Key insights from the week that was.
In Australia this week, the material divergence between business and consumer confidence was again highlighted. First to be released, the May NAB business survey reported a moderate deterioration in conditions and confidence; however, conditions remained well above average and confidence modestly so. Notably, the strength in conditions remains broad-based across the mainland states and industry, with construction the sole exception by sector given labour and material shortages. Also of significance, forward orders continued to increase at pace in May, labour demand remained strong and capacity utilisation was reported to be at historic highs. All in all, Australia’s business sector remains in good health, and the outlook for employment and investment positive. For those keen to know more about this theme, tune in to our latest Market Outlook in conversation podcast.
Amongst Australian consumers however, confidence looks to have been lost, June’s 4.5% decline in Westpac-MI Consumer Sentiment taking it to a level it has only been at or below during major economic dislocations over the survey’s 46-year history. As detailed by Chief Economist Bill Evans this week, the June survey depicts a slump in sentiment driven by historic and rising inflation, the abrupt policy response and a general loss of confidence in the outlook.
Unsurprisingly, views on family finances are materially below long-run average levels, as is consumers’ belief in whether now is a good ‘time to buy a major household item’. Contrasting these outcomes with households’ strong expectations of the labour market emphasises job loss is not the concern, but rather anxiety over declining purchasing power. Accelerating wages growth as evinced by the NAB business survey’s labour cost measure, RBA liaison and this week’s higher-than-expected minimum wage decision will help alleviate some of this concern, but not all. At least employment should remain an enduring positive, May’s employment print coming in materially higher than expectations at a strong 61k, driving the employment to population ratio to yet another record high.
With respect to investment, risk aversion is acute, with just over 64% of consumers nominating debt repayment or capital protected investment options as the wisest place for savings – in line with the extreme high of 65.5% seen during the GFC. ‘Time to buy a dwelling’ shows a similar degree of concern around housing, the index reaching a new post-GFC low in June. While the majority of households still expect prices to rise, these expectations are cooling rapidly now that prices have begun to fall and as interest rates rise.
The other key release for Australia this week was the migration data for May. Arrivals and departures rose at a slower pace in the month to be above a third of pre-pandemic levels at 651.1k and 664.0k respectively. April’s strength in short-term visitor arrivals (up to 235k), accompanied by a 27% lift in tourism-related services exports in April’s trade account, indicates that the international border reopening is starting to have a material impact on the Australian economy. It was also promising to see temporary work and student visa applications soar in March/April, suggesting that if grants continue to flow at this pace, the pick-up in visa arrivals can play a crucial role in alleviating the issue of labour undersupply.
Moving offshore to New Zealand. GDP came in a touch below Westpac’s flat expectation for Q1, a 0.2% quarterly decline instead reported. COVID-19 disruptions were a key factor behind the result, so a rebound is expected in Q2, circa 1.0%. Furthermore, despite the Q1 result, the New Zealand economy is still running above its non-inflationary potential, requiring the RBNZ to hold to its plan to tighten policy aggressively. Our team remain of the view that a peak cash rate of 3.50% will be seen at year end. Full detail on the GDP Q1 release and outlook can be found in our New Zealand team’s bulletin.
Further afield, outcomes for the west and east were polar opposite this week. Following last Friday’s historic US CPI print of 8.6%yr – a fresh multi-decade high, driven by broad-based price pressures for energy and food related to Russia’s invasion of Ukraine as well as domestic capacity constraints – and a very weak June reading for University of Michigan consumer sentiment, financial markets took on a decidedly risk-off posture and progressively priced in a 75bp June hike by the FOMC. The Committee delivered on this expectation and also emphasised their determination to bring inflation back to target in the medium-term, upgrading their forecast for the fed funds rate at year end to 3.4%, circa 175bps higher than the June level. An initial positive response from the market was short lived, with further significant falls in US equities seen overnight.
The crux of the matter is that, while the FOMC are confident they can hike interest rates aggressively and only bring GDP growth back to trend, the market is increasingly troubled by the probability of recession. Prior to the CPI report and this week’s developments, we had anticipated US domestic demand would decelerate to trend in 2022 and below it in 2023. With the FOMC now set to be more aggressive – we now forecast a 3.375% peak fed funds rate at year end instead of 2.625% — we concur with the mood of the market, anticipating US growth will stall in 2023.
It is worth emphasising that risks are squarely against the US, with GDP having contracted in Q1 on weaker inventory accrual and imports and potentially being set for a flat result in Q2 given a marked deterioration in growth in domestic demand. In our view, the cumulative impact of declining real incomes, tight financial conditions and very soft consumer confidence risk a prolonged period of growth well below trend. While the FOMC is likely to hold to its determined position regarding inflation to end-2022, policy will then be on hold until rate cuts begin. Our best assessment of the scale and timing of these cuts is 125bps beginning Q4 2023 and running to Q4 2024. Assuming the labour market remains relatively intact in the interim, moving the fed funds rate back to a broadly neutral level should be enough to bring GDP growth back to trend by late-2024.
Over in the UK, the Bank of England are similarly determined to bring inflation to target, but also face significant risks with respect to growth. The Bank of England decided to raise the bank rate by 25bps to 1.25% in June and implement a hawkish shift in guidance, now stating they will “act forcefully” if necessary versus May’s softer agreement on “some degree of further tightening”. Their long-term view looks largely unchanged, but in the near-term the Committee now expect inflation to be higher (a peak slightly above 11% in October) and growth to contract by 0.3% in Q2. The mixed run of recent UK data makes it difficult to judge the extent to which households are feeling the pain of inflation, but nevertheless, concerns about broadening price pressures and persisting supply issues are clearly front of mind. We now expect a 50bp hike in August, followed by 25bp hikes in September and November, bringing the bank rate to 2.0% by year end.
Finally to China. In May, industrial production, fixed asset investment and retail sales all beat the market’s expectations and most improved on their April outcomes. This is despite the Shanghai lockdown remaining in full effect through the month and many other cities also being impacted by shorter-term restrictions. Also out during the past week, the May credit data showed that the above improvement in activity was not a one off, with aggregate financing now up 12% year-to-date in 2022. A broad-based acceleration in local government and business investment therefore looks to be in train; the recent reduction in borrowing costs for consumers should also help this momentum spread to residential construction, albeit with a lag.
While Shanghai’s recent experience and authorities continued strong stance against the virus will weigh on consumption near term, in coming months the testing regime is likely to be accepted as a new – hopefully temporary – normal given households desire to return to a free social and work life. As we continue to highlight, the progressive removal of domestic restrictions on activity combined with a continuation of stringent international travel restrictions and encouragement to buy Chinese made goods will not only keep Q2 growth positive but also maximise the longevity and scale of the growth cycle to come, in stark contrast to the west.
