Key insights from the week that was.
Global inflation and its consequences for real income and interest rates were (yet again) the near sole focus of market participants this week. For Australia, the lens was our own Westpac-MI consumer sentiment survey. For the world, it was the latest IMF World Economic Outlook and, of course, the September US CPI report.
Beginning in Australia, despite a smaller than expected increase in the cash rate this month by the RBA (25bps instead of 50bps), Westpac-MI Consumer Sentiment remained deeply pessimistic in October, falling 0.9% to 83.7 – a historically-weak outcome. The available split of pre and post-RBA responses highlights that consumers viewed the smaller increase by the RBA as a material positive, with sentiment amongst those surveyed after the decision almost 15% higher. Nonetheless, with Westpac still expecting the cash rate to peak at 3.60% in March 2023, it is clear that interest rates will continue to place significant pressure on consumer sentiment for an extended period, particularly their views on family finances and housing. This headwind is in addition to the loss of real discretionary spending capacity from historic inflation.
Chief Economist Bill Evans provided a detailed discussion of these themes and other salient consumer sentiment trends in his video update this week; sentiment is also a key area of discussion in Westpac Economics’ latest Market Outlook in Conversation podcast.
In contrast to those facing the consumer, conditions remain highly supportive for Australian firms, NAB’s latest business survey reports. Up 3pts to +25 in September, the strength in conditions is broadly based across states and industries. And, with capacity utilisation still at historically strong levels, activity looks to have been resilient through Q3. Business confidence did however ease in September, down 5pts to +5, to be roughly in line with the long-run average. Constructive to the inflation outlook was the gradual easing in upstream cost pressures, although they remain at very elevated levels, having reached a peak in July.
The September overseas arrivals and departures release meanwhile continued to reflect a robust recovery, with each component having posted strong seasonally adjusted gains since the June/July travel season (+31k and +36k). The key highlight though was centred on net arrivals of travellers on ‘temporary work’ visas, an estimated +19k in September and +12k in August, marking significant progress in reducing visa processing backlogs. As grants continue to flow, the return of foreign labour should, in time, go some way towards alleviating Australia’s labour supply constraints.
Turning then to the US, where CPI inflation again surprised to the upside in September as headline prices rose 0.4% and the core measure (ex food and energy) gained 0.6%. Interestingly, while above market expectations and a multiple of the FOMC’s 2.0%yr medium-term target, the underlying detail of this report differed to recent reports with similar headline outcomes that sparked market alarm. Most notably, core goods prices were flat in the month, having averaged a 0.5% gain the past five months. Food inflation meanwhile looks to have peaked, admittedly at a very high level; and, albeit with less certainty, the same could be said of shelter. In our view, the overarching messages from this report is that support for inflation from demand looks to be fading quickly and, while stubborn, supply-side factors are topping out. For the FOMC, this should be a pleasing sign, although it is too early to slow the pace of tightening.
Westpac continues to expect another 75bp hike at the November FOMC meeting followed by 50bps in December and a final 25bp move at their January/ February meeting, leaving the fed funds rate at 4.625% at peak. Given the FOMC’s recent rhetoric, and the stubbornness of supply-side pressures, it is appropriate for the market to continue pricing modest upside risk to the peak level of fed funds and, more significantly, the length of time the fed funds rate will be held at peak. As discussed in Market Outlook in Conversation, the underlying trends evident in the inflation data along with the clear loss of momentum in domestic demand and job creation give us confidence that US interest rates will move lower from 2023, with term yields to front-run 200bps of cuts in the fed funds rate through 2024 and the first half of 2025 to a more neutral 2.625% at June 2025.
Finally to the IMF’s latest WEO. Unsurprisingly, the IMF’s global growth forecasts highlighted lost momentum and downside risks. At 3.2% and 2.7% for 2022 and 2023 respectively, the IMF are still more optimistic for the current year but pessimistic on 2023 than we are (Westpac 3.0% and 3.3% respectively). Regarding 2023, our more constructive view comes as a result of a stronger showing by developing economies, particularly in Asia as a result of their easier financial conditions; ability to stimulate; global tourism’s re-opening; the region’s ongoing economic development; and, for China, a progressive exit from domestic COVID-zero restrictions. These factors should allow the region to be materially stronger in 2023 than 2022, also supporting the currencies of the region against the US dollar, with flow-on benefit for Australia’s dollar. For interested readers, WEO provides considerable detail on the impact of inflation and tighter financial conditions on the global economy as well as assessments of past high-inflation periods and the lessons for today.
