Is the spreading Coronavirus outbreak a big deal economically?

Unfortunately, the Delta strain of the coronavirus that has rapidly spread around the world and is now spreading in Sydney and some other parts of Australia is a big deal for the economy, as well as being a worry for many people from a health perspective. Australia is very vulnerable because of our low vaccination rate, though it is encouraging that this is finally picking up as supplies of the Pfizer vaccine increase. We are still about 6 months away from having a high percentage of the population vaccinated so even if State governments feel confident enough to end the current lockdowns by September, and that is now far from certain, further lockdowns later in the year are quite likely. There is light at the end of this very dark tunnel, but that is probably not until early 2022 at best.

There is a strong likelihood that both the Federal Government and the Reserve Bank will need to provide further economic support as the lockdowns severely damage many businesses and individuals. While employment has been growing very strongly this year, some businesses are closed and many people are now having hours reduced. Already there is discussion about the economy falling into another short-term recession.

While financial markets are forward-looking and have remained confident that the current problems will be largely resolved as vaccination rates increase globally, it would not surprise if share markets, currently close to all-time highs, retreated in the face of the bad news and economic fallout.

Inflation: is it a precursor to higher interest rates?

The biggest debate in financial markets in recent months has been whether the recent significant increase in US inflation is transitory or more permanent and hence a threat to the buoyant share market, given inflation is typically (but not always) bad for share prices as Central Banks historically react by raising interest rates to slow the economy.

The core US Consumer Price Index (CPI) rose by 4.5% in the year to June 2021, the highest level in almost 30 years (since November of 1991). While the US Fed didn’t officially “blink” with any changes in policy, they pulled forward the first expected interest rate hike almost an entire calendar year from 2023 to 2022.

Australian inflation remains subdued at below 2% and the Reserve Bank would like to see it higher, though because of very low wage growth there is little likelihood of a significant increase in the near term.

Research by US Bank State Street shows that in the last 50 years the average rolling 12-month return for equities during periods of rising inflation was only 5.3%, compared to 10.4% return when inflation was trending down. Inflation trending up is a risk factor for equity market returns!

My view is that recent increases in US inflation are largely due to a US economic boom coming off a low base and some product shortages e.g. cars, as the US recovers from the Covid downturn. This will most likely prove transitory but rising housing costs may keep inflation higher than is comfortable and may lead to modestly higher interest rates next year.

The bond market is assuming the inflation risk is low as longer-term bond rates peaked in March and have since declined. A 10-year US Government bond is back to around 1.3%; an Australian 10 year bond is around 1.2%.

Share markets are at new highs so there is currently little obvious concern that inflation will persist and lead Central Banks to raise interest rates soon or significantly. The reason seems to be that high debt levels mean that any substantial rise in interest rates to curb inflation would end the economic recovery so, even if US inflation is uncomfortably high for a period, a significant rise in interest rates simply won’t happen. The spread of the Delta strain of Covid-19 across the world may also lead to slower economic growth and hence less demand pressure that contributes to rising inflation.

Longer term, productivity improvements will be deflationary as we have already seen with consumer goods, like TVs and computers, though in the future the productivity gains will be more in the services sector rather than in manufacturing.

Superannuation Changes effective from 1 July 2021

The big changes effective now are:

  1. An increase in contribution caps.
  2. An increase in the Super Guarantee percentage from 9.5% to 10.0%.
  3. An extension of the eligibility age for bring-forward cap for non-concessional contributions.

Contribution Caps

Contribution caps, which limit how much money you can contribute to Superannuation, have been increased as follows:

  • the annual concessional cap has increased from $25,000 to $27,500, allowing Australians to add tax-effectively an extra $2,500 each year into their superannuation fund(s). This cap includes employer SG payments as well as any amounts you salary sacrifice or contribute and for which you claim a personal tax deduction. The changes may seem small, but Colonial FirstState estimate that for a 35-year-old full-time employee earning just over $89,000 (AWOTE May to October 2020), the SG changes could result in an extra $76,626 at retirement (age 67).
  • The annual non-concessional cap has increased from $100,000 to $110,000, or up to $330,000 in one year if you utilise the bring forward rule that allows up to 3 years of non-concessional contributions in one year for eligible persons.

Since 1 July the superannuation guarantee (SG) has increased from 9.5% to 10.0% and this will rise to 12.0% in 0.5% increments each year to 2025.

Non-Concessional Super contribution bring-forward extension receives confirmed.

Legislation to increase the eligibility age for the bring-forward rule, which may provide new contribution opportunities for persons aged 65 or 66, received Royal Assent on 22 June 2021.
Clients aged less than 67 (previously 65) at the start of this financial year e.g. on 1 July 2021 may now be able to trigger the bring-forward rule in 2021/22 or a future financial year.

There is no change to the other eligibility rules, such as the total super balance (TSB) requirements, which can also limit the ability to make non-concessional contributions (NCCs). Also, the work-test still applies for contributions made on or after the person’s 67th birthday (unless the work-test exemption is applied). This change has been law since 1 July 2020.

Annual Super & Investment Statements coming soon

The last financial year has been a good one for most investors and this will be reflected in the Statements you should receive in coming weeks. Returns on defensive assets, like cash, have remained very low so typically the more exposure you have had to growth assets, like Australian & international shares, the higher your returns for 2020/21 will have been.

Members of Colonial FirstChoice Super funds can expect their statements during August and those with a Colonial FirstChoice Investment account should receive their statements at the end of July, which is helpful if you are wishing to file a tax return soon.

Some product providers are comparatively slow to provide Statements so it may be several months before you receive a Member Statement from other Superfunds or other product providers where you have an investment.

This newsletter contains general advice. It does not take into account your individual objectives, financial situation or needs. You should consider talking to a financial adviser before making a financial decision.

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