The silent cashflow squeeze in the economy has commenced as the RBA rate hikes of 2022 are starting to crush discretionary incomes.  This process will not only continue, but is very likely to accelerate, with more RBA hikes expected, likely triggering a number of business failures (those with tight working capital cycles will be challenged) and a material recalibration of business outlooks and employment prospects whilst RBA policy remains restrictive and somewhat backward looking.

Whilst global economic data has picked up after a poor start to the year, Australian data continues to disappoint.  As Australia has a higher ‘transmission mechanism’ – the impact of interest rate rises affects our economy faster due to variable rates mortgages – this cashflow squeeze is the beginning of a material bite into our economic performance and is already causing a huge cash flow squeeze across many sectors and businesses, as bill payment times are blowing out. Ask your friends and family about their own experiences with getting bills and invoices settled and I’m sure you will find that bad and doubtful debts are climbing quickly, on top of delays in invoice settlement times that already puts pressure on businesses cashflows. The net result is a slowing in economic activity which is starting to come through the data signalling that Australia is consistently underperforming expectations.

Recent incoming domestic data is losing momentum quickly. The unemployment rate has climbed from 3.5% to 3.7% with full time employment losing 43,000 jobs in January, reversing full time job growth which has occurred in every month of 2022 except July. Part time employment did improve (this series is very volatile over time), but it is full time work that is critical to a high functioning economy.  Retail sales over the last three months have been volatile (due to November black Friday effect) but in aggregate they are slightly negative in nominal terms (i.e. negative in real terms as they should grow with inflation). Wages are accelerating at 0.8%, but far below market expectations which is encouraging for the RBA and its fight to regain control over the inflation narrative and inflation expectations. Finally, our fourth quarter GDP numbers are also weaker than expected at 0.5% versus market expectations of 0.8%.

All of these data points should be cooling RBA policy expectations, but sadly for us all, because of historical data delays and an RBA caught badly behind the curve last year, the RBA will likely continue to tighten monetary policy in response to the latest official Q4 2022 inflation data released at the end of January. This headline data print, some of which was more than three months old at the time of reporting, showed headline inflation lifting to 8.4% which was higher than the markets expectation at 7.7%. Market reactions were swift to price in further RBA rate hikes, which will not be delivered until March, April and possibly May, by which time the actual inflation experience will be very different in the economy. However, those 2023 rate hikes will deliver additional economic pain through the second half of 2023 and into 2024 due to the monetary policy lag effect.

With the RBA being caught badly offside and starting so far behind the curve (‘’no rate hikes until 2024’’), it is now forced to scramble to catch up and restore its credibility. This process will likely create absolute chaos for many of those who are in the interest rate sensitive parts of the economy and will send plenty of hard working honest folks to the wall.  Sure, the RBA can cut rates thereafter (and with inflation the Central Bank should err on the side of caution) but having completely encouraged folks into the belief they could afford to borrow money at low interest rates, only to lift rates by ~4.00% (16 times the usual 0.25% increment), the economic damage will be absolute and final for many, not to mention the economic scaring which was witnessed in many offshore economies after the GFC. Regaining ‘animal spirits’ (a term used a number of times by the RBA pre-pandemic to explain the lack of aggressive investment) will not be easy to achieve with a Central Bank chasing behind the ball at every turn. After making a huge policy error of long dated and single outcome forecasting, it is very likely the RBA has already overtightened policy enough to cause a material default cycle. Now we just need time to complete the task.

It is also important to factor in the pro-cyclic nature of banking through this process. Credit availability is more pronounced right at the moment the economy is doing best, and retreats quickly (despite higher interest rates and net interest margins) as the economy cools. For a default cycle to really take hold, two conditions are required. The price of money needs to be high (we can check that box on a relative basis), and we need time for delinquency to occur.  If the price of money jumps higher, but then falls quickly back towards the status quo then the impact is negligible. If that price stays high, the impact is profound.  By using a backward looking and infrequent quarterly data series to direct forward impacting policy in a fast-moving environment, the second condition of time is likely to occur.

The RBA will change policy with longer run implications which will now extend well into 2024.  So whilst the cashflow squeeze is silent for now, expect to hear a lot more negative news around business and employment which is now struggling under a higher cost of capital and challenged working capital cycle.  Already just this week, we have seen the public failures of craft beer group Tribe Breweries which makes brands including Stockade Brew, and Scott’s Refrigerated Logistics. No doubt there will sadly be many more to come.