology on society and the heading on the section of your website says the rise of techno-socialism, what do you mean?

BK:  Well, if you look at how AI is likely to impact society, we are talking about some pretty significant structural changes in terms of labour participation.  Right now today the biggest companies in the world on the US stock market and so forth are increasingly technology led firms.  We know already why that is, the capital markets reward these companies because they produce profits at a much greater rate per employee or per dollar invested than traditional players.  This is why the capital markets reward that.  The problem with AI based companies, the next generation of industrial leaders from a capital markets perspective is that once that AI is created, it can essentially meet infinite demand without requiring additional labour force participation. 

As that happens you get these very, very profitable technology and AI-based companies, increasingly being rewarded by capital markets.  But as they increase participation in the economy, it means displacement of more and more workers.  At some point in time, people who are affected by that, just like we’ve seen what’s happened with Brexit and with Trump, there’ll be a pushback against those structural changes in the economy and the technology companies will be held to account for this and be sort of seen as the cause.  This sort of new more equitable distribution mechanism that arises out of this – and this is going to take 30-50 years.  You know, you would call it socialism in today’s terms but it’s really going to be more about the fact that these tremendous pools of wealth will be increasingly concentrated in owners of technology and artificial intelligence and not broadly distributed in the economy.

You seem to be talking about a sort of a conflict between progress and stagnation?

BK:  Well, that’s a good way to put it.  I think the political models and the economic models we have today aren’t really robust enough to transition into this world of the future.  But we are nonetheless pushing hard and fast towards this technology revolution.  That’s the other thing that history teaches us in the last 250-300 years, as we’ve seen major technologies like this come about.  We’ve never once actually sort of stepped back from the technology and said should we or shouldn’t do this.  We essentially let market forces drive the adoption of these technologies and worry about the implications later.

Thanks very much, Brett, good to talk to you.  

BK:  Thanks very much and have a great day down in Oz!

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And now for her take on the economy at the moment and in particular, the yield curve, here’s Sally Auld, the Chief Economist in Australia for JP Morgan.  Sally, what do you think of the inversion of the yield curve both here and in the US? 

SA:  That’s definitely something that is on people’s radar screens.  I think largely because there’s a decent chunk of the market who are happy to view inversion of the yield curve as an indicator that tells you that bad news is around the corner.  If we look back in time both in the US and also in Australia we do tend to find the periods of yield curve inversion usually happen before recessions or at least periods of much slower growth.  At JP Morgan, that’s on our forecast for the US and we actually think an easier combination of easier financial conditions and accommodative central bank in the US will mean that growth should be okay through the back half of the year.  But having said that, some of the recent data hasn’t been particularly constructive and our own models which try and predict the chance of a recession in the next 12 months have actually increased steadily over the last 3-4 months and are now sitting, somewhere around 45-50%.  You could probably read from all of that that we are starting to see a broader range of signals that tell us something a little bit more concerning about the outlook for growth. 

What about Australia, what’s your odds on recession here?

SA:  We don’t have a recession in our forecast and the reason for that is I think over the next 6 months we’re going to get a combination of fiscal policy shifting to expansion needs, so we should see that in the budget next week.  That’ll be quite a distinct shift, you haven’t really seen that for some time and we also think at some point later in the year the RBA will cut rates probably in the third quarter and we’ll probably get a little bit of stimulus from the lower currency as well.  The combination of those three things I think probably will be enough to put a floor on their growth and mean that the growth outlook here isn’t one of recession but more of growth somewhere at 2.5-3% next year.   

Have we seen any data this week that advances our knowledge of what’s going on?

SA:  Not really, it’s been a bit thin on the data front.  We do get some numbers later today from the ABS.  These are quarterly job vacancies, so they’re sort of a measure of how many job ads are out there and this has been one of the RBA’s favoured indicators to try to gauge where they think the labour market is headed over the next little while and they’re pointing to this indicator as one of the few indicators out there that tells them that the labour market is going to continue to do well.  I think people will be watching that number quite carefully today and if it does start to rollover which is what other leading indicators have done, then maybe they will sort of trim the RBA’s enthusiasm for the labour market as a sort of key narrative for the domestic economy.  

I suppose your reference to fiscal stimulus suggests that you think that next week’s budget will be a stimulatory one.  Afterall, it’s a pre-election budget, so yeah, hardly surprising.

SA:  Yeah, that’s right.  I mean, I think that’s the lens that we need to look at this budget through and it’s a government who are lagging in the polls, it’s also a government who finds itself with a bit more cash to play with than it probably thought it would be the case.  It’s going to allow them to present this idea that they’re sensible economic managers, they’ve prepared the budget, got it back to surplus, if not this year then probably next.  But also, because they’ve been so good at what they’ve done, they can provide a decent amount of cyclical support to thee economy at a time when most agree, it probably needs it and hence, we’ll see combination I think of either near tax cuts or existing tax cuts brought forward, possibly some cash payments to households and I would also think some decent infrastructure spending probably targeted at regional Australia.  All in all, we think that will take us to a point where fiscal policy actually starts to add to GDP.

Cash payments to households?

SA:  Yeah, potentially, there’s a little bit of chat around that.  I mean, I guess the government’s got the money to do it and depending on how quickly they can get it out there, that’s a reasonably effective way of lifting consumption which is one of the weak spots of the economy at the moment.  I think the whole issue with fiscal stimulus is really going to be a question of timing because I think what’s likely is we get the budget next week, it won’t be long after that until the government probably dissolves parliament, calls an election, then obviously we had the election campaign.  Parliament comes back and then if some of these stimulatory measures need to be legislated, then you’re at the mercy of the composition of the other house and so on and so forth.  That’s the risk with some of this fiscal stimulus is that it might all sound great on the night but in terms of thinking about when it actually hits the economy and has an impact, there might be a little bit of a delay, which probably means it doesn’t let the RBA off the hook.  

Yes.  Thanks, Sally

SA:  A pleasure, Alan.  Have a good day!

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And now for a bit of a take on what’s going on in the markets, here’s Julia Lee, equities analyst at Bell Direct.  Julia, what’s been the impact on markets of the yield curve inversion in the US?

JL:  Well, the inverted yield curve has caused a bit of volatility in terms of markets and that’s because before every recession since 1956 in the US, we’ve seen equities peaking after an inverted yield curve before the economy falling into recession 7-24 months later.  The biggest impact though has been for the banks because banks borrow at short-term rates and lend at long-term rates and if you think about an inverted yield curve it means that the short-term rate is higher than the long-term rate and that really squeezes the margins at the banks.  If you have a look over in the US at the S&P 500 sectors, the worst performing sector in mind has been the US financial sector which is down 3.4%. 

Here in Australia, for the month of March, we’ve seen stocks like ANZ down 9% and Commonwealth Bank down 5%.  If we continue to see inversion of that yield curve and continue to watch the banking stocks first because that’s where the biggest impact is. 

Yes, in fact, all the banks are down and do you think that’s entirely because of the yield curve inversion do you think, or is there other factors at work?

JL:  I think it’s mainly because of the yield curve inversion because it’s not just the Australian banks that have been impacted, but globally we’re seeing this trend and of course we’re seeing global bond markets that have been impacted and really, it started last Friday when we did see those very poor manufacturing numbers coming out of Germany, as well as the Eurozone.  If we have a look at those numbers coming out of Germany, Germany’s largest export market is the US, so it is fears that we are going to see a slowdown and a recession over in the US which is stoking these fears at the moment.  Having said that, we first saw inversion of the yield curve before the global financial crisis in December 2015 and then again in 2016 and then again in 2017.

It isn’t a cause for panic because it can be quite a bit of time before you see a recession come through in the US, but definitely investors should be a little bit cautious and see the warning signs flashing yellow but not red at the moment.   

I guess the other issue is the fact that the markets have rallied pretty strongly for the last few months and basically since Christmas Eve and so are not looking all that cheap at the moment?

JL:  I think it is time to offload some of the exposure, especially to the Australian market.  We’ve been looking at avoiding domestic cyclical exposure.  That means companies that are focused in on the Australian economy because we do see a slowing down in the economy, helped along by the weakness in the housing market, but instead focusing more on global.  The global leaders on the Australian share market will benefit from a lower Australian Dollar as well so they’ve got a benefit of being focused in on other markets so they’re growing more strongly, as well as that lower Aussie Dollar.  And I guess just being underweight the US because we have seen quite a good rally for the US market now, and instead looking at diversifying maybe geographically into markets that are even earlier part of their economic cycle.  In particular, overweight China at the moment.  The stimulus there should start to have an impact, they’re probably nearer to the bottom of the cycle rather than the peak and that’s actually been one of the best performing markets around the world in 2019 so far.

So you reckon the Chinese market’s got further to go?

JL:  I think the Chinese market is looking at putting in a base and they’re at probably the start of their economic cycle rather than the peak.  I guess some of that stimulus is something to watch and we’ll probably see a much stronger impact coming through in the second half of the year for the Chinese economy from that stimulus and then hopefully give growth a bit of a boost. 

The Chinese market’s had a huge rally this year, huge!

JL:  Yeah, it’s been absolutely huge but coming off an extremely low base.  If you think about the underperformance of the Chinese market compared to the outperformance of the US stock market over the last few years, the Chinese market’s been an extremely difficult place to be.  I mean, last year we saw it losing 25% in value, so it is coming off an extremely low base and that compares to the US stock market which has been pretty close to all time record highs.   

Great to talk, Julia, thank you.

JL:  Thanks, Alan.  Always a pleasure.

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[Parliament Audio Clip]

And now to discuss a lively week in politics, here’s Malcolm Farr, the National Political Editor of News.com.au.  Malcolm, I guess this week’s big news was Al Jazeera chucking a rock into the pond of Australian politics with its exposé of One Nation.  I suppose the question is whether it’s going to lead to a drop in One Nation’s vote and then secondly, whether that vote goes to the Coalition.  What do you think?

MF:  I think in the first question, yes it will result in a drop.  To your second question, I think the Liberals and the Prime Minister in particular are very ambitious, if not delusional, if they think the votes will then go to the Liberal Party or the National Party.  One Nation, by and large, is a vehicle for protest.  People send their votes there because they want to give the major parties a clip around the ear.  Now, if they find One Nation too odious, too silly, too shambolic to vote for, they more than likely will seek out another protest vehicle party and there’s going to be a stack of micro-parties, independents from which they can choose.

Clearly, as you say, Morrison and the Coalition are rubbing their hands together at this, they’re loving the demise or the problems of One Nation.  

MF:  Well, they are because it might solve the problem that the Prime Minister had before these revelations.  He was under pressure to put One Nation last.  Now, there’s the prospect, faint as it is, that One Nation will put itself last by offending voters.  But I don’t think things are going to be resolved that sweetly and cleanly for Prime Minister Morrison.   

The other thing that’s coming up which is also possibly good news for the Coalition is that the budget next week and the stories coming out suggest that the budget’s already going to be in surplus.  What do you think about that in terms of both boosting the Coalition’s economic management credentials but also given the money to spend?

MF:  Yes, well look, for some time now, Ministers have been saying off and on the record that the objective of the budget will be to reward tax payers for a couple of years of hard decisions in cut-backs in spending in various areas of reduction in services.  So, this is the big opportunity and what do you know, it’s just going to be announced just on the doorstep of an election.  There’s a lot of money around, corporate tax receipts are booming well past the MYEFO projections. 

As you say, there’s speculation that there might be a budget surplus in this economic statement and we won’t have to wait until next year.  We’ll see how the money is spent because whilst people think, yes that’s very nice that the national Exchequer’s been well managed.  But they still want answers on household expenses, they want answers on sluggish wage growth and they want answers on basic questions of provision of health and education services.

Do you think this sort of thing, and I guess One Nation, but more the budget is going to give the Coalition a sniff at the election?

MF:  I’ve always said, never underrate Scott Morrison.  The energy he’s putting into this, the determination and virtually the bloody-mindedness of the man on this, he is determined to win.  I know of senior figures who’ve had private chats with him who’ve come out shaking their heads and reporting that, “He still thinks he can win.” – they’re a bit bemused by it all.  But as long as Scott Morrison thinks he can win, then they are in there with a sniff and as long as they’ve got a lot of dough to throw around and particularly to placate some of those regional people who normally would vote Nat and went for the part-timers in the New South Wales State Election of the Shooters, Fishers and Farmers, then he might stand a chance.

But at the moment, whatever he might gain in North Queensland could be lost in Melbourne and Sydney, so it really is going to be a tough run and were I a betting man I would have one and sixpence I think still on Labor.

I suppose the other problem with the budget situation is that whatever money the Coalition has to spend, the Labor Party does too. 

MF:  That’s exactly right and they have certain tax measures which would even increase that pot over the medium term, so that’s absolutely true.  If Scott Morrison’s got a lot of dosh or Josh has got a lot of dosh to toss around, then so will Chris Bowen.

Yes.  Great to talk, Malcolm, thank you.

MF:  Pleasure, Alan, bye.

[Music]

And Happy Birthday Lady Gaga, who you might know from her recent film, A Star is Born, which is a remake of the 1937 classic with the same name.  If my surname was Gaga, I don’t think I’d call my child Lady, to be honest.  But anyway, she turns 33 today, younger than both my daughters!  Here’s a bit of Shallow, the headline track from the movie which is quite catchy.

[Music]

That’s all from me, have a great week.