Key insights from the week that was.
With the domestic and international data calendar light, the actions and rhetoric of policymakers was the key focus for markets this week.
While the RBA’s decision to deliver a 25bp rate hike in March was widely expected, the dovish guidance in the decision statement was a surprise to markets, with the Governor opening the door for a pause potentially as soon as April by noting that the Board would be assessing “when and how much” to increase interest rate hence. This compares to only “how much” in February. Coming updates on household spending, inflation and the labour market will be crucial to the RBA’s decision making in the months ahead. The greater degree of comfort shown by the RBA over the Australian CPI as the FOMC once again asserted their concerns over US inflation hit the Australian dollar hard, AUD/USD falling below USD0.66. Australian yields also fell, the AU/US 10yr spread widening to -25bps.
It is important to recognise, however, that the RBA still has a strong tightening bias given inflation is not expected to return to 3% until mid-2025. This represents three years in which inflation is outside of the RBA’s 2-3% target band, the key reason a pause was dismissed in December. Hence, we continue to expect 25bp rate hikes in both April and May, producing a peak cash rate of 4.10% which will be held through the remainder of 2023 and followed by gradual policy easing over the course of 2024 and 2025.
On the limited data received this week, Australia’s trade surplus printed a little below expectations, down from $13.0bn in December to $11.7bn in January. The main surprise centred on a burst in transport equipment imports thanks to improved supply and ahead of Lunar New Year, up 29% in the month. While total imports rose 4.6%, the downtrend in goods imports excluding transport remains well entrenched, the 6.8% fall pointing to a softening in consumer spending in early 2023. Our Westpac Card Tracker broadly corroborates this, with a clear stalling in nominal spending activity.
In the US, FOMC Chair Powell’s appearance before both the Senate Banking Panel and the House Financial Service Committee were this week’s highlights. His comments before the Senate Banking Panel were construed by the market as hawkish, with a clear focus on inflation’s persistence following upward revisions to annual CPI and PCE inflation to December 2022 as well as stronger-than-expected readings for January. Also called out by Chair Powell was the labour market’s persistent strength and evidence of a bounce back in consumer spending as 2023 begins. For policy, the intent was clear: the FOMC will do what it takes to bring inflation back to target within a reasonable timeframe.
In his follow-up appearance before the House Committee, Chair Powell conveyed the same concerns over inflation as well as confidence in the robust health of the US economy; but on policy, he was a little more circumspect, making clear that the FOMC’s decisions are not on a pre-set path and will instead be determined by the strength of the data. While the market continues to hedge its bets between a 25bp and 50bp hike at the March meeting, arguably Chair Powell’s tone means that the payroll and CPI data to come over the next week will have to outperform to warrant the larger move.
Also evident in Chair Powell’s remarks this week was a belief that the Committee has already tightened policy and financial conditions materially, and that the full effect on the economy will come with a lag. So, as long as coming labour market and inflation data point to decelerating momentum, this cycle likely only has a few more hikes left in it before a lengthy pause to March quarter 2024. A similar state of affairs is evident in Euro Area monetary policy; while, in Canada, a pause has already commenced. For each of these markets, it is our expectation that inflation will ebb back towards target in 2023 without need for a recession. The longer-term concern is whether these nations are dynamic enough to rebound to, or above, trend growth once financial conditions ease. If not, faced with high debt burdens, their futures are likely to prove very challenging.
Though China’s 2023 growth target of ‘only’ 5% disappointed the market this week, it should have been seen as a reason for confidence. From the detail of the accompanying remarks, it is clear authorities do not see a need to pump up economic growth with aggressive public infrastructure spending. While this type of investment continues at a robust pace, it is the strength of the private sector (and efficient SOEs) that will dictate the scale of China’s outperformance, both in the near term and further out.
In our view, having shown considerable strength amid tremendous uncertainty in 2020-22, and with burgeoning export opportunities across the developing world, China’s industry has a high probability of delivering national growth outcomes well above authorities’ stated 2023 ambition. Importantly, being driven by productivity and capacity and with benefits flowing through to the Government and households, this momentum should prove sustainable and non-inflationary.
