Key insights from the week that was.
In Australia, the RBA was the focus for participants this week. Offshore, with the data calendar light, markets had time to reflect on last week’s nonfarm payrolls surprise and the responses of FOMC members.
The RBA delivered a 25bp rate hike in February, a decision that was widely expected by market participants and in line with Westpac’s view. What was more surprising, however, was the slightly hawkish shift in rhetoric since their last meeting in December. Going against the trend seen in market chatter, which has been focused on the potential for a lower peak in the cash rate or even a near-term pause, the Board instead responded to the 6.9% print for annual trimmed mean inflation in Q4 which was above their forecast of 6.5%. Coupled with the RBA’s central expectation that inflation will not reach the top of the target band until mid-2025, this result led them to take a firmer stance in their forward guidance, stating that “further increases in interest rates will be needed over the months ahead.” A full view of the RBA’s baseline forecasts and assessment of risks will be available in their February Statement on Monetary Policy (due 11:30am AEDT).
As outlined by Senior Economist Matthew Hassan in this week’s video update, these developments are consistent with Westpac’s view that the cash rate will be raised by 25bps in March and May to a peak of 3.85%. Inflation threats should then recede over the course of 2023 allowing a series of interest rate cuts to occur through 2024. This period of contractionary policy will come at a cost though, a material slowdown in economic growth, centred on the Australian consumer.
Indeed, some evidence of this weakening has begun to emerge in the retail sector, as evinced by the 0.2% decline in retail sales volumes in Q4. With annual growth now down to 1.8% from 5.5% in June, it is clear that key retail segments are feeling the effects of tighter policy and lost purchasing power owing to elevated inflation. It should be noted that broader measures of consumer spending such as the Westpac Card Tracker suggest non-retail spending has been offsetting much of the weakness in retail, meaning total consumer spending likely remained resilient into year-end.
The trade surplus meanwhile finished the year with a sizeable surplus, having printed $12.2bn in December. For Q4, the surplus widened from $29.3bn to $38.3bn, representing a substantial $9bn improvement in the trade position due to higher commodity prices and a lower import bill. Constructive for the outlook, easing restrictions in China and their mandate for outbound students to return to in-person learning are both set to support Australia’s services exports and the broader trade position this year.
This week’s big story offshore actually came to the market last Friday: January’s stellar nonfarm payrolls gain of 517k, with +71k in back revisions to the prior two months. Questions have been raised over the impact of strikes and seasonal adjustment. Still, at 356k, the average of the past three months is 3.5 times the monthly pace the FOMC believe balances demand and supply.
Intriguingly, despite strong job creation and limited supply, wage growth abruptly decelerated through the second half of 2022 into 2023, with average hourly earnings gaining around 0.3% per month over the period – a sub-4% annualised pace compared to the 5.9% peak for annual growth at March 2022. While this measure has likely been biased down by the creation of low-to-mid income jobs, the composition adjusted Employment Cost Index reported a similarly sized deceleration Q2 to Q4 2022, the annualised pace of private sector wage growth slowing from 6% to 4%.
Despite the market’s shock over the payrolls print, the policy consequences seem benign. A slew of FOMC members spoke this week and, while watchful for upside risks for inflation, their consensus expectation from December for a peak fed funds rate of 5.125% (just 50bps higher than the current level) was affirmed. Chair Powell in particular took a balanced approach to the risks, highlighting that financial conditions had tightened following the payrolls release and that the deceleration in wages growth was constructive for services inflation which, to date, has only crested while annual goods inflation more than halved.
We remain of the view that the prudent path for the FOMC would be to deliver one more 25bp hike then pause through the remainder of 2023, allowing time to assess the cumulative effect of policy on inflation and activity. An additional 25bp hike to 5.125% is certainly justifiable on risk management grounds, though the market clearly believes this would prove too much for the economy and be reversed quickly, with the move to 5.125% priced in by June but out by December. The risk we need to remain watchful over is an acceleration in demand-driven inflation. Arguably this would require wage growth to kick higher, improving household’s discretionary spending power and confidence.
The data out this week was of little significance. US consumer credit data came in materially below expectations, highlighting the effectiveness of contractionary monetary policy. But initial claims remained benign, indicating that the majority of households have robust job security. The US service PMIs (out last Friday) conflict with one another, the ISM expansionary at 55.2 but S&P Global’s measure contractionary at 46.8. An average of the two points to modest growth in the economy at the start of 2022; but the divergence between the two surveys suggests this growth is unequally distributed, with small-to-mid sized firms under pressure.
