Shane Oliver: Bushfires to scorch Australian dollar

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Bonds, not stocks or houses, are pointing to Australia’s future

Via Shane Oliver:

Introduction

The Australian bushfire season that began in September has been horrific with more than 7 million hectares of bush destroyed, more than 25 deaths, significant loss of livestock, estimates of more than a billion wildlife animals killed and more than 1800 homes destroyed. More than 200 fires are still burning. Following the intensification of the bushfires over the Christmas/New Year period attention has now turned to the impact on the economy. This note looks at the key impacts.

The short-term impact on GDP and wealth

Physical disasters invariably cause a brief disruption to economic activity as measured by GDP followed by a boost as wealth destroyed by the disaster is rebuilt. In this sense measured across a year or so they are often seen as positive for economic growth, albeit this seems perverse particularly for those directly impacted.

The damage to property and wealth flowing from the bushfires will likely run into many billions. For example, the Victorian Black Saturday bushfires are estimated to have cost $4.4bn, whereas the current fires have covered an area 15 times bigger. So there will be a very big rebuilding boost to economic activity to come once the fires are brought under control. But the fires have been very widespread, have been going on for several months now and the crisis is continuing, so there will be a significant short-term negative impact and it likely will involve more than a short-term disruption to economic activity.

  • Activity related to farming, manufacturing, transport, tourism and business generally in the affected areas will be disrupted – this will involve around 2-3% of the population and will be concentrated around the March quarter. It will also be partly offset as affected people have to undertake spending that they otherwise wouldn’t have had to.
  • A bigger impact on economic activity is likely to come via a hit to consumer spending as the constant news of the fires and the smoke haze in several capital cities weighs on confidence. Australians were already very hesitant about the economic outlook after the slowdown in growth seen last year and continuing weak wages growth and high underemployment. A Roy Morgan survey released late last year found that 40% of Australians thought that 2020 will be worse than 2019, which is the worse reading since the early 1990s recession. At the same time a record-low 12% thought it would be better resulting in a net negative reading of 28% which is the worst in the survey’s 40-year history.
Source: Roy Morgan; AMP Capital
Source: Roy Morgan; AMP Capital

This may exaggerate how bad things really are. The economy is still in far better shape than it was at the time of the early 1990s recession (I was there, I remember!). But a combination of more negative news flow today due to the rise of social media, more divisive politics and expectations rising faster than reality may be altering perceptions of the economy in a negative way and exaggerating the gloom. Nevertheless, a range of other surveys also show that consumers are uncertain and depressed, and this looks to have intensified since Christmas. The constant terrible news since October about the bushfires along with the smoke in cities is likely weighing further on the national psyche adding to weakness in consumer spending as Australians feel less motivated to spend when their fellow Australians are suffering. The hit to household spending power from higher prices for food and a likely rise in insurance premiums flowing from the fires will only accentuate this.

  • Inbound tourism is also likely to be impacted by the heavy coverage of the bushfires globally – with ridiculous maps showing much of Australia on fire (including where I am right now) – likely to adversely affect perceptions of Australia. This may be short lived (just as the positive boost from the 2000 Olympics was) but it could still last a year or so.

Taken together we expect a detraction from GDP due to the bushfires of around 0.4% starting in the December quarter but mainly impacting the March quarter before a rebuilding boost kicks in from the June quarter. Given the uncertainty, the range around this negative impact is -0.25% up to a worse case of -1% of GDP should the fires continue on a widespread basis through the rest of summer. The rebuilding boost should reverse much of this drag later in the year, but there is considerable uncertainty around this as the impact on tourism and consumer spending may linger longer.

A big proximate contributor to the severity of the bushfires is the severe drought gripping much of Australia. This has already driven a decline in agricultural production, which has been directly detracting around 0.2 percentage points from GDP growth for the last two years. Unfortunately, the Southern Oscillation Index is still in El Nino territory pointing to ongoing relatively dry conditions in eastern and top-end Australia.

Source: ABS, Australian Bureau of Meteorology, AMP Capital
Source: ABS, Australian Bureau of Meteorology, AMP Capital

More policy stimulus

With the bushfires likely to contribute to a flow of weak economic data for the next several months, questioning the RBA’s “gentle turning point” in the economy and resulting in a movement away from the achievement of the RBA’s full employment and inflation goals, the fires have only added to the pressure for more policy stimulus. We remain of the view that the RBA will cut the cash rate to 0.5% in February (with the market probability now up to 53.4% from a low of 36% before Christmas) and to 0.25% probably in March. The bushfires will push up food prices and insurance premiums but the RBA’s focus on underlying inflation will mean that it should look through this. In fact, increases in such prices will act as a tax on consumer spending power and are negative for spending and so could depress underlying inflation.

The pressure for further fiscal stimulus has also intensified. The Federal Government has already committed an additional $2bn for bushfire recovery to be spent this year and next (which is relatively small at 0.05% of GDP per year) and the NSW Government has committed another $1bn. However, the total hit to government budgets from the bushfires is likely to be much greater than this given assistance under existing disaster programs, extra expenses associated with fighting the fires and the impact of slower growth in the short term on revenue flows.

More broadly given the hit to confidence a circuit breaker is arguably needed to help boost economic growth. Monetary policy alone is unlikely to be enough. So there is a need for a broader fiscal stimulus – maybe in the form of a bring forward of the personal tax cuts, an increase in Newstart and broad based investment allowances. To have an impact it needs to be at least 0.5% of GDP (or around $10bn).

Rightly in the face of the pain caused by the bushfires the Government has relaxed the focus on achieving a budget surplus and it is now questionable as to whether it will be achieved this year and next. That is not a major problem in the relative scheme of things given the relatively good state of Australia’s public finances.

Some longer-term challenges

The bushfires pose a number of longer-term challenges.

First, increased pressure to adopt a tougher stance in reducing carbon emissions. While Australia has always had droughts and bushfires we have been warned for more than a decade now that the world and Australia is getting warmer, that increasing global greenhouse gas emissions are likely contributing to this and that in the absence of actions to reduce emissions the world will get significantly warmer with the outcome being rising sea levels and more extreme weather events – including storms, floods and droughts – with more severe bushfires an outcome of the latter.

* Number of extreme heat days each year. Source: Bureau Meteorology, RBA
* Number of extreme heat days each year. Source: Bureau Meteorology, RBA

Second, the damage inflicted by the extreme bushfires highlights the need for investors to be aware of industries and businesses that are vulnerable to climate change risk – whether it comes from the physical impact from climate change or via measures to reduce emissions.

Thirdly, the severity of the bushfires and the risk that this is the new normal will necessitate better strategies for reducing the risk to property posed by future bushfires.

Finally, in the absence of policy action the bushfires risk accentuating the decline of some regional communities particularly where key industries have been destroyed by the fires – with some taking their insurance and rebuilding elsewhere. This will only further centralise Australia in its big cities adding to all the costs that entails – notably congestion and expensive housing.

What does it mean for investors?

The likelihood of more RBA monetary easing and continuing weak economic growth in the short term will likely keep Australian bond yields down relative to global bond yields, possibly pushing them lower.

This will also keep the Australian dollar relatively soft.

So far the Australian share market appears to be looking through the short-term hit to economic growth focusing more on the rebuilding boost, but the negative impact of the bushfires risks seeing it remain a relative underperformer versus global shares.

What reconstruction? A few homes. The damage bill for lost activity will be far higher.

David Llewellyn-Smith

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

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Comments

  1. Regarding re-construction – I have a friend who works in insurance. From the insurance perspective when home owners get their house destroyed by fire often they don’t wish to re-build – at least where their destroyed house was.Too many bad memories. So many take their insurance payout and move elsewhere.

    • What happens to the land the house(s) were built on? Does it revert to bush – the capital cost being written off, or does someone else come along and build on it – the same thing as re-building? (eg: there was a landslip in Queenstown, NZ a few years back, that wiped a few houses off the map. Today, there are 10 time more dwelling on the ‘cleared’ blocks than there were back then!)

      • With the Black Saturday fires many rebuilt, but some land nothing was rebuilt due to flame zone classification of the land. In the case of Kinglake where my mum’s place is there was a road of land that was going uphill, it was all classified as flame zone which is super expensive if not impossible to build on.

        If some had permits right after fire they had to keep renewing or they expired and never allowed to rebuild again. But I think this is wrong. You should be allowed to build on any land zone classification. Just have to build to certain standards.

        If fires comes through they will wipeout everything anyway and it’s not like a fire goes that has a low BAL rating so I’ll stop burning now.

        Plus if you ask me the whole land zoning thing done in rural areas is a stitch up. When an owner of land tries to rezone it gets knocked back. They sell and council and their mates but it / rezone and make a mint.

        I’m almost certain this could happen to fire / flame zone land in future. Some of these properties were sold for $10k or so. If you were allowed to build they would be worth $100-$200k or more.

    • I agree with you, the analysis these MSM are spurting out is delusional
      I’m overseas now, no one is going to come to AUSTRALIA this year, they think they are going to be burned alive
      The BIG TV in Singapore international lounge had the bushfires on constantly
      This is big
      The analysis that they will all rebuild in H2 and really how long do you think the fight with insurance company’s will go on for
      It isn’t going to play out the way it’s being reported

      They’ll probably build bunkers when they get their money in 2 years

    • Irrespective of what people decide to do with their money, the reason there is no real boost to the economy is that every dollar that is paid out to these people is re-couped in higher premiums to punters country-wide, meaning less disposable income after insurance costs. That is how the insurance industry model works. Of course, the cost is spread out nice and thin so that it doesn’t all land on one group of people although country dwellers will feel the pinch a bit more, no doubt.

  2. This is all setting up perfectly for the year the AUDUSD falls into 50s
    *RBA cuts more than US implements QE
    *No one is expecting 50s and forecasting 70s

    We all know the rest of the reasons

    The ducks are lining up for AUDUSD with a 5 handle this year

    • You’ve traded professionally so it’s different but I would never recommend any retail guy / Joe Blow trade FX – at least not on margin, CFDs etc. It’s a surefire route to the poorhouse. Also, I think short AUD is a potential widow-maker this year. Gold has had a stellar run these past 15 months and a gold rally precedes a rally in the AUD by about 12 months – and while there is nothing to suggest history will repeat, it has happened often enough that investors should take note.

      That said, if your housing bust theory is correct the Pacific Peso will get smoked.

    • Peter & Dom
      I’m not wanting to get too fancy
      The downside is you are stuck with USD you can spend them.
      US short dated treasuries short dow gives you a long dollar
      I’m not going to short gold even though I think it’s going down, but I’m going to hedge my long gold position via 2 x inverse gold which means my long gold is hedged and I have only half the USD exposure
      The most is ever do is 2x leverage
      I don’t do derivative CFDs I have no idea not interested
      I only short when I have a very strong conviction
      My end is goal is to have equities Australian US, Gold Silver low end income property
      Don’t think I’ll ever buy a residential house I’m just going to rent so I can move around btw Gold Coast, Thailand and Melb

      I have a very strong conviction Aussie housing is going to get hosed with the AUSUSD into 50c
      Peter I’d rather own kiwi than AUD and I wasn’t that bearish equities but if I think gold is going down with Australian housing the ASX would have to get hammered
      What you are suggesting is too complicated for me
      I might be wrong and the odds are against me because everyone has lost consistently shorting Australia but don’t think the downside is very much
      I think 2020 is the big Australian Short
      I’m actually sitting by the pool in Thailand now
      32 every day, Singha Pad Thai
      Living the dream

  3. Why would the RBA “look through” a permanent rise in insurance costs?
    That should contribute to CPI and if it doesn’t then CPI is even more buggered than I thought it was.
    What it should read is: “RBA will ignore inconvenient data and get on with lowering teh rates because it needs more people to borrow their way to being wealthy”.

  4. Tathra had their fire just under 2 years ago & lost ~70 houses. A lot bought in Bega, but there were a lot rebuilt as well – pressuring trades & their prices. Talking to the town planner a couple of days ago & he was up in arms saying they still hadn’t crossed all T’s & dotted I’s on that last one yet….. & really isn’t looking forward to this huge mess – can’t comprehend it’s size or even where to start.

    There’s practically whole towns & villages wiped out this time, & there’s some doubt not only about who’s insured & who’s not, but just the viability of resuming services in some of them (ala micro Tamworths). A lot of businesses have been hanging on by the fingernails for a couple of years at least & they’re already just walking away – they have been before this! By what I hear from a couple of truckies that get around it’s pretty much been the story throughout rural Oz for some time already. Then there’s the Tourist aligned ones that needed these 2 months to make it through to next Christmas – they’ll be gone too! Then there’s the secondary suppliers etc….. The saved & untouched are truly blessed, but I can’t see how they won’t be deeply affected as peripherals either. All these area’s will need “Where the bl00dy hell are ya” on steroids.

    Your homing in on lost activity is spot on & likely permanent in a high number of cases imo.

    • Yep. Local Coastal tourism that makes all its money between Xmas and Easter … I like it, I am an enthusiastic consumer of it, and I am genuinely extremely sad because a lot of it is going bust this year. ☹️

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