In recent weeks, we've been discussing growth in the Indo-Pacific, specifically Southeast Asia and India. We believe that growth in this area will replace the growth in demand that has traditionally been provided by China, particularly for the kinds of products that Australia exports.

In this issue I will examine some recent slides from the International Energy Agency's, World Energy Outlook report. The first slide outlines projections for world oil demand between now and 2030. Demand which is expected to reach just under 104 million barrels per day by 2030. Recently, oil demand has been growing by around a million barrels a day, but that growth has recently slowed to about 0.8 million barrels per day. Even with this slower growth, our projections suggest oil demand could reach 105 million barrels a day by 2030, indicating that the IEA estimates might be slightly conservative. Still, they still show a steady increase in demand for oil.

From 2015 to 2023, the biggest single increase in oil demand came from China, with an increase of 5 million barrels per day, followed by India, which saw growth of over 1 million barrels per day. Southeast Asia and Africa also contributed, each with increases of about 0.3 million barrels per day. Conversely, demand in Europe has decreased by about 0.9 million barrels per day, while North America has seen steady demand and Japan and Korea have experienced declines.

Looking ahead, the landscape of oil demand is changing significantly. The International Energy Agency notes that the rapid growth in oil demand in China has come to an end, largely due to the electrification of vehicles powered by a dramatic expansion of nuclear power and renewables. While oil demand in China may stabilise, there is a rapidly increasing demand in India, projected to grow by 2 million barrels a day. Southeast Asia and Africa will also experience growth, each by about 1.3 million barrels per day.

Between 2015 and 2023 the demand for liquefied natural gas (LNG) also rose. Between 2015 and 2023, the European Union saw a demand increase of over 100 billion cubic meters, followed by China with a growth of 74 billion cubic meters. India had smaller growth, while Southeast Asia's demand was flat. Japan’s demand fell.

The future looks different, with significant demand growth expected in the Indo-Pacific. From 2023 to 2025, China will still see a rise in demand of just under 50 billion cubic meters.

Indian LNG demand is projected to grow by about 54 billion cubic meters by 2035, and Southeast Asia, driven by increased manufacturing, is expected to see a rise of 104 billion cubic meters in demand by 2035. Japan is anticipated to see a decline in the demand for natural gas.

Overall, global LNG production is set to increase dramatically, from 600 billion cubic meters in 2024 to about 840 billion cubic meters by 2035. Australia, as a major LNG exporter, will play a crucial role in meeting rising demand, particularly driven by manufacturing growth in the Indo-Pacific, including in countries like Vietnam, the Philippines, and Indonesia.

Over the past couple of years, I've been very interested in that there’s been a US consensus of economists that the US was about to go into recession. The majority of market economists believed that for the previous couple of years. The reason for that was that the yield curve was inverted. Short term rates were higher than long term rates.

My argument was that even in that circumstance, you couldn't have a U.S. recession because the budget deficit was so large. There was so much stimulus being provided to the U.S. economy that it would keep growth strong. I talked about it as being “a wartime stimulus in a peacetime economy”.

Now, the rather startling result of that US budget stimulus, particularly the Inflation Reduction Act, which encourages building electric cars in the United States and spending on the energy transition and the Chips Act is that you've had an enormous explosion in expenditure on Factory building. Here's the chart shown from the Federal Reserve Economic Database showing that dramatic explosion. There are a number of different slides which are less dramatic, but I thought that this would be showing how heroic this amount of spending was.

The rise of factory building, in the scenario that I provided a couple of months ago, was supposed to top out in the second quarter of this year and then start falling. Unfortunately, it decided to continue to go up. We think that after a 31% annualized growth in this spending in the first quarter, this was followed by a 22% growth in annualised spending in the second quarter. Hopefully in the part of the chart you can't see because it hasn't happened yet, the current scenario now is that this forms a plateau. It drops from about 20% growth to about 1% growth and no growth in the final quarter, and then next year, it begins to decline.

The rate of decline of this manufacturing construction spending in 2025 is pretty significant: 24% annualised in the first quarter, 12% in the second quarter, and 12% in the third quarter and then gradually, it drips away. As that happens, the U.S. economy slows down. So, the U.S. economy in the second quarter of 2024 grew faster than we thought, 3% annualised. That should slow to 2.8% annualized in the third quarter, 1.9% annualised in the fourth quarter.

What that means is that for a full year in 2024, the annual growth rate of GDP is 2.7%, and that drops to 2.1% next year.

Well, that’s stronger growth. I thought does that knock over our forecast for cuts in the Fed Funds? So, I ran the Fed funds rate model.

Our Fed funds rate is still allowing for very significant cuts in the short term because it's not about growth. It's about the falling inflation, which is driving the Fed funds rate model down.

So, the fed funds rate currently stands at 485 basis points, which is after a 50-basis point cut. Our model says fair value is 349 basis points. That means a cut of 1.35% from where we are now. I think rates will fall at 25 basis points every meeting pretty until we reach that level near 3.50%.

We compare that to our RBA model, where the model is at 4.2% and the actual rate is 4.35%. So, there's really no prospect of rate cuts in Australia for the next couple of quarters.

For those interested in policy or prospective policy in the US election, I'll do more about this in future meetings. But there was a terrific interview, which you can find on YouTube, between Trump and John Micklethwait, who is one of the toughest guys on Bloomberg. It was interesting for me because it was for the Economic Club of Chicago. If you've been to Chicago, you've seen the Trump Tower. You'll see Trump has a significant presence in Chicago. It was an extremely interesting discussion about tariffs.

John Micklethwait took up the issue that there's a economists' consensus that inflation will be higher under Trump than under Biden Harris. That is not my view. I have written about this before. If you look at the record, when Trump was doing the exact same sort of policies that he's talking about introducing now, in his first term, the average inflation rate was 1.8%. But running the numbers this morning again, prices were up so far by 22.2% under Biden/ Harris. And the average inflation rate is 4.4%. The Biden /Harris level of inflation is two and a half times the level under Trump.  

That happens because of very large amounts of Biden/Harris deficit spending.

This is providing “A wartime stimulus in a peacetime economy”.

‍

Investment Watch is a quarterly publication produced by Morgans that delves into key insights for equity and economic strategy.

This latest publication covers

• Economics – A brighter outlook for Australian resources
• Fixed Interest Opportunities – 2024 Additions
• Asset Allocation – A decisive turn in the global rate cutting cycle
• Equity Strategy – Reweighting ASX 20 exposures
• Resources and Energy – China monetary stimulus impact
• Travel - Demand trends still solid
• Technology - Rate cuts lend support but fully valued overall
• Telco - Still seeing better value elsewhere
• Property - Nearing the peak

It has paid off to put cash to work this year with equity markets touching all-time highs and bonds benefitting from rate cut expectations. Looking ahead, the fundamentals remain supportive. The US economy is slowing but not stalling. Employment is also slowing but job losses are still minimal, while consumer spending is boosted by falling inflation. In our view, this is not the time to play defence and we continue to expect growth assets such as equities and real assets to do well. This quarter, we look at tactical opportunities on the back of a global push for policy stimulus which include: commodities, emerging market equities, and across the Australian equity market (resources, agriculture, travel and technology).

A brighter outlook for Australian resources

There has been much discussion about the slowdown in growth in China. Last year, Chinese GDP grew by 5.2%. We think growth will slow to 4.6% in 2024, just short of the official 5.0% target. However, it is still growing much faster than the United States, Japan or any major Western European economy. China has the largest steel industry in the world. This industry produces a little over half of all the steel in the world annually.  Chinese steel production indeed peaked in May 2021 at an all-time high of 99.5 million tonnes per month, and production has moved sideways since then. Yet, this still generates a very strong demand for Australian iron ore. Our model estimate for the equilibrium price of iron ore in August 2024 was $US106.42.

The standout economy is India. India will be the strongest and the most rapidly growing economy this year. In 2023, GDP grew by 7.8% and is expected to grow 6.8% this year. However, India is not the only economy producing this kind of growth and in fact this rate of growth has been produced by other countries in the Indo Pacific.  One historian has referred to these countries as the “Indosphere”.* This group of rapidly growing countries includes Vietnam, the Philippines and Indonesia. Vietnam is expected to grow by 6.0% this year and 6.4% next year. The Philippines is expected to grow by 5.7% this year and 5.9% next year. Indonesia is expected to grow by 5.7% this year and 5.1% next year.

Morgans clients receive exclusive insights such as access to our latest Investment Watch publication. Contact us today to begin your journey with Morgans.